BEW YORK (Bloomberg) -- Refco Capital Markets Ltd. operated a "Ponzi scheme," using money invested by customers to buy companies and pay expenses, a lawyer representing customers owed $1.7 billion said at a bankruptcy hearing.

"The evidence will show that this not a legitimate company. This is a Ponzi scheme," Thomas Moloney, the customer group's lawyer, told US Bankruptcy Judge Robert Drain in New York.

Moloney made the comment at the first day of hearings on the group's request that Drain liquidate the company immediately and return cash and securities held by Refco Capital to the customers. A second group of customers, the parent company Refco Inc. and a committee of unsecured creditors oppose the request. About 125 people crowded into the courtroom for today's hearing.

Drain's decision will affect how much customers owed $4.2 billion will recover in Refco Capital's bankruptcy case. The key issue is whether the company operated as a stockbroker. Bankruptcy law requires that stockbrokers return customer assets through liquidation. The bankruptcy is now a reorganisation, allowing the debtor to keep operating.

In a Ponzi scheme, people are promised high returns on their investments, with the money coming from new investors. The scheme is named for Charles Ponzi, who cost investors millions of dollars in the 1920s.

Executives of VR Global Partners LP, which is owed more than $700 million, and RB Securities Ltd. will testify on behalf of the customer group today, said Moloney, of Cleary Godttlieb Steen & Hamilton in New York

"We obviously oppose" liquidation, Anthony Clark, a lawyer representing Refco Capital, told the judge. "It wasn't a stockbroker. The suggestion is hogwash."

Clark said Moloney's suggestion that Refco Capital operated as a Ponzi scheme "was hyperbole".

"A minority of the clients of RCM are trying to step ahead of the majority and get paid first," Clark said. "Nothing compels such an unfair result."

Clark said liquidating RCM would "only lead to wasteful litigation between" creditors and significantly reduce their recovery.

"None of these clients thought they were dealing with Charles Schwab," Clark said, referring to Moloney's assertion that the company is a stockbroker.

Refco Capital Markets, its parent and 22 affiliates filed the 15th-biggest bankruptcy in US history on October 17, with creditors owed $16.8 billion. The company disclosed earlier that month that former chief executive officer Phillip Bennett concealed debt and that its financial statements since 2002 couldn't be relied upon.