By Joseph Weber and Aaron Pressman
Federal and in-house auditors are investigating whether Phillip Bennett, the ousted CEO of giant commodities trader Refco (RFX ), may have tried to conceal $430 million in trading losses by repeatedly shifting the debt among Refco affiliates and at least one outside firm, BusinessWeek Online has learned.
A source close to the probe says the debt, dating from 1997 or 1998, appears to have been moved from affiliate to affiliate like a "tennis ball" every quarter for several years. Accounting firm Grant Thornton, which took over auditing duties at Refco from defunct Arthur Andersen three years ago, said in an Oct. 11 statement that the debt was "hidden" at the end of each quarter by transfers from a company controlled by Bennett to a third-party customer account.
But to investors in the firm's August initial public offering, the debt looked as if it were an asset, when the loss should have been booked as an "uncollectible" debt, according to the person close to the probe. Investigators are also looking into whether Bennett worked with at least one other high-ranking former executive at Refco and with an outside fund firm, New Jersey-based Liberty Corner, to repeatedly hide the debt -- making Refco's financial picture look brighter than it would have otherwise.
At issue: whether an outside party was paid to provide confirmations of transactions to mislead auditors, while an insider made false journal entries about the transfers. Officials for Liberty Corner did not return calls for comment.
Repeated efforts to contact Bennett for this story were unsuccessful. A call to his home in New Jersey was not returned, and his legal counsel, Jack Weinberg, did not return calls for comment for this article.
CEO since 1998 (he joined Refco in 1981), Bennett took an open-ended leave of absence from the company this week after Refco announced it had uncovered the questionable debt. It also warned that it would have to delay its latest quarterly earnings report until it reviews all its financial statements going back to at least 2002.
After the IPO, Bennett was actually able to pay off the debt. He pledged his holdings in Refco stock to a bank in exchange for a loan that he used to pay off the obligation, having received substantial payments both from the August IPO and from the sale of a majority stake in Refco to private-equity firm Thomas H. Lee Partners in 2004, according to Securities & Exchange Commission filings. Thomas H. Lee Partners declined to comment for this article.
The origin of the bouncing debt still appears murky. However, the source close to the investigation says it appears to be related to Asian trading losses. Bennett's connection to the loss, if any, is also unclear.
Grant Thornton first started raising questions about the debt transfers earlier this month. During a routine quarterly audit, the debt popped up when the usual quarterly transfer of the loss by mistake had apparently not been made, and the auditors began to investigate. Refco said it has now called in the SEC, the Commodity Futures Trading Commission, the New York Stock Exchange, and other regulators, and is fully cooperating with them.
Refco's shares fell 11% on Oct. 11 following the new disclosures, to $13.85 a share, before trading was halted in the late afternoon. The share price had plummeted 45% on Oct. 10 in response to the initial disclosures of the management problems.
Already, investors in Refco are exploring legal action. The firm of Lerach Coughlin Stoia Geller Rudman & Robbins is seeking class-action status for a shareholder lawsuit. The world's biggest futures brokerage, which handles trillions of dollars of contracts regularly, Refco says it's cooperating fully with its own auditing firm and outside investigators, has no liquidity problems, and has the financial wherewithal to weather the storm.
Before its latest travails, Refco had gone far toward cleaning up a checkered regulatory history. In 1999, the CFTC ordered it to pay a record $7 million in fines for rules violations regarding order-taking and recordkeeping in handling customer orders in Treasury-bond futures and options conducted in 1995. Throughout the 1990s, it was cited by federal regulators for such problems as combining commodity pool-account balances improperly and failing to supervise clerks on trading floors in Chicago.
Since then, respected execs such as Refco Global Futures head Joseph Murphy were brought in to clean up its operations. With Bennett's departure, Murphy was elevated to president of Refco, while Executive Vice-President William Sexton is the new acting CEO. Sexton had planned to retire, but it now seems he'll be helping lead the firm through what could be a tough, new stretch.