Can Refco Get Off the Ropes?

With its former CEO charged in a securities fraud scheme and its stock price in free fall, some investors and analysts have their doubts

By Joseph Weber and Aaron Pressman

The reign of Phillip R. Bennett as CEO of commodities titan Refco (RFX ) has ended with a lightning bolt that has rattled the commodities markets and could threaten the firm's future, some analysts say. On Oct. 12, federal prosecutors accused Bennett of a massive securities fraud, charging him with a scheme to hide a debt of as much as $545 million that he allegedly tried to keep secret from investors in the lead-up to an August initial public offering.

Refco's board asked the Cambridge-educated Briton who joined the company 24 years ago and had headed it since 1998 to leave earlier in the week. Now, Refco is struggling to contain the damage to its stock price and reputation in the futures trading world.

At issue: a series of transactions over several years in which the debt was switched among largely unregulated Refco operations as well as a New Jersey-based hedge fund and a company Bennett controlled separately (see BW Online, 10/12/05, "Following Refco's Bouncing Debt"). Auditors believe the losses originated in Asian trading dating back to 1998 or earlier, but details are still murky.


  At an Oct. 12 press conference, Michael J. Garcia, U.S. Attorney for the Southern District of New York, said auditors had labored around the clock since the accounting irregularity came to light on Columbus Day, and the federal probe is continuing. The irregularity was first uncovered by Refco's accounting firm, Grant Thornton, and Refco says it is cooperating fully with investigators from the Securities & Exchange Commission and other authorities, while conducting its own internal review.

Much remains unknown about the details of Bennett's alleged maneuvers. The six-page federal complaint, hastily filed on Oct. 12 after Bennett was arrested, is limited to dealings dating back to 2004. It says the dealings led Refco to file a "false and fraudulent" registration statement for its August, 2005, initial public offering, which raised $583 million.

The complaint claims that Bennett sought to disguise the "related-party nature" of the debt, which was owed to Refco, by transferring it between Refco Group Holdings Inc., a private company he controlled, and an unidentified Refco customer. A person close to the investigation has told BusinessWeek Online that Bennett dealt with Liberty Corner hedge fund in Summit, N.J., though officials there did not return calls for comment. Liberty Corner hasn't been charged in the case.

Repeated efforts to contact Bennett for this story were unsuccessful. A call to his home in New Jersey wasn't returned, and his legal counsel, Jack Weinberg, didn't return calls for comment for this article. U.S. Attorney Garcia said Bennett was arrested Tuesday night, Oct. 11.


  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. 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. Federal prosecutors contend that Bennett intended to keep the asset hidden from auditors, regulators, and investors.

More bad news for Refco could follow. Investigators are also looking into whether Bennett worked with at least one other high-ranking former executive at Refco, along with Liberty Corner, sources say. In addition to Bennett, Refco's board also asked a colleague of his at the firm -- brokerage Chief Executive Santo C. Maggio -- to take a leave. Efforts to reach Maggio for this story were unsuccessful.

Investigators are exploring whether the repeated transfer of the massive debt from ledger to ledger was meant to make Refco's financial picture look brighter than it actually was before Refco's August IPO. They're also probing whether the company paid an outside party to provide confirmations of transactions to mislead auditors and whether an insider made false journal entries about the transfers.


  Auditors say the debt that Bennett allegedly hid should have been carried as an "uncollectible" debt on company books, although Bennet had promised the unidentified customer he would pay it, according to the federal complaint. As CEO, he signed a letter of guaranty to the customer involved, pledging that if his separate company, Refco Global Holdings, defaulted on it, giant Refco would make the customer whole, according to the complaint.

Bennett paid off the debt to Refco by Oct. 10, according to the company, but was able to do so only by pledging stock in Refco that was created in the public offering. He borrowed the money from a bank to make the payoff, according to a source close to the probe. Bennett 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 SEC filings. Thomas H. Lee Partners declined to comment for this article.

Analysts are warily watching any fallout for Refco. Its share price fell $3 on Oct. 12, to close at $10.85, following the filing of federal charges. That's down 62% from its close of $28.56 on Oct. 7, before disclosures of the scandal first surfaced early. Standard & Poor's debt analyst Thomas Foley cautions "there's a fair chance" a rival could sweep in to buy out the firm, should its stock price continue to slide.


  The key will be whether Refco's customers, largely banks, hedge funds, and other institutional customers, decide to stick with the outfit or cut off their dealings. And that may turn on what further actions follow from the regulatory probes.

Although Refco declined to make its executives available to comment for this story, it says it has the wherewithal to weather the storm, having now shaken up the management team and pledged full cooperation. Its capital position remains strong, Refco says. Already, though, investors who have watched the stock price drop are exploring legal action. The firm of Lerach Coughlin Stoia Geller Rudman & Robbins is seeking class-action status for a shareholder lawsuit.

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 J. 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 M. 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 very challenging era.

Weber is BusinessWeek's Chicago bureau chief, and Pressman is a BW correspondent in Boston

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