Wall Street braces for Refco fallout
Lawsuits loom, delisting sought as bankruptcy filing comes two months after broker's IPO


(Gold9472: For some reason, the name, "Refco" stands out to me in relation to 9/11, but for the life of me, I can't remember why. Anyone?)

Wednesday, October 19, 2005 Page B12

NEW YORK -- Just two months after going public in a successful share offering, commodities and futures broker Refco Inc. has crashed to earth in Wall Street's latest corporate scandal.

With its former chairman charged with fraud and its underwriters facing the threat of lawsuits, Refco announced Monday night that it was seeking bankruptcy protection and had agreed to sell its core brokerage business for $768-million (U.S.)

The debacle poses significant financial risk to leading Wall Street firms that underwrote the initial public offering, as well as the Boston-based private equity firm, Thomas H. Lee Partners LP, which bought a controlling share of Refco last year for $507-million (U.S.).

In the deal announced late Monday, a group of investors, led by J.C. Flowers & Co. LLC, hope to salvage Refco's core brokerage operations, but will first have to gain court approval. Christopher Flowers, a former Goldman Sachs Group partner who is leading the buyout, said Refco's main business operations remain viable, despite the damage to the corporate holding company.

"Those businesses are solvent and doing business normally," he told CNBC yesterday. "We have an option to buy the rest of it and we're keenly interested in seeing if we can resuscitate all of Refco's business."

In August, Refco went public with a share offering that raised $583-million (U.S.) at a price of $22 a share. Within a few weeks, the company was trading at $30.55 a share, and its chairman, Phillip Bennett, was promising glory days to come.

Then, last Monday, Refco announced Mr. Bennett was suspended over allegations of dubious related-party transactions that were not disclosed to investors.

Two days later, the U.S. Attorney for Southern Manhattan charged Mr. Bennett with securities fraud, a charge that could land him in jail for up to 20 years. On Thursday, the New York Stock Exchange halted trading in Refco stock, which had plunged 72 per cent to $7.80 (U.S.), wiping out $1-billion in market value. Yesterday, the NYSE moved to delist the company.

According to federal prosecutors, Mr. Bennett hid from investors certain related-party transactions that were used to cover up a debt of more than $430-million owed to Refco by a company controlled by Mr. Bennett. Refco entered a series of deals throughout 2004 and early 2005 that appeared to be timed to move the debt owed by Mr. Bennett off the company books for purposes of financial reporting.

The fallout from Refco's collapse is reverberating through the financial system. The Securities and Exchange Commission is investigating the collapse, and there were reports yesterday that it had broadened its inquiry to include other senior executives at the firms.

The SEC is also looking into the role of Refco auditor, Grant Thornton LLP of Chicago, which failed to report the quarterly financial deals between Refco and the related companies that led to the company's implosion.

Though its auditors did warn that Refco was lacking adequate financial controls, Grant Thornton has said it too was the victim of a fraud perpetrated by Refco, arguing that outside auditors cannot be expected to catch a well-planned, well-hidden fraud.

Investors are also suing Refco, and are expected to name the underwriters and auditor to the class actions that lawyer Melvyn Weiss said his firm, which has already filed a shareholder action against Refco, would soon add the accountants and underwriters as defendants.

"This is a monumental audit failure," he said in an interview.

Mr. Weiss said the underwriters and auditor had "due diligence" responsibilities and should have detected the questionable deals.

"It would seem to me highly suspect that they couldn't have dug deeply enough to find out that there was cooking the books going on here," he said. "For a company to blow up within two months after going public is an incredible happenstance and a real black mark on our securities markets."

The three lead underwriters were Credit Suisse Group's Credit Suisse First Boston, Goldman Sachs Group Inc. and Bank of America Corp.'s Banc of America Securities.

Despite those repercussions, Refco's core business of trading in futures and commodities appeared to be unimpaired yesterday.

David Gary, a spokesman for the Commodity Futures Trading Commission, noted Refco LLC, the division that carries on trading, was not included in the bankruptcy filing and appeared to be carrying on business as usual.

"Our people, our auditors and attorneys, are actively engaged in reconfirming that Refco LLC's customers' funds on deposit remain uncompromised and that the capital requirements for Refco LLC are being met," Mr. Gary said.

"So they still are able to trade, close accounts, transfer accounts, open accounts -- that basically has not been impacted by today's bankruptcy filing."

Refco unravels
A week after its CEO was suspended in a financial scandal, commodities broker Refco Inc. files for bankruptcy protection and agrees to be bought.

Seven days at Refco
Oct. 10: Refco announces that CEO Phillip Bennett has been put on an indefinite leave of absence after the company discovered that an investment fund Mr. Bennett controlled owed Refco $430-million (U.S.). Refco says Mr. Bennett has since repaid the money but that its earnings reports dating to 2002 will have to be revisited. The company's shares drop 45 per cent.Oct. 11: The SEC launches an inquiry into the situation at Refco.

Oct. 12: Mr. Bennett is arrested and charged by federal prosecutors with securities fraud. Bail is set at $50-million, and Mr. Bennett faces up to 20 years in prison if convicted.

Oct. 13: Refco decides to temporarily shut down one of its key units, Refco Capital Markets Ltd., because of lack of liquidity. Refco's share price is halted on the NYSE at $7.90, and the price of the company's bonds plunges.

Oct. 17: Refco files for bankruptcy and agrees to sell its regulated futures brokerage business to a group of investors led by hedge fund J.C. Flowers & Co. The deal gives the brokerage firm the choice of an all-cash payment worth about $770-million, or the option of retaining a 20-per-cent interest in the business and also receiving a cash payment.

The stock
Refco went public on Aug. 11. Its stock surged 25 per cent to more than $27 on the first day. Before the shares were suspended last week, they traded at $7.90. Shares trade over the counter yesterday at 65ยข.

The suspended CEO
The lawyer for Mr. Bennett, 57, says he will fight the criminal charges. Bennett is a U.K. native who played rugby at Cambridge. A banker -- not a trader -- by background, Mr. Bennett led Refco on a global acquisition spree that formed the biggest independent futures broker. Before joining Refco in 1981, he worked in Toronto, London and Brussels for Chase Manhattan Bank.

The allegations
A criminal complaint filed against Mr. Bennett, suspended as CEO last week, alleges he used Refco Capital Markets to hide $430-million in bad debt.

The company
Refco began trading agricultural commodities in 1969 and gradually diversified into foreign exchange, fixed- income products and asset management. It operates in 14 countries and 16 cities worldwide.

The future
Private buyout company J.C. Flowers & Co. is in talks to buy Refco's futures-commodities business, which operates through a handful of subsidiaries, for $768-million.