Refco was a New York-based financial services company, primarily known as a broker of commodities and futures contracts. It was founded in 1969 as "Ray E. Friedman and Co." Prior to its collapse in October, 2005, the firm had over $4 billion in approximately 200,000 customer accounts, and it was the largest broker on the Chicago Mercantile Exchange. The firm's balance sheet at the time of the collapse showed about $75 billion in assets and a roughly equal amount in liabilities. Though these filings have since been disowned by the company, they are probably roughly accurate in showing the firm's level of leverage.
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Refco was a New York-based financial services company, primarily known as a broker of commodities and futures contracts. It was founded in 1969 as "Ray E. Friedman and Co." Prior to its collapse in October, 2005, the firm had over $4 billion in approximately 200,000 customer accounts, and it was the largest broker on the Chicago Mercantile Exchange. The firm's balance sheet at the time of the collapse showed about $75 billion in assets and a roughly equal amount in liabilities. Though these filings have since been disowned by the company, they are probably roughly accurate in showing the firm's level of leverage.
Refco became a public company on August 11, 2005 with the sale of 26.5 million shares to the public at $22. It closed the day over 25% higher than that, valuing the entire company at about $3.5 billion. Investors had been attracted to Refco's history of profit growth -- it had reported 33% average annual gains in earnings over the four years prior to its initial public offering.
The Scandal
Refco, Inc. entered crisis on Monday, October 10, 2005 when it announced that its chief executive officer and chairman, Phillip R. Bennett had hidden $430 million in bad debts from the company's auditors and investors, and had agreed to take a leave of absence.
Refco said that through an internal review over the preceding weekend it discovered a receivable owed to the company by an unnamed entity that turned out to be controlled by Mr. Bennett, in the amount of approximately US$430 million. Apparently, Bennett had been buying bad debts from Refco in order to prevent the company from needing to write them off, and was paying for the bad loans with money borrowed by Refco itself. Between 2002 and 2005,"Refco's Creditors Sue Austrian Bank," Wall Street Journal, April 26, 2006, page C5 he arranged at the end of every quarter for a Refco subsidiary to lend money to a hedge fund called Liberty Corner Capital Strategy, which then lent the money to Refco Group Holdings. Bennett's company then paid the money back to Refco, leaving Liberty as the apparent borrower when financial statements were prepared. It is not yet clear if Liberty knew it was hiding scam transactions; management of the fund has claimed that they believed it was borrowing from one Refco subsidiary and lending to another Refco sub, and not lending to an entity that Mr. Bennett secretly controlled. On October 20, they announced plans to sue Refco.
In April 2006, papers filed by creditors of Refco seemed to show that Bennett had run a similar scam going back at least to 2000, using Bawag P.S.K. Group in the place of Liberty Corner Capital Strategy.
The law requires that such financial connections between corporation and its own top officers be shown as what is known as a related party transaction in various financial statements. As a result, Refco said, "its financial statements, as of, and for the periods ended, Feb. 28, 2002, Feb. 28, 2003, Feb. 28, 2004, Feb. 28, 2005, and May 31, 2005, taken as a whole, for each of Refco Inc., Refco Group Ltd. LLC and Refco Finance Inc. should no longer be relied upon."
