Refco

Refco
Company type	Public (until 2005)
Industry	Financial services, brokerage
Predecessor	Ray E. Friedman and Co.
Founded	1969; 57 years ago in New York City, United States
Founder	Raymond Earl Friedman
Defunct	October 2005
Fate	Filed for Chapter 11 bankruptcy; assets sold to Man Financial and others
Successor	Marex Financial Limited (European division)
Headquarters	New York City, United States
Area served	United States, Europe (via European division)
Key people	Phillip R. Bennett (former CEO and Chairman), Robert Trosten (former CFO), Tone N. Grant (executive)
Products	Brokerage services for commodities and futures contracts

Refco was a financial services company headquartered in New York City, specializing mainly in brokerage services for commodities and futures contracts. Established in 1969 by Raymond Earl Friedman under the name Ray E. Friedman and Co., the firm expanded to oversee more than $4 billion across roughly 200,000 client accounts, becoming the largest brokerage on the Chicago Mercantile Exchange. At the time of its downfall in October 2005, Refco's balance sheet reflected assets and liabilities each nearing $75 billion, indicating extensive leverage.

The company went public on August 11, 2005, offering 26.5 million shares at $22 apiece. The stock closed with a gain exceeding 25%, placing the company's market valuation near $3.5 billion. Investor interest was driven by Refco’s consistent profit growth, with average annual earnings increasing by 33% over the preceding four years.

The scandal

Refco’s troubles surfaced on October 10, 2005, when CEO and Chairman Phillip R. Bennett revealed that he had hidden $430 million in non-performing loans from both auditors and investors, prompting him to take a leave of absence.

An internal investigation uncovered that Bennett had arranged for a Refco subsidiary to extend loans to a hedge fund named Liberty Corner Capital Strategy, which then funneled the funds to an offshore entity covertly owned by Bennett himself. This circular transaction concealed bad debts by presenting them as receivables from unrelated parties. It remains uncertain whether Liberty Corner's management was aware of this scheme; they subsequently considered legal action against Refco.

According to creditor filings made in April 2006, Bennett had conducted comparable undisclosed related-party transactions since 2000 involving Bawag P.S.K. Group. These actions violated financial disclosure regulations and led Refco to declare its financial statements from 2002 through mid-2005 as unreliable.

Following these disclosures, Bennett was arrested on October 12 on charges of securities fraud. Refco’s share price plummeted from above $28 to $0.80 by October 19, when trading was suspended and the company was removed from the New York Stock Exchange.

On October 17, 2005, Refco sought protection under Chapter 11 bankruptcy laws, initially reporting assets near $49 billion—potentially ranking as the fourth largest bankruptcy in U.S. history—but later revising these figures to approximately $16.5 billion in assets against $16.8 billion in liabilities. The firm announced intentions to sell its regulated futures and commodities operations to a consortium led by J.C. Flowers & Co. for roughly $768 million; however, competing offers came from Interactive Brokers and Dubai Investments. After a bankruptcy court rejected a breakup fee designed to safeguard the Flowers proposal, Man Financial acquired the business on November 10. Man Financial retained most futures operations but divested Refco’s European division to Marathon Asset Management, which relaunched it as Marex Financial Limited.

The regulatory fallout from the scandal was comparable to that of Enron, especially since Refco had completed its IPO only two months prior to the fraud’s exposure. Failures in due diligence by auditors (Grant Thornton) and IPO underwriters (Credit Suisse First Boston, Goldman Sachs, and Bank of America Corp.) severely impacted their reputations along with that of significant investor Thomas H. Lee Partners.

Class-action lawsuits were filed by shareholders against Refco, Thomas H. Lee Partners, Grant Thornton, Credit Suisse First Boston, and Goldman Sachs on October 27, 2005. By March 2006, unsecured creditors initiated legal claims against IPO underwriters alleging complicity in the fraud or breaches of fiduciary duty. Additionally, creditors sued Bawag P.S.K. Group for more than $1.3 billion in April 2006.

In April 2006, Christie's auctioned off Refco’s valuable art collection, which included pieces by artists such as Charles Ray and Andy Warhol.

On February 15, 2008, Phillip R. Bennett entered a guilty plea on 20 counts involving securities fraud and related offenses; he received a federal prison sentence of 16 years on July 3, 2008.

The $430 million in uncollectible debts

According to anonymous sources cited by The Wall Street Journal and other outlets, Bennett’s $430 million debt stemmed from losses across as many as 10 client trading accounts, including those managed by Ross Capital and hedge fund operator Victor Niederhoffer. Niederhoffer asserted that Refco assumed both assets and liabilities in his accounts under a formal contract dated October 29, 1997, which was subject to regulatory oversight. He claimed no outstanding balances existed between them and that any losses Refco absorbed were minimal compared to the $460 million receivable tied to the company's downfall. The Journal indicated that Refco either settled Niederhoffer’s debt for less than owed or incurred losses while unwinding his positions.

Ross Capital, headed by Wolfgang Flottl—whose father previously led Bawag P.S.K. Group, an Austrian bank that financed Bennett’s repayment to Refco—was also implicated. In 1999, Bawag acquired a 10% stake in Refco and held a €75 million loan when Refco collapsed. Prior to the disclosure of the concealed loan, on October 5, 2005, Bennett obtained a €350 million loan secured by his Refco shares, which he used to settle the hidden $430 million liability. Following the collapse of Refco’s stock value, Bawag initiated legal action seeking €350 million plus punitive damages, alleging nondisclosure of material facts. Austrian regulators subsequently investigated Bawag’s role.

The fraud came to light through Peter James, Refco's new controller, after Bennett failed to make a temporary debt repayment via Liberty Strategies during the preceding fiscal quarter. The firm’s chief financial officer had not identified the loan; former CFO Robert Trosten left in October 2004 with a $45 million severance undisclosed in the IPO filings and was later scrutinized for possible awareness of Bennett’s fraudulent activities. Trosten pleaded guilty to five charges in 2008. Another executive, Tone N. Grant, was convicted on five counts and sentenced to a decade in prison later that year.

$525 million in counterfeit bonds

In March 2006, U.S. prosecutors disclosed that Refco maintained offshore accounts containing up to $525 million in counterfeit bonds associated with Bawag P.S.K., an Austrian banking institution, and the hedge fund Liquid Opportunity. These two entities jointly owned six companies registered in Anguilla that held the fraudulent securities. Initially, these companies filed creditor claims amounting to $543 million during Refco’s bankruptcy proceedings but did not pursue further litigation. The withdrawal of these claims potentially advantages other creditors; however, their involvement points to ongoing criminal investigations affecting Refco, Bawag, and Liquid Opportunity.

Historical controversies

Refco had a troubled regulatory history, with over 100 enforcement actions by the Commodity Futures Trading Commission and National Futures Association since its inception. It was frequently cited as a leading broker for regulatory violations. In 2001, Refco compensated investors with $43 million after one of its brokers used falsified order tickets to clear trades.

In May 2005, Refco revealed it had received a Wells notice concerning improper short selling practices at Refco Securities, including naked short sales involving Sedona Corp. stock. The company reached a settlement with the SEC that included an injunction and a significant civil penalty, allocating $5 million for this resolution. Sedona also filed suit against Refco over these trading activities.

The scandal

The $430 million in uncollectible debts

$525 million in counterfeit bonds

Historical controversies

Further reading