A crisis of confidence: how Refco veered from a Wall Street debut into bankruptcy

The dramatic implosion of the worlds biggest independent futures broker has left investors facing losses of more than $3bn and raised concerns that warning signs may have been missed.

The view of New York's Central Park from the offices of Weil, Gotshal & Manges is spectacular, particularly at this time of year. But when the board of Refco, the brokerage group, convened for an emergency meeting at the law firm's headquarters on October 6, no one was looking at the autumn leaves. All eyes were on Phillip Bennett.

The 57-year-old chief executive of Refco had been summoned to explain why he had failed to disclose a $430m debt he owed the company when it went public in August. Board members were furious. "There was a great deal of shock," says one person present at the meeting. "We were completely duped," says another.
Mr Bennett stated quietly that the $430m stemmed from bad debts run up by Refco customers in the late 1990s and which he had bought from the company. "Bennett said he thought the debts had value, so he had purchased them," says one of those present. "I am day, Mr Bennett agreed to repay me $430m immediately. But although he raised the funds to do so, it was not enough to save his job or, as it turned out, the company. Ten days later the group had filed for bankruptcy as clients and funders fled. Yesterday, Refco's futures brokerage was auctioned off and much of the rest of the group, including its prime brokerage, is expected to be liquidated. Investors face losses of more than $3bn and some clients fear they will not get all their money back.

Although the scale of the collapse is dwarfed by the likes of Enron and WorldCom, its speed was unprecedented: from flotation on the New York Stock Exchange to bankruptcy in two The implosion of the world's independent futures broker underlines how critical market confidence is for a financial services company such as Refco. And. in the febrile atmosphere following a string of scandals, how fragile.
It has also raised concerns that, in an echo of the flotation fever of the late 1990s, the prospect of quick profits is driving some companies to go public before they are ready. Some of Wall Street's leading banks, and top legal and accounting firms that advised on Refco's flotation, are nursing damaged reputations at best. At worst, they could face big claims for damages.

Legal actions have been launched against Thomas H Lee, the private equity firm that bought a majority stake in Refco last year, as well as against the lead underwriters in the initial public offering - Goldman Sachs, Credit Suisse First Boston and Bank of America - and Grant Thornton, its auditors. Also under scrutiny will be work done by Mayer, Brown, Rowe & Maw, the law firm, and accountants KPMG and PwC.
Refco revealed Mr Bennett's debts on October 10. In a press release that some Refco advisers considered opaque, the company said it had "discovered through an internal review a receivable owed to the company by an entity controlled by Phillip R. Bennett, chief executive officer and chairman of the board of directors, in the amount of approximately $430m". It added: "The company believes that the receivable was the result of the assumption by an entity controlled by Mr Bennett of certain historical obligations owed by unrelated third parties to the company, which may have been uncollectable."

Because the receivable had not been disclosed as a "related party transaction" in its financial statements, its accounts for the past four years "should no longer be relied upon", Refco said. Grant Thornton insisted on the warning because of fears that there could be further problems with Refco's financial reporting. Still, Refco was able to highlight the fact that Mr Bennett had repaid the money, leaving the company's financial position unaffected. Some of its advi—:- ^c^ieveti the market was bound to be nervous but that there was no need to panic.

One senior executive says they were aware the group could face a potential cash squeeze if nervous clients and lenders withdrew funds. "But we thought the company's liquidity was enough to withstand almost anything that could have possibly happened," he says. On October 10, that confidence appeared justified. Although Refco's shares tumbled 45 per cent, there was no net outflow of funds from the group.