So
far, Refco's troubles haven't posed a broader threat to the world's financial
markets -- a sign of how far-flung global investors today can absorb even a big
shock. Refco's financial obligations are spread across a wide range of
companies and individuals, and the firm is in a number of ways dissimilar from
a player such as Long Term Capital Management, whose troubles shook the system
in 1998 and prompted the Federal Reserve to push other firms to bail it out.
LTCM, a hedge fund, or private pool of capital, had more debt and operated in
markets that weren't as liquid. The Federal Reserve Bank of New York is watching the Refco
situation, but so far has not seen anything nearing systemic risk, said a
person familiar with the matter.
The
toll is heavy on shareholders who bought in the weeks since the firm went
public in August. The last, after-hours trade of its stock was for $7.90 a
share, down 72% in a week. Its notes due in 2012 have fallen so far they trade
for 34 cents on the dollar.
Just
Monday, Refco assured customers, lenders and investors it was in great
financial shape. Its statement came after what the company said was a $430
million cash repayment of debt held by its then-chief executive, Phillip
Bennett -- who is alleged to have accumulated that debt in secret.
On
Tuesday, Mr. Bennett was arrested on charges of securities fraud, starting a
cascade of concerns that slammed Refco's stock and bonds and crushed its
ability to borrow money to continue trading. On Thursday, the New York Stock
Exchange halted trading in Refco shares. Mr. Bennett, confined by an electronic
monitor at his New
York
apartment, couldn't be reached for comment, and his lawyer declined to comment.
While
two of Refco's business units are frozen, the company's futures-trading unit,
its flagship business, remains afloat. Exchanges in New York and Chicago have said Refco remains
able to honor its trades, but they are monitoring the firm more closely and, in
some cases, have restricted its ability to withdraw money.
Late
yesterday, possible buyers of parts or all of Refco's business emerged. Man
Group, a London hedge fund, expressed
interest, said someone familiar with the situation. Also, regulators asked Goldman
Sachs Group Inc. and other firms to buy or assume financial responsibility
for its massive futures-trading operation, said people familiar with the
matter. A person familiar with Goldman's thinking said it wasn't interested.
Executives
at J.P. Morgan Chase & Co. on Friday discussed whether the big bank
should step in to help shore up Refco, but decided against such a move because
the bank is a trading partner and could potentially wind up as a creditor, said
someone familiar with the matter.
The
approaches, made by regulators at the Chicago Mercantile Exchange and Commodity
Futures Trading Commission, may help calm fears among investors, lenders and
trading partners. Any buyer would likely be expected to guarantee deposits of
the unit and allow traders to unwind their positions. But barring a takeover,
the firm could face the prospect of filing for protection under the federal
bankruptcy code.
Refco
was formed in 1969 as Ray E. Friedman & Co., named after its founder, a Chicago dealer in meat and
grain. Soon, Refco and other firms introduced contracts linked to financial
products such as stock indexes, currencies and U.S. Treasurys, rather than
traditional products like wheat or hogs.
For
more than a century, futures contracts, which convey the right to buy or sell
an underlying item on a fixed expiration date, had been used to guard against
the financial risk of sudden price swings in natural resources. But with these
new products, traders had a new universe of opportunities to place sophisticated
bets on the economy, interest rates and other broad financial trends.
Refco
seized that market under Mr. Friedman's stepson, Thomas Dittmer, who took the
helm in the 1970s. The firm gained a reputation as a rough-and-tumble
competitor for new customers, fees and trading.
Mr.
Bennett was hired in 1981 from Chase Manhattan Bank and immediately set up a
finance and treasury subsidiary, Refco Capital Corp. In 1983, Mr. Bennett was
named chief financial officer of the overall firm.
Refco
has had a long history with regulators. In 1983, the federal CFTC levied a
then-record $525,000 fine against Mr. Dittmer and Refco for excessive
speculation in cotton, soybeans, corn and wheat. The firm also gained notoriety
for handling Hillary Clinton's livestock futures trades in the late 1970s, when
she turned a $1,000 investment into a $98,000 profit in less than a year. It
wasn't accused of wrongdoing in that episode.
In
1999, Refco agreed to pay $8 million in regulatory penalties to settle charges
that it helped manipulate customer accounts in a case involving celebrated California money manager Jay Goldinger.
Also in 1999, the CFTC ordered Refco to pay $7 million for allegedly failing to
comply with rules regarding order-taking and recordkeeping of customer orders.
In both cases Refco neither admitted nor denied wrongdoing.
Mr.
Bennett became chief executive in September 1998, about a year and a half
before the bursting of the dot-com bubble roiled markets and caused heavy
losses for some of Refco's clients. He built a reputation for tirelessness,
often arriving before 6
a.m. at
his glass-walled office overlooking Refco's trading floor in lower Manhattan. He led a string of
acquisitions of smaller firms. In regulatory filings, the firm said it handled
more than $1.2 trillion in foreign-currency trades and $13.7 trillion in U.S. Treasurys
volume in its most recent fiscal year.
It
also held $4.1 billion in funds for its core futures-trading clients, making it
one of the largest independent brokerage firms in the world. That figure is
massive in the world of futures trading, which is highly leveraged, or financed
using borrowed money, allowing users access to vast amounts of funding using
relatively little cash up front.
In
1998, Refco launched a joint venture with an Austrian bank to provide clearing
services for futures and options traded at European exchanges. The bank, Bank
fur Arbeit & Wirtschaft AG, in 1999 bought 10% of Refco. It was the source
of a loan this week to Mr. Bennett to repay the $430 million debt to Refco, according
to someone close to Refco. Officials of the Austrian bank didn't return calls
for comment.
Mr.
Bennett led the firm heavily into technology, forming joint ventures that would
allow trades to move off the people-intense exchange floors. In 2004 Refco
agreed to sell a major stake to Thomas H. Lee Partners, an investment firm in Boston. By then, Mr. Bennett
said, Refco was growing 30% annually.
The
biggest deal was taking Refco public. In August, Refco raised about $580
million through an initial offering led by Credit Suisse First Boston, Goldman
Sachs and Bank of America. Mr. Bennett maintained a 34% stake and the Lee firm
a 38% share. As the banks vetted the offering, say people close to the deal,
they noticed several hundred million dollars in debt, but auditors assured them
a hedge fund would pay it back.
On
Sept. 15, Refco threw a party for its largest customers at the Sheraton Hilton
and Towers in Chicago to celebrate the IPO.
As the crowd of several hundred ate their steak, Mr. Bennett made a jubilant
speech about the firm's prospects. "He talked about how much things had
grown and how great the company's future would be," says Josh Levy,
managing director of Tactical
Asset Management, a money manager that traded
foreign-exchange contracts through Refco.
But
a newcomer in the controller's office at Refco questioned the debt owed to
Refco, according to people familiar with the matter. That led to the discovery
of an alleged convoluted scheme involving Mr. Bennett's firm and a hedge fund
called Liberty Corner Capital Strategy LLC., which is based in Summit, N.J.. The firms moved the
debt back and forth, according to a federal complaint filed against Mr. Bennett
this week. A lawyer for Liberty Corner said it believed it was borrowing from
one Refco unit and lending to another.
Refco's
board on Friday confronted Mr. Bennett. On Monday the company said he repaid
Refco $430 million. His lawyer, Gary Naftalis, said in court that Mr. Bennett
pledged stock as collateral for a loan. His Refco stock was valued at about
$1.6 billion ahead of the debt disclosure.
Mr.
Bennett was put on indefinite leave, along with another executive. The next
night, he was arrested and charged with fraud. By the end of the week, his
stake in the firm was of uncertain value.
Confidence
in Refco quickly eroded, particularly after investor suits were filed. "I
worried that these lawsuits would ultimately cost the company billions of
dollars," says Mr. Levy. But he figured he would have months to unwind his
positions. After all, big trading firms don't vanish over night.
But
on Thursday morning, he says, he got a call at 6 a.m. from portfolio managers at his firm with
rumors that Refco might file for bankruptcy. Mr. Levy ducked in and out of Yom
Kippur services near his Brooklyn home, checking in on
news, and calling Refco executives to move millions of dollars out of his
account into a Refco competitor. He moved all the money out, he said, by
Friday.
"It
was incredible -- shocking -- how fast this came apart," he says.
"And it happened while half of Wall Street was off at Yom Kippur services,
praying for atonement."
--Robin Sidel, Peter A.
McKay and Kara Scannell contributed to this article.
