Refco - The $430 Million in Bad Debts

The $430 Million in Bad Debts

Though no detailed report on Bennett's transactions has yet been made public, anonymous sources cited by the Wall Street Journal and other publications have stated that the debt stemmed from losses in as many as 10 customer trading accounts, including that of Ross Capital, and the widely reported October 27, 1997, trading losses of hedge fund manager Victor Niederhoffer. Niederhoffer said on his website in response to these news articles that Refco wanted to take over the assets in his accounts and assume all the liabilities in order to meet capital requirements, and that he and Refco signed a formal agreement to that effect on Oct. 29, 1997, in the presence of two major law firms and under the close scrutiny of regulators. "There were no debts, loans, or any other financial obligations left open between us," Niederhoffer said. "Refco received considerable assets from us as part of our agreement. I don't know how much money Refco received for these assets, or how it accounted for the transaction, or whether it ended up with a profit or loss. If Refco did suffer a loss, I am confident that it was quite minimal relative to the $460 million receivable said to have been a key link in the firm’s debacle, or to the actual sums that the principals and key players of the firm took out many years later." The story in the Journal implies that Refco settled Niederhoffer's debt for positions that were worth less than he owed them, or perhaps that they accrued trading losses unwinding those positions.

Ross Capital has also been named by the Wall Street Journal's anonymous sources as one of the firms with losses that somehow led to Bennett's $430 million debt. Ross Capital is run by Wolfgang Flottl, whose father used to run Bawag P.S.K. Group, an Austrian bank that lent Bennett the money to repay Refco. In 1999, Bawag purchased 10% of Refco in a private transaction, and had an outstanding loan of 75 million euros to Refco at the time the firm collapsed. On October 5, before news of the hidden loan was made public, Phillip Bennett applied for a 350 million euro loan, to be collateralized with his shares in Refco. The loan was granted on October 10, and Bennett used it to pay off the hidden $430 million. The Refco stock that collateralized the loan is now worthless, and on November 16, Bawag joined the line of people suing Refco, demanding 350 million euros plus punitive damages in compensation for the company's failure to disclose information that would have discouraged Bawag from lending the money to Bennett. The Austrian National Bank and Financial Market Authority were investigating Bawag's involvement with Refco.

The apparent fraud was caught by Peter James, Refco's newly hired controller. Apparently, in the fiscal quarter before the story broke, Bennett failed to execute his temporary Liberty Strategies-hidden repayment of debt. This left the position on the books for James to find. It is unclear why the firm's Chief Financial Officer had not spotted the loan, but the firm's previous CFO, Robert Trosten, left Refco in October, 2004 with a $45 million payout that was not disclosed in the firm's IPO prospectus. He was under investigation by regulators who suspected he may have known something about Bennett's malfeasance. Robert C.Trosten pleaded guilty to five charges in 2008. Tone N. Grant, a Refco official, was convicted of 5 charges on April 17, 2008. He was sentenced to 10 years on August 8, 2008.