Corporate Governance

Refco and the Criminal Plea of Phillip Bennett

By Michelle Larson-Krieg

We have, to some degree, followed the claims arising out of the collapse of Refco.  It is an example of a fraud uncovered in the post-SOX era, a consequence of a more active audit committee.  Please refer to our previous posts for information on the topic.     

The latest shoe to drop was the guilty plea, as reported inThe Wall Street Journal and Bloomberg.com, of Phillip R. Bennett, the former CEO of Refco, Inc. plead guilty to 20 criminal charges including bank and securities fraud, conspiracy, money laundering, and wire fraud. Bennett entered the guilty plea a month shy of the scheduled start of a criminal trial to determine his role in an 8-year accounting scheme that cost investors more than $2.4 billion.

Bennett, a British citizen, built Refco, Inc. into one of the biggest independent U.S. futures traders. Its August 2005 initial public offering (IPO) raised $583 million. Although the company appeared successful and attracted significant investment, Bennett and others actively engaged in nearly a decade of fraud to cover up poor financial performance.

Refco’s problems began when the company extended credit to customers who experienced significant trading losses during the Asian debt crisis of the late 1990s and were unable to make payments. To hide the shortfall from auditors and investors, Refco moved more than $1 billion in debt to Refco Group Holdings Inc. In return, the Bennett-controlled holding company gave the brokerage worthless IOUs which Refco characterized as a large receivable. Under Bennett’s direction, and with the help of the Vienna-based Bawag PSK Bank and unnamed customers, Refco was able to hide the fraud for years. Indictment, United States v. Bennett, No. 05-CR-1192 (S.D.N.Y. filed Nov. 10, 2005).

The carefully constructed house of cards finally toppled in October 2005. On October 10^th, Refco announced the discovery of a $430 million receivable owed it by a Bennett-controlled entity. Further, Refco stated that its 2002 through 2005 financial statements were unreliable. Bennett was arrested on October 12^th. On October 13^th, Refco announced that it lacked sufficient liquidity to continue operations and the New York Stock Exchange (NYSE) halted trading of the stock to evaluate the company’s suitability for continued listing and trading. Order Regarding Withdrawals, Unsecured Loans or Advances from Refco Securities, LLC and Refco Clearing, LLC, Exchange Act Release No. 52606 (Oct. 13, 2006).

Refco filed for Chapter 11 bankruptcy protection on October 17th and the NYSE formally suspended trading on October 18^th after concluding its evaluation. In the aftermath, the company’s stock fell from a post-IPO high of over $30 per share to 81 cents per share and resulted in market capitalization loss of more than $1 billion.

On November 18, 2005, the New York Stock Exchange filed an application with the SEC to delist the stock. The SEC granted the application effective November 30, 2005. Refco, Inc., Order Granting Application to Strike from Listing, File No. 1-32604 (Nov. 29, 2005).

Mr. Bennett will be sentenced for the criminal charges on May 20, 2008. If federal sentencing guidelines are followed, the former CEO may spend the rest of his life in jail. Though the criminal phase is drawing to a close, Bennett still faces civil lawsuits by investors. SEC counsel filed a complaint against Bennett in the U.S. District Court for the Southern District of New York on February 19, 2008.

The primary materials discussed in this post may be found on the DU Corporate Governance website. 

Full post as published by The Race to the Bottom on March 20, 2008 (boomark / email).