Those of us who have been following the Refco case are familiar with the allegations that have brought the big securities trader to its knees in bankruptcy — Refco’s former CEO, Phillip R. Bennett, hid ties to the bad debt to improve Refco’s balance sheet and mislead investors. The theory of the case against Mr. Bennett is that he assumed about $430 million in bad debts of Refco — some of which arose years ago — that let Refco avoid reducing net income and wiping out nearly all of the company’s profits for the past three years. The alleged purpose of hiding the losses was to facilitate Refco’s recent IPO and an earlier deal in which Thomas H. Lee Partners LP acquired a controlling interest in Refco. For his part, Mr. Bennett has denied wrongdoing, and his lawyer has said that his client will fight the charges.
Despite the superficial allure of criminal charges against crafty businessmen, I remain skeptical of criminal cases against anyone until I truly understand them, and the post-Enron era of the government playing to the public’s resentment of wealthy business executives has only reinfored my skepticism. So, I continue to look for a coherent explanation of the details behind the government’s above-described theory of the case against Mr. Bennett, and this NY Times article comes closest to date of actually breaking down the transactions on which the government’s indictment of Mr. Bennett is based. However, even the Times’ explanation is not clear:

At the start of every quarter, Refco Capital Markets would extend loans to several hedge funds, including Liberty Corner Capital Strategies. The hedge funds would pay interest on those loans, which was recorded in Refco’s financial documents and whose existence was confirmed, every quarter that it was checked, by Refco’s auditor.
The next two steps were not apparent to the auditor a few days into the quarter: a loan from the hedge funds to RGHI, Mr. Bennett’s company, and effectively a second loan, from Refco to RGHI. Mr. Bennett’s company used the loan to repay the hedge funds, plus interest. Before the end of the quarter, the hedge funds would repay the obligation to Refco. The effect of the transaction was to convert, for bookkeeping purposes, an obligation by RGHI to Refco into an obligation by the hedge funds to Refco every time an auditor might look. But during the quarter, RGHI held the obligation to Refco.

O.K., so let’s break this down:

RGHI owes money to Refco;
Refco makes loan 1 to the hedge fund;
Then, hedge fund makes loan 2 to RGHI;
Refco then makes loan 3 to RGHI;
RGHI uses the proceeds from loan 3 to pay the hedge fund for loan 2; and
Then the hedge fund uses the proceeds from the loan 2 repayment to repay loan 1 to Refco.

Got it?
There’s just one big problem with the Times’ explanation — loan 3 from Refco to RGHI remains outstanding. The Times’ explanation confuses repayment of loan 1 with repayment of loan 3. Consequently, based upon the Times’ explanation of what occurred, Refco had a loan to RGHI — “Mr. Bennett’s company” — that should have been reflected as a loan to an insider on the company’s financial statements.
So, what again is exactly the fraud here? I await further clarification, and the original complaint against Mr. Bennett does not provide much.
By the way, Dale Oesterle, a contract law professor at Ohio State, notes in this post that Refco and Mr. Bennett’s fate likely would have been far different had the company not gone public. Similarly, Larry Ribstein points out that, if Mr. Bennett really did commit a fraud at Refco, a loophole in the Sarbanes-Oxley legislation wasn’t the reason he was able to do so.