So, Refco’s former CEO and chairman Phillip Bennett pled guilty late Friday in a Manhattan federal court to fraud and other charges stemming from the 2005 collapse of the company (previous posts here). Peter Henning analyzes the plea here.
Bennett’s guilty plea appears to have been prompted by the plea deal last December of Santo C. Maggio, Refco’s former executive vice president, who was expected to testify against Bennett and the other Refco-related criminal defendants, former Refco executives Robert C. Trosten and Tone N. Grant, and former Mayer Brown partner and primary Refco outside counsel, Joseph P. Collins. Trosten and Grant’s case is scheduled to go to trial in March.
Although not entirely unexpected, Bennett’s guilty plea nevertheless leaves hanging the most intriguing question about the entire Refco affair:
Why on earth did Bennett ever take Refco public?
Let’s recall the story. Refco — a well-known Wall Street commodities and futures trading broker — filed a chapter 11 case in mid-October 2005 a week after the company announced that a $430 million debt owed to the company by a firm controlled by Bennett had been concealed and then repaid by Bennett. Refco’s board placed Bennett on indefinite leave and he was arrested on federal securities fraud charges shortly thereafter.

The indictment against Bennett alleged that Refco suffered hundreds of millions of dollars in bad debts in the late 1990’s as a result of customer trading losses. The customers were unable to make good on the losses, so Refco was left on the hook because it had extended credit to the customers. Rather than making Refco’s financial condition look less healthy by writing off the losses, Bennett allegedly had the losses assumed by a company that he owned and controlled — Refco Group Holdings, Inc. (“RGHI”) — and then hid that fact from auditors and investors on multiple occasions by arranging the following series of transactions.
First, a Refco subsidiary — Refco Capital Markets, Ltd. — would make a short term loan (usually, about a two week term) in various amounts ranging from $325 million to $720 million to a third party, Liberty Corner Capital Strategies.
Liberty Corner would simultaneously make a short term loan to Mr. Bennett’s company (RGHI) in the same amount and with the same maturity of its borrowing from Refco Capital (but at a slightly higher interest rate), and Refco the parent would guarantee RGHI’s payment of the loan to Liberty Corner.
RGHI would then use the loan proceeds from Liberty Corner to pay Refco the amount of its related party indebtedness at the time shortly before the end of an upcoming Refco reporting period. Inasmuch as the debt was paid prior to the end of the reporting period, Refco’s auditors did not report the amount of RGHI’s previous indebtedness to Refco as related party indebtedness.
Finally, upon maturity of the two short term loans (which was timed to occur after the end of Refco’s reporting period), the loans were “unwound” (apparently without telling Refco’s auditors) so that RGHI was put back in the position of owing the same amount of related party indebtedness to Refco that it owed before it borrowed the money from Liberty Corner.
This arrangement apparently continued each quarter even after Thomas H. Lee Partners paid $500 million for a 38% stake in Refco in 2004 and even while the company was preparing its IPO, which took place in August, 2005. Less than two months after going public, the above-described scheme was exposed publicly, Refco proceeded to plunge into bankruptcy and Thomas H. Lee Partners’ investment in the company went up in flames.
But why did Bennett take the considerable risk of having the scheme exposed under the microscope of taking Refco public and operating it as a public company? Had the fraud been discovered while Refco was a private company, matters probably would have turned out much differently for both Refco and Bennett. Bennett almost certainly would have been forced to resign, but the company would have been under no obligation to disclose the resignation publicly and, if it was disclosed at all, probably would have been described in the euphemistic manner of ìpursuing other opportunities.î
Similarly, as a private company, Refco would have had no legal obligation to advise the market on why Bennett resigned and the financial press probably would not have connected it to fraud at Refco absent a leak from inside the company. Inasmuch as most folks would have never heard of Refco, Bennett’s resignation would not have been particularly newsworthy outside of Wall Street. Indeed, unless Refco alerted the authorities about the fraud — which it probably would not have done out of fear of triggering an Enronesque experience — Bennett would not have been arrested.
Meanwhile, Refco’s new management and board would have probably arranged an adjustment of the purchase price on the large investment that Thomas H. Lee Partners made in Refco in order to avoid a civil lawsuit that would have publicly disclosed the fraud. Perhaps the Refco board and management would have instituted some internal controls to lessen the risk of such a fraud occurring in the future. But most importantly, Refco probably would not have collapsed.
Now, compare what happened after Refco went public. The scheme was discovered almost immediately by the company’s auditors, Refco’s board was obligated to report what it concluded immediately to both the market and criminal authorities, Refco proceeded to go through an Enronesque experience and filed bankruptcy, Bennett was indicted, and Thomas H. Lee Partners lost over $300 million on its Refco investment. Meanwhile, Refco’s creditors and investors are seeking hundreds of millions dollars in damages from Refcoís board, Refco’s auditors (Grant Thornton) and the underwriters of the Refco IPO.
Did Bennett take Refco public simply because he was greedy, wanted to cash out on the IPO, and thought he could continue to cover-up the fraud? Maybe, but it doesn’t seem likely. Did he lose control after taking in the Thomas H. Lee Partners investment and developments just overwhelmed him? Perhaps, but I’m still scratching my head on this one. Something doesn’t add up. I am definitely staying tuned.