Friday, October 14, 2005
Former Refco CEO Phillip Bennett had the nickname of "The Closer" for his ability to close deals, and he built Refco Inc. into the largest futures trading firm. He was charged with one count of securities fraud in a criminal complaint filed in the Southern District of New York (see earlier post here) that accuses him of hiding a $430 million debt he owed to Refco by shuffling it between ostensibly unrelated entities at the end of quarters. Bennett's fast shuffle has rendered Refco's financial statements a sham, and the company has lost over 60% of its market value since the revelation of the accounting fraud on Oct. 10. Bennett is out on a $50 million bond and confined to his luxury Park Avenue apartment -- not the worst place to spend your time, but not as nice as the purported European wine-tasting vacation he was going to leave on when the government arrested him. All this despite the fact that Bennett repaid the $430 million debt, apparently by pledging his Refco shares (he owns over a third of the company) for a loan from a European bank. How often do you see a fraud in which the perpetrator repays the money as soon as the deception is revealed, yet the company is pushed to the brink of insolvency because of the conduct?
Refco's plight illustrates how much companies, particularly those in the financial sector, are built on trust and the understanding that they will continue to operate successfully. Bennett's alleged fraud violates a principle of the market that all related-party transactions must be fully disclosed, and the nature of a company's debts fairly presented. If investors had known that Bennett owed a significant debt to the company, that information likely would have caused investors to question the offering price for the firm when it went public in 2004. Even though Bennett has repaid the debt, and therefore the company is ostensibly in a better position than it was before the revelation, the market's reaction is now one that shows a significant, and perhaps overly extreme, mistrust of Refco, and probably a fear that another shoe (or two) will drop out of the company's financial statements and knock the firm flat. The reputational risk to a firm from the misconduct of one of its officers, particularly one with a large stake in the firm, means that any misstep can come close to destroying it. Refco may survive the accounting fraud, but it will not be trusted by investors for years. A Reuters story (here) discusses the problems the firm faces from Bennett's conduct. (ph)
UPDATE: Tom Kirkendall on the Houston's Clear Thinkers blog has an interesting post (here) on Refco.