Refco: A 21st Century Run On the Bank

published 7 November 2005

Within a week, Refco went from "stockmarket darling to carcass", said Daniel Gross on Slate.com. Last Monday, the firm was one of the world's biggest futures and commodities brokers. But early this week it filed for Chapter 11 bankruptcy protection. Last Tuesday, chairman and chief executive Phillip Bennett (see below) was charged with securities fraud for disguising a $430m debt he owed to the company. News of the accounting irregularity sent the shares into freefall and triggered a lawsuit from shareholders who had piled in at Refco's flotation in August. By Thursday, the group had halted operations at its prime brokerage, which serves hedge funds, and this week the shares were delisted from the main exchange.

Refco's financial position had arguably improved early last week, since Bennett paid the loan back, said David Wighton in the FT. The trouble was that the company said its accounts for the past four years could not be relied on as a result of the discovery. The resulting loss of confidence was fatal because if a broker's customers and depositors, who lend and deposit billions, fear for their assets, they will withdraw them.

As customers fled, liquidity dried up, leading to the closure of one of the units, said Gross. It was a "21st-century run on the bank" - as well as a "stunning breakdown in due diligence", said Anthony Currie on Breakingviews.com. Refco's accountants Grant Thornton, private equity group Thomas H Lee and the banks that took Refco public - including Goldman Sachs and CSFB - all failed to spot that a $430m loan to an outside company was in fact a loan to an entity owned by Bennett and should have been disclosed. Equity under-writers in the US charge stonking fees; judging by this episode, they will have to work "a hell of a lot harder to justify them".

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The good news is that Refco's implosion looks unlikely to cause a threat to the financial system akin to the demise of Long-Term Capital Management, which resulted in a Fed bailout to restore calm. Lex in the FT notes that Refco's client base is very broad, which limits systemic risk, while much of the business is regulated, with customers' cash held in segregated funds rather than bound up inside the company. The "biggest losers" from this saga, says Lex, are Refco's investors.

Prior to being charged last Tuesday with securities fraud, Phillip Bennett, 57, was "a striking Wall Street success story", said Katherine Griffiths in The Independent. The Cambridge-educated Briton was recruited by Refco in 1981 after 11 years at Chase Manhattan. Then, Refco was a small outfit specialising in cattle futures trading. Thanks in part to a series of acquisitions, he oversaw its transformation into a brokerage business with a presence in 14 countries, handling derivatives in energy and mining commodities, and currencies and equities.

Although Bennett led Refco's "growth stampede", his work habits "could not have been more different" from those of typical futures traders, said Jeremy Grant in the FT. While fellow students remember him as "one of the blokes", former colleagues say the father of two worked 12-hour days and rarely socialised; one former colleague said he "made it his business to know everything" about the markets, "and it showed". Now under house arrest, the one-time dollar billionaire - one of the wealthiest Britons in the world - will be lucky to be left with a tenth of that amount.

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.