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October 21, 2005
Markets Main
Refco's Debts Started With Several Clients
Bennett Secretly Intervened To Assume Some Obligations;
Return of Victor Niederhoffer
By DEBORAH SOLOMON, CARRICK MOLLENKAMP, PETER A. MCKAY and JONATHAN WEIL
Staff Reporters of THE WALL STREET JOURNAL
The $430 million in bad debts at the heart of Refco Inc.'s meltdown stemmed from losses by multiple customers, including money manager Victor Niederhoffer, whose hedge fund suffered heavy losses during the 1997 Asian financial crisis, according to people familiar with the matter.
Another of the customers was Ross Capital, one of these people said. Ross Capital is run by Wolfgang Flottl, whose father until the mid-1990s headed the small Austrian bank Bawag P.S.K. Group that last week lent Refco's chief executive, Phillip R. Bennett, money he used to pay off the $430 million. (See related article.)
Messrs. Niederhoffer and Flottl both denied owing Refco any money.
Reached last night in New York, Mr. Flottl said Ross Capital was never in debt to Refco except for when his firm tapped a credit line, which he said typically was paid back within 24 hours as a normal course of business. "Nothing could be further from the truth," Mr. Flottl said when asked whether Ross Capital owed money to Refco. "Never, never, ever."
The crisis at Refco, which this week filed for Chapter 11 bankruptcy-court protection, began Oct. 10, when the futures brokerage disclosed that a company controlled Mr. Bennett secretly had owed Refco $430 million, which the company said consisted of bad debts dating to the late 1990s. A person familiar with the matter said the debts stemmed from as many as 10 customers. Last week Mr. Bennett was put on indefinite leave.
The futures brokerage's financial problems may also extend beyond the $430 million, a person familiar with the matter said. This person cautioned that it is too early to gauge the extent of those problems, but that it appeared Refco executives also had manipulated other financial metrics.
Federal prosecutors in the U.S. have accused Mr. Bennett of securities fraud for allegedly hiding his ties to the bad debt to improve the company's bottom line and mislead investors in advance of Refco's initial public offering of stock in August. Mr. Bennett has denied wrongdoing, and his lawyer has said Mr. Bennett will fight the charges.
Mr. Bennett's assumption of the bad debts let Refco avoid slashing net income and wiping out nearly all of Refco's profits for the past three years, which would have killed Wall Street's appetite for the huge commodities broker's IPO and, before that, Thomas H. Lee Partners LP's deal in 2004 to buy a controlling stake in Refco.
Mr. Niederhoffer became a minisensation in the 1990s as a successful hedge-fund manager and author of "The Education of a Speculator," about making contrarian trades. But his hedge fund experienced one of the more dramatic collapses in late 1997, when he suffered losses on an options bet on futures tied to the Standard & Poor's 500-stock index at the Chicago Mercantile Exchange.
After taking a leveraged bet that would have gained in value if the S&P index rose or stayed stable, Mr. Niederhoffer received a margin call for about $50 million from Refco, his clearing broker, on Oct. 27, 1997, when stocks tanked amid the Asian financial crisis. Refco at the time denied the loss would cause it broader problems.
The people familiar with the matter say they believe the customers, including Mr. Niederhoffer, had no knowledge of the steps Mr. Bennett allegedly took to hide the debts.
In a statement posted on his Web site Oct. 13, Mr. Niederhoffer said his former fund, Niederhoffer Investments Inc., Weston, Conn., closed out its debt to Refco with a $2 million payment shortly after the fund's 1997 troubles. "Neither I, nor my firm, nor anyone associated with me has had any loans or financial dealings of any kind with Refco in seven years," Mr. Niederhoffer wrote.
Paul Hendry, treasurer for Mr. Niederhoffer's current firm, Manchester Trading LLC in Norwalk, Conn., said yesterday: "There were no outstanding receivables, as far as I would understand it, when we finished our dealings with Refco." He added that Refco covered Mr. Niederhoffer's losses, in part, by liquidating the remaining assets in his account. Likewise, he said, only Refco itself would know precisely how much money it recouped from that liquidation, and how much of Mr. Niederhoffer's debt it covered.
According to a person familiar with the matter, Refco may have allowed some financially weak customers to take on overly risky positions. While the mechanics of the trades remain unclear, at least some of the customers' problems were tied to margin loans.
Investigators also have turned up evidence that more than one hedge fund was used to help Mr. Bennett hide Refco's losses. Last week, a Summitt, N.J., hedge fund, Liberty Corner Capital Strategy LLC was reported to have been used by Mr. Bennett to conceal the debts. Yesterday, Liberty Corner said it had been told it wasn't the target of the criminal investigation into Refco and that it plans to take legal action against Refco over the matter.
Separately, former SEC Chairman Arthur Levitt said he no longer is an outside adviser to Refco. Refco on Oct. 13 announced it had retained Mr. Levitt and former U.S. Comptroller of the Currency Eugene A. Ludwig as special advisers to its board of directors.
Mr. Flottl said that Ross Capital began using Refco approximately in the early 1990s as a broker to trade bonds, foreign exchange and futures. Mr. Flottl said that in the late 1990s, Ross Capital quit using Refco. Mr. Flottl also said he traded for Bawag, the bank that his father, Walter, ran until 1994. Mr. Flottl said his father didn't have a business relationship with Refco. The son said that when questions were raised about the propriety of his trading for Bawag, he stopped and the money was returned to the bank.
--Erin E. Arvedlund and Kara Scannell contributed to this article.
Write to Deborah Solomon at
deborah.solomon@wsj.com, Carrick Mollenkamp at
carrick.mollenkamp@wsj.com, Peter A. McKay at
peter.mckay@wsj.com and Jonathan Weil at
jonathan.weil@wsj.com