BACKGROUND Of Refco: The Fall of Refco

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[center]ZT: The Fall of Refco [/center]

Two weeks ago, the chairman of the Philadelphia Stock Exchange and a banker from HSBC went to visit Phillip R. Bennett, the chief executive of Refco, one of the largest commodities and futures trading firms, at its offices in the World Financial Center in lower Manhattan.

Mr. Bennett, smartly dressed and in good spirits, sat and chatted about the paintings on the office walls and the options that Refco had for moving when its lease came up at the end of the year. In riding a worldwide boom in the trading of commodities and derivatives, Refco was on top of its game: the company had successfully gone public in August, selling $583 million in stock and making Mr. Bennett and other top executives very rich men.

"He didn't seem to have a care in the world," said the chairman of the Philadelphia exchange, Meyer S. Frucher.

Mr. Bennett is no longer chief executive. Forced to wear a monitoring device on his ankle, he now faces a charge of securities fraud in connection with $430 million in debt that prosecutors say he hid from regulators and investors. His firm is rapidly sliding over the brink as customers flee and regulators and bankers look to pick up the pieces.

Wall Street's history is littered with abrupt financial collapses, but few have been as fast and furious as the implosion of Refco this week.

Yesterday, the firm announced it was shutting down one of its biggest units, Refco Securities, its regulated broker-dealer arm.

The Securities and Exchange Commission suspended withdrawals of funds from the unit and Refco Clearing for 20 days in an effort to prevent a run on the bank.

At the same time, Refco's advisers are scrambling to salvage what they can of the firm, seeking to sell what remains.

One person said the situation was "chaotic," describing a conference call with the Refco board as "involving a lot of screaming."

The rapid downward spiral of Refco is an illustration that on Wall Street what often matters most is not so much the size of the balance sheet that keeps a firm solvent as it is the character of the person at the top.

Indeed, firms that once dominated the financial landscape, like Drexel Burnham, E. F. Hutton, Salomon Brothers and Kidder Peabody, have all disappeared, done in largely by scandals involving individuals who undermined trust in the firms.

In the case of Refco, some of Wall Street's finest names appear to have trusted in Mr. Bennett and may pay a heavy price as a result: Goldman Sachs and Credit Suisse First Boston, Refco's underwriters; and Thomas H. Lee, a well-known private equity investor who last year bought a majority stake in the company.

"It is unfortunate that accountants can't put trust and reputation on a balance sheet. There is just no line for it," said Andy Kessler, a former research analyst and hedge fund manager who has written books about Wall Street. "In many cases it's more valuable than the cash."

A wave of scandals in recent years have spelled the end for a string of chief executives, from Kenneth L. Lay at Enron to Bernard J. Ebbers at WorldCom.

The relentless pressure that chief executives face in feeding the appetites of impatient investors, combined with the calculus that better earnings equal a higher stock price and a richer trove of options, can in some cases cause a chief executive to cross a certain ethical, if not legal, line. But what drives one executive to make such a choice and another to stay true to his values remains largely a mystery. Many on Wall Street say that the extent to which chief executives can fight off the temptation to think of themselves as larger than their firms is one of the crucial challenges that corporations and their boards face today.

"Character starts at the top," said Winthrop H. Smith Jr., a retired senior executive at Merrill Lynch. "Look at all these examples at Enron and Tyco and WorldCom. It's hubris."

There are still many questions about how a private company controlled by Mr. Bennett came to have a $430 million debt owned to Refco and about the transactions that hid that debt from Refco's books.

Mr. Bennett, a 57-year-old Briton with homes in Manhattan and Gladstone, N.J., repaid the money on Monday, but he was arrested on Tuesday night. His lawyer has said the government "jumped the gun."

On Thursday, Refco announced that it would shut down its capital markets business, an unregulated entity that offered services to hedge funds, such as lending securities, maintaining accounts and clearing trades. Customers were told they could liquidate their accounts but were informed they would not get their money for 15 days.

Customers treated the news yesterday that another unit was being shut down as confirmation that the firm was collapsing.

"You are securing your capital and figuring out where you will do business on Monday," said one Chicago-based trader who did business with every part of Refco's operations.

Refco's remaining business, its futures trading business, has not been shut down, but institutional and individual investors are scrambling to get their accounts moved.

Refco's bonds continued to slide yesterday, falling to 34.13 cents on the dollar, a sign that investors believe the firm will default.

A spokesman for Refco did not return calls for comment.

Rumors spread around Wall Street that Goldman Sachs, which has been retained as a financial adviser to the firm, would assume some of the firm's trades to settle them.

A spokesman for Goldman said it was not asked to assume the trades and had not done so. A spokesman for the Commodity Futures Trading Commission said, "We have not asked any firms to invest on behalf of Refco."

As regulators and lawyers swarmed the company, Goldman canvassed Wall Street looking for potential buyers for all of, or pieces of, Refco's business. Executives at rival banks expressed interest in acquiring client accounts and trades, but no one is likely to want the full company for fear of the liability associated with it.

Lawsuits have already been filed against the company and are expected to be filed against many of the advisers, underwriters and bankers who did not catch the alleged fraud: the firm's auditor, Grant Thornton; Thomas H. Lee, the buyout firm that bought 57 percent of Refco in 2004; the lenders in that buyout, including Bank of America, Deutsche Bank and Credit Suisse First Boston; and the underwriters who took Refco public in August 2005, Goldman Sachs and Credit Suisse First Boston.

Refco officials were scheduled to take part in a conference call yesterday with banks who lent the company $800 million last year. At the last minute, the company said it would not participate in the call, indicating that it had been told not to by its lawyers.

The banks, which are now owed about $648 million, are expected to issue a letter by Monday indicating that the company is in default of its loan.

But the banks have not yet decided to call the loan, which could send Refco into bankruptcy court proceedings. The company has been in breach of obligations to its lenders since Monday, when it announced that its financial statements dating back to 2002 could not be relied upon. Banks depend on such statements to make loans.

Certainty of financial soundness is imperative in the trading business. Refco was forced to shut its unregulated capital markets business because of fears that there would not be anyone to assume the obligations of a trade. If a mutual fund wants to buy $100 million worth of United States Treasury securities through Refco, it calls the firm and asks it to find a seller. When Refco finds a seller, it buys the bonds from the seller and sells them to the mutual fund.

But in a liquidity crisis, the seller would not want to deliver the bonds to Refco for fear that it would not get paid, and the buyer, or the mutual fund, would not want to pay Refco for fear it would not get the securities.

"It's the ultimate credit-default risk," said one commodities trader, who did not want to be named because of the sensitivity surrounding the demise of Refco.

"If you are the customer or the counterparty, there is no assurance you would get the securities you wanted or Refco would have the money to pay for them."