Refco Suit Targets Austrian Patron Bawag

Updated from 1:28 p.m. EDT

Refco's(RFXCQ) creditors alleged in court Tuesday that Austria's Bank Fuer Arbeit und Wirtschaft was an active participant in the accounting fraud that led to the collapse of the once-dominant commodities brokerage.

In a lawsuit filed Tuesday in federal bankruptcy court in Manhattan, Refco's creditors alleged that Bawag wrongfully stripped $1.3 billion out of Refco before it collapsed last October. In conjunction with the filing of the lawsuit, Bankruptcy Judge Robert Drain signed an order freezing any assets Bawag may have in the U.S.

Questions have swirled from months about the relationship between Bawag, Austria's fourth-largest lender, and Refco, in which Bawag once owned a minority interest. Bawag became a lightning rod for lawyers after confirming that it lent former Refco CEO Phillip Bennett $410 million just as the accounting scandal was being divulged.

Bennett, charged last year by federal prosecutors with several counts of securities fraud, used the Bawag loan proceeds to pay down $430 million in bad debt owed to Refco that he allegedly was hiding from investors. Prosecutors contend the former executive was hiding up to $750 million in uncollectible trading losses for years in an private entity he controlled.

Refco collapsed just two months after it went public in a $585 million IPO led by Goldman Sachs(GS), Bank of America(BAC) and Credit Suisse(CSR).

"Bawag was a key participant in Bennett's scheme and Bawag assisted Bennett in stripping out over $1.3 bilion from Refco Group Ltd., much of which wound up in Bawag's pocket,'' says Scott Edelman, a partner with Milbank Tweed Hadley & McCloy, the law firm representing Refco's hundreds of creditors.

The creditors, which include a number of hedge funds and small brokerages, allege that Bawag had a hand in Bennett's scheme to hide the bad customer debts. They also allege that Bawag had a secret deal with Bennett that effectively gave the bank a greater ownership interest in Refco than the 10% stake it had always claimed. Bawag sold its equity stake in the $1.9 billion leveraged buyout of Refco in August 2004 by Thomas H. Lee Partners.

"Pursuant to a secret arrangement between Bawag and Bennett, and through a complex maze of transactions with its own offshore affiliates, Bawag held a far greater economic stake in (Refco) than was publicly disclosed, thereby giving it far greater economic control,'' the lawsuit alleges.

TheStreet.com first reported details of a "proceeds participation agreement" involving Refco and an entity called DF Capital last month. The lawsuit filed by the creditors quotes extensively from that article, under a section of the complaint titled, "Bawag's Hidden Losses.''

The lawsuit alleges that "a secret deal was designed to allow Bawag to participate in any sale of [Refco], while at the same time publicly disclaiming that it owed any more than a 10% equity stake.'' TheStreet.com reported the essence of the agreement on March 24.

In the suit, creditors' lawyers allege that around the time of the buyout by Thomas H. Lee, a Boston-based private equity firm, some $1.3 billion was transferred from Refco to Refco Group Holdings Inc., the entity controlled by Bennett, which prosecutors say played an instrumental role in the debt-hiding scheme. Bawag then got some of the proceeds from the transfer, pursuant to the secret deal with Bennett.

The complaint says Bawag "was not an innocent recipient of the subsequent transfers'' because it "had been an active participant in Bennett's scheme.'' The creditors allege that Bawag's contribution to Bennett's alleged debt-hiding scheme involved a $254 million loan to the DF Capital entity, which apparently was used to help hide some of the Refco customer losses.

The allegations against Bawag come during a rough time for the lender. The bank has been under fire in Austria for its role in the Refco scandal and the recent revelation that it, too, was hiding more than $1 billion in trading losses for several years. Refco allegedly had a hand in helping Bawag hide those trading losses, which have since been absorbed by the bank.

It's not known what, if any, assets Bawag has in the U.S. Any assets found by the creditors could be subject to the judge's freeze order. The bank recently hired Morgan Stanley to find a buyer for it.

Up until February, Bawag had been an active behind-the-scenes participant in the U.S. market for PIPEs, or private investments in public equities. PIPEs are financing deals done by small-cap companies looking to raise cash quickly.

Last month Bawag announced it was quitting the PIPEs business, following a critical story in TheStreet.com about its financial ties to four foreign hedge funds that have invested heavily in PIPEs deals.

TheStreet.com also has reported that Bawag has a financial interest in LH Financial Services, an unregulated advisory firm located in New York's swanky Essex House hotel on Central Park South. LH Financial has served as an adviser on PIPE deals to the hedge funds with ties to Bawag.

The bank, in an internal report compiled by Austrian bank regulators, has disclaimed any direct ownership interest in LH Financial. But a lawyer for the creditors says if LH Financial owes any money to Bawag, it could be subject to the judge's freeze order.

Officials at LH Financial, whose 27th-floor suite overlooks Central Park, declined to comment.

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