Updated from 2:07 a.m. EDT

Refco ( RFX), the New York derivatives house battling to survive an accounting scandal, looked ready to hoist the white flag Friday, announcing steps that will greatly diminish the business of its U.S. brokerage arm.

But in a bit of good news for Refco, the firm's three main banks decided to take no immediate action on the question of whether Refco has defaulted on its debt. They will meet again next week to consider the matter.

A day after shuttering an offshore unit, Refco said Friday that its regulated U.S. brokerage, Refco Securities, has "initiated the process of unwinding proprietary and client positions." The brokerage will engage only in "security transactions to the extent necessary to offset and effectively liquidate outstanding long and short customer and proprietary positions."

The move came as the three banks that arranged an $800 million bank loan for Refco met to decide how to proceed in the wake of the massive $430 million accounting scandal that's led to criminal charges against the firm's former CEO. The meeting was led by Bank of America ( BAC), the administrator on the bank deal that also included Credit Suisse First Boston ( CSR), and Deutsche Bank ( DB).

A source with CSFB says the Swiss-based investment bank's exposure to the bank debt taken on by Refco is negligible because much of the original loan was syndicated to other banks and investors -- a common practices in such financing.

There was speculation that the banks would demand changes in the terms of the bank debt in light of recent events and the downgrade of Refco's bonds further into junk status by two major ratings agencies.

Refco's bank debt is trading on the secondary market at the depressed price of 60 cents for each dollar of par value. But that's still considerably higher than the price for Refco's bonds, which have been trading as low as 23 cents on the dollar.

An analyst who did not want to identified said the securities arm is not a big a part of Refco's operation and the decision to shutter it should not have any immediate impact on its future business.

Meanwhile, a customer of Refco's big futures business, Refco LLC, says his firm got an email from Refco saying the division was solvent and planned to continue operating. Late Friday, speculation was swirling on Wall Street that Goldman Sachs ( GS), hired Thursday as a financial adviser to Refco, was actively shopping around the futures operation to Wall Street firms.

Hours before the bank meeting, the Securities and Exchange Commission got a court order that temporarily prohibits Refco's brokerage arm and clearing division from "making a withdrawal of equity capital, or unsecured loan or advance to a stockholder, partner, employee or affiliate." A regulatory source says the action was taken to make sure that no one at Refco tries to make off with any customers assets.

On Thursday, Refco imposed a 15-day moratorium on all activities of its offshore securities and foreign exchange division, Refco Capital Markets, "to protect the value of the enterprise." The company said that unregulated entity "represents a material portion of the business of the company." Refco Capital, based in Bermuda, provides prime brokerage services to offshore hedge fund customers.

Refco took the unusual move of shuttering the business to prevent a run on brokerage, after a number of customers sought to withdraw their assets. Only a day earlier, Refco said it had adequate liquidity and financing to continue operations.

Goldman Sachs, one of the underwriters on Refco's August IPO, is trying to find a buyer to help Thomas H. Lee Partners, a Boston-based buyout firm, gracefully get itself out of this mess. A spokesman for Thomas H. Lee could not be reached for comment.

A year ago, Thomas H. Lee sunk $507 million into Refco in exchange for a 49% equity stake. In Refco's $583 million IPO, the buyout firm raked in about $165 million, but it still owns 40% of the company's stock.

Initially, Thomas H. Lee had valued Refco at $2.2 billion. The firm is now worth less than half of that, based on the price of the stock, when trading was halted Thursday in the company's shares by the New York Stock Exchange.

The NYSE took the unusual action in order to determine whether the stock should be delisted because the company has said its financial statements since 2002 can no longer be relied on. The stock was last quoted at $7.90 a share.

Refco's stock has lost 72% of its value since the firm disclosed Monday that Phillip Bennett, the firm's former chief executive, had hid $430 million in debt owed by a company he controlled from investors. On Wednesday, federal prosecutors filed a securities fraud charge against the former Wall Street titan, alleging he concealed the debt through a series of suspicious transactions in order to deceive investors in the company's $583 million IPO in August.

In charging Bennett with one count of securities fraud, prosecutors alleged that the 57-year-old executive secreted $430 million in bad debts owed to Refco to a separate company he controlled. The debt -- run up by Refco customers over seven years and unlikely to be repaid -- showed up on Refco's balance sheet as a cleaned-up receivable, its connection to Bennett masked by accounting sleight-of-hand involving yet another unaffiliated party.

The scheme, according to prosecutors and sources, began with a series of $335 million loans made by Refco Capital Markets to Liberty Corner Capital Strategies, a Summit, N.J., hedge fund that's part of a $15 billion conglomerate managed by Terrence Pigott, a former executive vice president of asset management at Daiwa Securities. Liberty Corner then turned around and lent Bennett's Refco Group Holdings $335 million, charging Bennett a higher interest rate than it was paying Refco.

The curious transactions permitted Liberty Corner to pocket a quick profit on the transactions. Meanwhile, prosecutors say that Refco Group Holdings used the transactions as cover to "temporarily eliminate its debt to Refco" at the end of each quarter and "hide the related-party nature of its "continuing indebtedness" to Refco.

Refco Group is a private entity that Bennett used to control his considerable equity stake in Refco.

Prosecutors and the company have not said what old debts Bennett's Refco Group Holdings had acquired and why he was trying to conceal them from investors in the initial public offering. The company, however, has said much of that $430 million in debt were "historical obligations," which it had deemed as hard to collect.

In other words, there was little chance that Refco would ever collect on those outstanding debts and it appears that Bennett wanted to conceal that fact from investors in order to make the company's financials appear healthier than they really were.

Refco's auditor Grant Thornton claims it had no knowledge of the transactions. The three investment banks that led the August IPO, CSFB, Bank of America and Goldman Sachs, have not commented on the situation.

Sources say some of the "historical obligations" may have been trading loses incurred in conjunction with the collapse of a hedge fund run by Victor Niederhoffer, a former Refco customer, whose money management empire collapsed in 1997. At the time, Refco officials denied that the brokerage had sustained any substantial losses from the collapse of Niederhoffer's fund.

But in 1999, Niederhoffer filed a lawsuit against the Chicago Mercantile Exchange ( CME), seeking $100 million in damages for losses he claimed the futures exchange had helped cause. Niederhoffer claimed that problems with the exchanges trading system had led to some of his losses. In the lawsuit, said it and Refco "suffered substantial losses" on and after Oct. 27, 1997.

The lawsuit was settled in 2002, the same year that Refco says its financials stopped becoming reliable. A lawyer for Niederhoffer declined to disclose the terms of the settlement, saying they were sealed. He said his client did not believe his debts were those that Bennett had sought to conceal.

On his Internet blog, Niederhoffer said his firm and Refco resolved all claims past, present and future in October 1997.

"The releases between Refco and me were scrutinized by several regulatory authorities at the time and thereafter. There were no loose ends, accommodations or outstanding receivables or debts of any kind between us," other than a small loss related to an options transaction, Niderhoffer wrote.

Another issue for Refco and its shareholders is what happens to the 34% equity stake held by Bennett, after the IPO and a special post-IPO dividend, in which he pocketed more than $140 million.

According to prosecutors, when Refco ousted Bennett and said he had made the company whole, about 350 million in euros were being wired into an account in the name of Bennett and Refco Group Holdings. The transfer came from an unnamed foreign bank.

Given the subsequent drop in the company's stock, people familiar with the inquiry say the institution that made the loan to Bennett effectively controls those shares.

The whirlwind of events surrounding Refco have led to some fast actions by the bond ratings agencies.

Standard & Poor's said Thursday afternoon there's "substantial doubt" about the company's liquidity. S&P and Moody's, which were heavily criticized in 2002 for failing to detect accounting fraud at Enron, both downgraded Refco's credit rating further into junk status.
As originally published, this story contained an error. Please see Corrections and Clarifications.

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