Updated from 5:29 a.m. EDTRefco Inc. ( RFX), the scandal-tarred derivatives brokerage, filed for chapter 11 bankruptcy protection after cutting a deal to sell its primary business to a group led by hedge fund J.C. Flowers. The filing, a nightmare scenario for investors who have been unable to trade the stock since Thursday, covers Refco Inc. but not the regulated subsidiaries Refco LLC and Refco Securities. The company agreed to sell Refco LLC to a consortium led by J.C. Flowers for $768 million, although it expects the bankruptcy court to entertain competing offers. Refco, which came public two months ago, has been struggling to retain customers and stay solvent since CEO Phillip Bennett was arrested last week and charged in a $430 million accounting fraud. The company previously shuttered its offshore capital markets group and was unwinding trades at Refco Securities. Along with J.C. Flowers, the investor group buying Refco LLC includes Enstar, Silver Point Capital, MatlinPatterson Global Advisers, and Texas Pacific Group. Refco was advised in the transaction by Manhattan investment boutique Greenhill & Co. "In accordance with the terms of its engagement, the services of Goldman Sachs ( GM) terminated on Oct. 17, 2005, upon the bankruptcy filing," Refco said. Goldman was one of the three lead underwriters on Refco's $583 million IPO. Shares of Refco, which have fallen from a post IPO high of nearly $30 a share to $7.90, remain halted on the New York Stock Exchange. Refco named Mark Winkelman, formerly head of commodities trading firm J. Aron, chairman, and Jacob Goldfield vice chairman. "We believe that Refco has a tremendously bright future ahead of it," Winkelman said. "Refco's unique platform offers clients a compelling value proposition, and we are providing Refco with a stable and well-capitalized shareholder base that will permit it to continue providing superior service to clients. We expect to close this transaction as soon as possible and we will begin our partnership with Refco employees immediately." The sale of Refco LLC is a consolation for Thomas H. Lee Partners, a Boston-based buyout firm. A year ago, Thomas H. Lee sank $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. Last Wednesday, federal prosecutors in New York charged Bennett with one count of securities fraud in the scandal. They 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. 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 debt to Refco. Refco Group is a private entity that Bennett used to control his considerable equity stake in Refco Inc. Prosecutors and the company have not identified the debts that Bennett's Refco Group Holdings acquired or said 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 hard to collect. Most of the debts, sources say, were trading losses incurred either by Refco's customers or Refco itself in trying to hedge its exposure to trades made on behalf of its customers. Meanwhile, new information has emerged about the foreign bank that provided Bennett with the cash to pay the outstanding debt before he was ousted from the firm last Monday. Sources say Bank für Arbeit und Wirtschaft, or BAWAG, one of Austria's largest banks, lent Bennett the money to pay down the $430 million obligation. BAWAG has not confirmed it was the source of the loan to Bennett, but the bank said this weekend that it has a $510 million exposure to Refco. The bank said it has "collateral'' to collect on it, if the outstanding debt is not repaid. Federal prosecutors allege that Bennett came up with the $430 million by borrowing money from a foreign bank and posting his 34% equity stake in Refco as collateral. At his bail hearing, authorities also claimed that Bennett, prior to his arrest, had been planning to travel to Austria. It's not surprising that Bennett would turn to BAWAG for help, since Refco had a prior relationship with the Austrian lender. A subsidiary of BAWAG was a 10% equity investor in Refco when the company was still privately-owned. The bank's interest in Refco was bought out by Thomas H. Lee Partners, when it invested in the brokerage last year. Bennett was released from custody last Wednesday after posting a $50 million bond. In light of the government's claim that Bennett poses a flight risk, he's been ordered by a federal magistrate judge to wear an electronic ankle bracelet and remain at his Manhattan home. The investigation into the accounting scandal continues, however. Santo Maggio, the former president and chief executive of Refco Securities and Refco Capital Markets, who was ousted along with Bennett, has retained white-collar defense attorney Paul Schectman. Refco has said that Maggio had some knowledge of the transactions involving Bennett. Refco Securities and Refco Capital Markets are the two divisions the firm said last week it was shuttering. Even before the accounting scandal, Maggio was in hot water with securities regulators for his failure to supervise two Refco brokers, who allegedly had a hand in helping an offshore hedge fund manipulate shares sold in 2001 private stock placement. A source says regulators also are interested in speaking with Robert Trosten, Refco's former chief financial officer, who suddenly resigned a year ago to pursue other interests. The timing of Trosten's resignation is curious, because by leaving Refco he forfeited a chance to cash in on its upcoming IPO. Trosten, who now lives in Florida, could not be reached for comment.