Refco, once the largest broker on the Chicago Mercantile Exchange, was managing $4 billion for over 200,000 clients. Refco stock was sold in an initial public offering (IPO) in the summer of 2005. The IPO raised $583 million. Phillip Bennett was the CEO and retained majority ownership after the IPO.

A newly appointed controller, Peter F. James, noticed irregularities in financial reports for the quarter. There was $430 million of off-balance-sheet debt. The debt was held by a subsidiary managed by Bennett, Global Securities. Refco claimed the debt had been repaid. However, federal authorities discovered that Bennett had still owed as much as $545 million. From 2002 to 2005, Bennett hid debt within his clients accounts. Refco had several different business units running underneath it that offered various financial services. The group that Bennett ran was called Refco Global Holdings Inc. Customers incurred trading losses, which they were unable to cover. These losses should have been written off. But write-offs would have hurt reported results. Bennett transferred these losses from client accounts into the company he controlled. For example, on February 23, 2005, Bennett loaned a client $335 million. On the same day, the customer then turned around and loaned Bennetts Global Holdings $335 million. According to the SEC charge, the customer was guaranteed to make money on the loan because he or she lent the money to Bennetts company at a higher rate than it paid to Refco. Refco said that during its process of going public, an external auditor found two significant deficiencies in our internal controls over financial reporting, including a lack of formalized procedures for closing our books. When the fraud was revealed, the stock price collapsed and the company filed for Chapter 11. Along with Bennett, former Refco president Tone Grant was charged with securities fraud and conspiracy in January 2007.

Topic 2: Performance Misrepresentation

After reading Case 12 Refco: Misrepresentation and Hidden Debt in Chapter 9 of your text, explain the unethical actions taken by Bennett and how these actions distorted performance measures. How was the fraudulent behavior discovered? Why do you think that the newly appointed comptroller was the first to discover the fraudulent behavior? Provide information from and a link to an Internet site that discusses this case.