Refco Probes Lead to $525 Million in Phantom Bonds, Hedge Fund

March 15, 2006

Refco Inc. held offshore accounts with as much as $525 million in fake bonds, indicating the futures broker's troubles may be more extensive than previously reported, according to four people with direct knowledge of evidence gathered by U.S. prosecutors investigating Refco's collapse.

New York-based Refco held the securities for Bawag P.S.K. Bank, Austria's fourth-largest bank, and Liquid Opportunity, an offshore hedge fund, under identification numbers that don't correspond to registered bonds, said the people, who declined to be identified because the investigations are ongoing. One person said Bawag and Liquid Opportunity had shares in six Anguilla companies, which in turn held the bonds.

The U.S. Attorney in Manhattan and the Securities and Exchange Commission are trying to find out where the bonds originated and how they were valued, the people said.

The bond accounts were at Refco's Bermuda-based unit, beyond the reach of U.S. regulators. Refco owed creditors $16.8 billion when it filed for bankruptcy protection on Oct. 17, a week after former Chief Executive Phillip Bennett allegedly used a loan from Bawag to pay uncollectible debts he had concealed from investors. Bennett denied wrongdoing.

``These unregulated entities are opaque to the U.S. government,'' said Michael Greenberger, a University of Maryland law professor and former head of trading and markets at the Commodities Futures Trading Commission. ``Because there is no handle on them here or in any of the other major financial centers, it's just that much easier to commit fraud.''

Anthony Clark, an attorney who represents Refco at Skadden, Arps, Slate, Meagher & Flom in Wilmington, Delaware, declined to comment on the bond accounts. ``I'm not saying it did or didn't happen,'' he said.

`Banking Secrecy'

Vienna-based Bawag declined to answer written questions about the bond accounts, citing legal restrictions and ``banking secrecy.'' Bawag doesn't comment publicly ``on questions which are the subject matter of pending legal proceedings,'' Thomas Heimhofer, a spokesman, said in an e-mail.

The lender, owned by Austrian trade unions, sued Refco in federal court in Manhattan in November, saying it was duped into extending the 350 million-euro ($421 million) loan to Bennett.

Liquid Opportunity's fund manager, Jonathan Knight, didn't respond to four messages left on an answering machine seeking comment. Knight, 36, works in Lake Mary, Florida. David Esseks, the Assistant U.S. Attorney handling the Refco probe, and John Nester, an SEC spokesman in Washington, declined to comment.

U.S. Attorney Michael Garcia in Manhattan accused Bennett of fraud on Oct. 12 after the futures broker disclosed he hid losses. That week, customers abandoned Refco, forcing it to seek protection from creditors. Bennett, 57, pleaded not guilty to federal fraud charges in November.

British West Indies

U.S. officials haven't accused Bawag, Liquid Opportunity, Refco, PlusFunds or any related individuals of wrongdoing in connection with the bond accounts.

Refco's creditors are hunting for information about six companies based in the British West Indies that may be linked to the bonds that prosecutors are scrutinizing.

Liquid Opportunity and Bawag held shares in the six companies, which in turn held the bonds, according to a person with knowledge of the Refco accounts who didn't want to be identified because of the ongoing investigations by the Justice Department and the SEC.

The companies, named for islands in the South Pacific and regions of Argentina, were incorporated on July 26, 2004, by a local agent, according to government records in Anguilla.


They were initially listed as Refco creditors with a combined claim of $543 million, according to court filings prepared by Refco's lawyers. Unlike other creditors identified by Refco, none of the companies filed any legal papers in the bankruptcy case. Refco has since dropped four of the six from its creditors list and now says that it doesn't owe any money to the remaining two.

In December, a judge overseeing Refco's bankruptcy authorized the creditors to subpoena former Refco executives, including Bennett, and Bawag for details about the six companies, court filings show.

``All of a sudden, half a billion dollars of liabilities just vanished,'' said Howard Seife, a lawyer at Chadbourne & Parke in New York who represents Refco creditors. ``No one appeared on their behalf in court. It was as if they didn't exist.''

A woman who answered the phone at the office of the agent for the six companies, Anguilla Offshore Management Ltd., declined to give her name and said she couldn't provide any information about them. ``You'll have to contact the customers directly for that,'' she said.

Mystery Fund

The ties between Bawag, officially known as the Bank fuer Arbeit und Wirtschaft, and Refco date back to at least 1998. That year the two companies formed a joint venture to clear futures and options traded on European exchanges. The bank bought 10 percent of Refco in 1999. It sold the stake five years later.

The relationship between Refco and Liquid Opportunity hasn't been disclosed. Corporate records for Liquid Opportunity couldn't be located in the U.S. and a dozen offshore jurisdictions. The fund also doesn't appear in any SEC filings.

The fund administered the bonds on behalf of an investor until the end of 2004, when the assets were transferred to Bawag, according to one person close to Liquid Opportunity, who declined to be identified because of the probes. Liquid Opportunity had no reason to believe the bonds were fake, the person said.

A predecessor, Liquid Opportunity-Plus Fund, was formed in 2000 and raised about $325 million from unidentified investors, according to a 2001 press release by International Portfolio Analytics, a Bahamas-based money manager that ran it. Jonathan Knight's father, Jon Knight, owned a stake in International Portfolio Analytics until at least 1999, SEC filings show.

PlusFunds Connections

Through a Liechtenstein-based partnership, Bawag and Liquid Opportunity's Jonathan Knight are co-investors in at least two dozen companies, according to SEC filings. They also share a connection to Refco through PlusFunds Group Inc., a New York- based money manager that sells investments based on hedge fund indexes.

PlusFunds Chairman Christopher Sugrue worked at Refco as a senior vice president from 1993 to 1998. A biographical note formerly posted on PlusFunds' Web site said he was ``involved'' in Bawag's purchase of the stake in Refco in 1999.

Last year, Sugrue, 35, pledged his controlling interest in PlusFunds to Refco as collateral for a loan of more than $200 million, according to a Dec. 16 lawsuit by Refco creditors against a client of PlusFunds and a person with direct knowledge of the loan, who asked not to be identified while the suit is pending. Neither Sugrue nor PlusFunds is a party to that lawsuit.

Offshore Centers

``In his dealings with Refco or any other financial institution, Chris Sugrue believes he acted properly,'' said Stanley Arkin, Sugrue's lawyer at Arkin Kaplan in New York. ``With respect to Liquid Opportunity, he has no knowledge of any fake bonds, and if there is any culpability there, he had no culpable role.''

Arkin represented Richard Wigton, the former head of arbitrage trading at Kidder Peabody & Co., who was indicted for insider trading during the 1987 junk bond scandal. The charges were later dropped. He also defended former Gemstar-TV Guide International Inc. Chief Executive Officer Henry Yuen in an SEC accounting probe and criminal fraud trial last year. Yuen is awaiting a federal judge's verdict in the trial.

Hedge Fund Index

PlusFunds helped draw investors to Liquid Opportunity, and Liquid Opportunity in turn was a participant in the PlusFunds ``platform,'' International Portfolio Analytics said in its 2001 statement. PlusFunds made money by investing client assets in all or some of the 41 hedge funds in the Standard & Poor's Hedge Fund Index. The company filed for bankruptcy protection on March 6.

Offshore companies played central roles in the accounting frauds at Enron Corp. and Parmalat Finanziaria SpA, according to prosecutors in those cases.

Houston-based Enron allegedly used subsidiaries in the Cayman Islands to cut the company's U.S. taxes and hide losses, before collapsing in the U.S.'s second-largest bankruptcy in 2001. Parmalat, the Italian food company that in 2003 filed the country's biggest-ever bankruptcy case, inflated sales, fabricated assets and funneled debt through units in the Netherlands Antilles and the Cayman Islands, according to Italian court documents.

Refco lawyers told Esseks, one of Garcia's prosecutors handling the Refco probe, about Liquid Opportunity as early as Oct. 21, according to court filings in Refco's bankruptcy case.

MIT Doctorate

Liquid Opportunity's Knight, who holds a doctorate from the Massachusetts Institute of Technology in Cambridge, Massachusetts, made investments for other clients through offshore entities including Gamma Capital Opportunity Partners, Siam Capital Management and Regenmacher Holdings Ltd., SEC filings show. Regenmacher is the German word for ``rainmaker.''

Alpha Capital AG, a Liechtenstein-based investment firm part-owned by Bawag, participated in many of the same investments, according to the filings.

Bawag CEO Johann Zwettler stepped down after the Refco loans became public, saying the move was not an admission of guilt, but meant rather to keep the lender from being damaged. Zwettler hasn't been accused of wrongdoing in the U.S. probe.

The bank's involvement with Refco prompted a regulatory investigation in Austria. Bawag is preparing measures to improve corporate governance and risk management, spokesman Heimhofer said in his e-mail.

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