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Judge To Rule Today On Refco Creditors Payouts

by Glen Shapiro,, New York

27 September 2006

Refco's bankruptcy judge Robert Drain will consider today in New York whether to permit Refco to pay US$642m to secured lenders. The application has been resisted by a group of hedge funds holding 25% of Refco's stock - although they appear to have acquired their holdings after the company's bankruptcy in October, 2005.

Refco filed for Chapter 11 protection from creditors on October 17th, one week after the firm said former chief executive Phillip Bennett had hidden $430 million of bad debt. The company is now selling assets to pay creditors that claim they are owed up to $16.8 billion. Bennett has pleaded not guilty to eight counts of conspiracy, fraud, and other charges.

Refco wants to use the money to pay Bank of America and other lenders, and says this would stop the daily accrual of $200,000 in interest charges, and pave the way for an end to the bankruptcy. Refco also wants to use settlement monies to be received from Austrian bank Bawag for the same purpose. In exchange, Bank of America would drop claims that Refco gave it misleading financial data related to the loans. Hedge funds JMB Capital and Lonestar have particularly objected to the proposed use of Bawag proceeds, saying that their allocation should be controlled by the judge.

The proposed settlement is distinct from the fate of Bermuda-based subsidiary Refco Capital Markets, the subject of a repayment plan put in front of New York bankruptcy Judge Robert Drain earlier in the month.

US Bankruptcy Judge Robert Drain ruled earlier in the year that Refco Capital Markets should be liquidated under Chapter 7 of the US bankruptcy code, separately from the remainder of Refco, and that a trustee should be appointed for the offshore broker-dealer unit. However the preliminary ruling was suspended to give creditors time to work towards a consensual liquidation plan. Under the Chapter 7 procedure, assets would be sold and the proceeds distributed first to customers and then to other creditors.

Creditors have opposed a proposal that Refco Capital Markets should repay its customers (mainly large banks) 70 cents on the dollar in respect of $2.7 billion liabilities, while its unsecured creditors, owed $890m, would get only 26 cents on the dollar.

Although Refco Capital Markets was registered in Bermuda, it was incorporated as an exempt company, allowed to do business anywhere except Bermuda, and in fact had no staff in Bermuda. Neither the Bermuda Monetary Authority nor US regulators had any formal responsibility for its operations, and it appears to have ignored such elementary good practices such as the separation of client accounts from general corporate funds.

The Capital Markets unit was implicated in the dealings between Refco and Austrian bank Bawag, which earlier this year settled a lawsuit brought against it by Refco's creditors for US$675 million.

As part of the settlement, creditors could receive compensation of up to US$200m if Morgan Stanley is successful in selling Bawag for more than EUR2bn. Morgan Stanley says it expects to have a deal to sell Bawag before the end of this year. Attorneys for Refco's creditors say that they will in all likelihood also have a veto or at any rate a right to call for an independent review of any sale.

Bawag admits that it was involved in the financing of investment companies mainly engaged in interest rate and currency derivative transactions in the 1990s, at an eventual cost of more than EUR1 billion. Independent enquiries have revealed that Bawag has also been involved in the little-known PIPE (public investment in private equity) market in New York, in which cash-strapped public companies sell off new stock at junk prices, often to or via hedge funds.

According to, Bawag's investments into the PIPE market were via four Liechtenstein-based hedge funds: Alpha Capital, Austinvest Anstalt Balzers, Austost Anstalt Schaan and Celeste Trust. Bawag is also said to have a financial interest in LH Financial Services, a New York investment firm that is heavily involved in the PIPE market.

Bloomberg said at the time that Refco itself appeared to have held offshore accounts with as much as $525 million in fake bonds at its Bermuda-based unit. The bonds appear to have been owned by six companies incorporated in Anguilla, which were in turn owned by a fund called Liquid Opportunity and Bawag. The six companies were incorporated on July 26, 2004, by a local agent, and were initially listed as Refco creditors with a combined claim of $543 million.

BAWAG set up a joint venture with Refco in 1998 and bought a 10 percent stake in the futures broker in 1999. It sold the stake in 2004 to private equity firm Thomas H. Lee Partners. The Refco creditors claim that the company raised new debt at the time of the buy-back which found its way to Bawag.

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