Lessons Learned From Refco’s 2.4 Billion Dollar Fraud and Bankruptcy

Online forex trading has exploded in recent years, with retail trading accounts becoming widely accepted and automated forex trading also becoming increasingly popular. A slew of online forex brokers will now open an account with as little as $1 in some cases.

Yet the increasing availability of forex trading (learn more about forex trading) to the retail market brings the risk of fraud as wily brokers, account managers and just plain scammers look to profit from the ignorance and greed of others who want access to the huge forex market.

Nevertheless, frauds that can cost unsuspecting forex traders substantial amounts of money can crop up even with well established companies doing business in highly regulated places like the United States.

The fraud case involving the forex broker Refco and the company’s subsequent bankruptcy is one such notable example that resulted in a $2.4 billion loss of funds for its 17,000 forex trading customers. this story will teach you many things to look out for when detecting a fraud.

The Refco Fraud Case

Phillip Bennett was the CEO of Refco, a large forex and commodities brokerage house that was one of the main brokers on the Chicago Mercantile Exchange. In October of 2005, Bennett was accused of padding the company’s finances by hiding the $550 million in debts of a wholly-owned and unregulated subsidiary which he controlled by the name of Refco Capital Markets.

Refco — which had over 17,000 customer accounts — eventually declared bankruptcy. In the bankruptcy proceedings, Bank of America and other large creditors managed to convince the bankruptcy court that Refco’s customers were actually unsecured creditors because of Refco’s failure to segregate the customer accounts from their general funds.

This resulted in the unsecured customer accounts being considered for reimbursement only after the secured customers in the distribution of whatever funds were left. In effect, this left Refco’s 17,000 trading account customers with virtually no return of funds from their accounts.

Watch Out for Comingled Accounts

The Refco situation illustrates well how a forex broker’s fraud related financial troubles can result in the loss of their clients’ money on deposit without their customers having any effective recourse just by having client accounts comingled with their own.

Refco’s thousands of forex trading account holders were basically shafted and their funds lost due to the broker failing to segregate their funds from their clients in individual accounts. This sent out a clear warning signal against using forex brokers that comingle funds in this way.

Beware of Brokers Domiciled in Poorly Regulated Countries

Yet another lesson from the Refco fraud was that the company was not based in a major and well regulated country, although it operated out of New York City.

In this case, the domicile of Refco Capital Markets was in Bermuda, thereby resulting in a lack of proper regulatory oversight into their financial dealings that may well have contributed to their ability to perpetrate and cover up this fraud.

Accordingly, when shopping for a retail forex broker to entrust your trading account to, be sure to double check the domicile of the company even if their business address looks reputable.

If the company is based in less well regulated countries like Panama, Costa Rica, the Russian Federation and the Bahamas for example, you might want to think twice about giving them your money based solely on the company’s domicile.

Select a Local Broker

As a result of the global marketplace provided by the Internet, you can now choose a forex broker based almost anywhere on earth. Nevertheless, selecting a forex broker that is based in your country of residence can provide significant advantages in case a problem occurs.

In essence, if your forex broker is based in the same country in which you live, you will generally enjoy significantly better chances of having your funds returned since you enjoy greater legal recourse if a fraud or unsatisfactorily resolved problem occurs that threatens your trading account’s funds.

By the same token, if your forex broker goes bankrupt or out of business, you will usually have improved chances of seeing your funds recovered if you are in the same country as the broker versus if you are instead living elsewhere.

Furthermore, having your forex broker based nearby will give you the advantage of being able to discuss problems that might arise with the broker’s staff during their normal customer service hours, thereby potentially eliminating problems due to poor communication or misunderstandings. See our list of trusted brokers.

Even Regulation Might Not Save Your Funds

In general, when forex brokers have maintained their registration in good standing for some time with major financial regulatory agencies like the NFA, CFTC, FSA, ASIC, or a similar agency in an EU country, that tends to be a good sign that the company is operating legitimately.

Also, such a good regulatory track record may well indicate that some legal recourse could be available via the agency if a problem getting your funds back arises.

Nevertheless, even well established and duly regulated companies can get caught up in a forex fraud. The forex trading customers of Refco discovered this fact out the hard way since the comingling of their funds with the broker’s prevented them from recovering funds after the company’s subsequent bankruptcy.

The Risk Presented by Corporate Fraud

The Refco fraud case, like the Enron fraud case, involved corporate stock fraud that generally involves corporate officers who circulate untrue or deceptive information to bolster the market price of the stock of their company. They usually do this to be able to sell the stock at an inflated price.

The Refco fraud was a classic example of corporate stock fraud or “cooking the books” that was intended to boost a company’s stock price prior to an Initial Public Offering or IPO by its CEO hiding large corporate debts. The company then went into bankruptcy once the fraud came to light.

This type of fraud that is perpetrated by corporate officers at the highest level — like that seen at Refco — is not only potentially costly to the broker’s account holders, but it can clearly also rip off investors who bought the company’s overvalued stock at the IPO only to see its value trashed after the bankruptcy was subsequently announced.

Chris Lee

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