Refco's flameout ends history of ups, downs

By Elliot Blair Smith, USA TODAY

During the Vietnam War, Army Lt. Thomas Dittmer served the military as a social liaison to the White House, where he attended state dinners and made small talk with politicians and visiting businessmen and danced with their daughters.

Refco and NYSE officials ring the opening bell Sept. 9 during better days.
By Mel Nudelman, NYSE via AP

Fresh off the Midwest plains, Dittmer used his White House connections to pay his stepfather a favor that otherwise would have been beyond either's reach. The man Dittmer called Pop was an obscure Sioux City, Iowa, businessman named Ray E. Friedman, who had been convicted more than a decade earlier of selling substandard chickens to Army troops during the Korean War. Friedman served two years in federal prison for that offense. (Story: Dittmer to unveil new trading venture)

In June 1966, President Lyndon Johnson pardoned him. Last week, Dittmer, in a rare interview, confirmed to USA TODAY that he had helped rehabilitate his late stepfather's criminal record.

LBJ's intervention might have been the last time the reclusive Dittmer and the flamboyant Friedman welcomed Washington's influence. By the time of the presidential pardon, Friedman was on the rise again, amassing a fortune at the Chicago Mercantile Exchange. He traded cattle futures at a raucous new market there, launched in November 1964, that was prone to traders' excesses.

Ray Friedman founded Refco with stepson Thomas Dittmer in Chicago in 1969.

Dittmer left the Army in 1966 and moved to Chicago to learn the commodities trade. Three years later, he and Friedman formed a partnership called Ray Friedman & Co. Eventually, the firm moved to New York, was renamed Refco and grew into a global trading powerhouse. Along the way, Friedman and Dittmer created riches for themselves and select clients while frequently clashing with regulators and less-fortunate investors.

Now, Refco courts ruin amid another criminal investigation. Dittmer's successor, Refco CEO Phillip Bennett, 57, was charged by federal authorities with a felony count of securities fraud last month. Today, Refco's regulated commodities trading business will be auctioned off in bankruptcy court while management and creditors sort out the tangled affairs of its unregulated investment businesses in the months to come.

Federal authorities acted after internal auditors at Refco accused Bennett of manipulating the firm's financial statements to disguise a $430 million personal debt to it. Bennett repaid the IOU and denies wrongdoing. But Refco investors responded to the scandal by pulling billions of dollars of capital. The liquidity drain forced the firm to seek bankruptcy-court protection from creditors.

Amid civil and criminal investigations, Refco's flameout is one of the most spectacular financial failures in U.S. history. More than $1 billion in investor capital evaporated between its initial public offering in August and its Oct. 17 bankruptcy filing. That is the swiftest crash of a public company on record.

Refco's unraveling is all the more remarkable because the firm handled more trades than do most of the world's financial exchanges. Its edge was electronically matching buyers and sellers through its own unregulated global trading platform.

"Refco — if they wouldn't have gone broke — in five years they would have been the exchange," says Dittmer. "That is the right business model." The legendary trader, now 63, cashed out the family stake in the firm and retired to a private life in the British Virgin Islands in 1999.

In what promises to be a major development in the easily spooked futures markets, Dittmer now plans to return to Wall Street, prompted by Refco's collapse and its effect on his and his stepfather's legacy.

He considered making an offer for Refco's assets in bankruptcy court, backed by Dubai, a member of the United Arab Emirates. Now Dittmer plans to form a venture with nephew Bradley Reifler to compete with it. Reifler, 45, Friedman's grandson, is a former star trader at Refco who says he left in 2000 after Bennett refused to sell him a stake in the firm.

Dittmer and Reifler were in London on Tuesday to negotiate financial backing for the partnership, which Reifler says they plan to launch "imminently."

Reifler says, "Tom and I are both very, very upset that this has happened, that a great company and great people within the company have been destroyed."

Former Refco trader Hany Labib, who left the firm in 1987, adds that Dittmer is "perfectly capable" of again becoming the dominant commodities trader he once was on Wall Street.

Dittmer refuses to discuss Bennett, but his bitterness is undisguised. He had hired the suave Brit as chief financial officer, and promoted him to CEO, to inject professional management into a firm that was run on traders' instincts. Bennett led Refco's peripatetic expansion into lightly regulated derivatives, foreign exchange and other sophisticated financial products around the world. The end result was catastrophic.

Key dates in ups and downs of Friedman and Refco

September 1913: Ray E. Friedman is born.
April 22, 1952: Friedman and American Produce plead guilty to felony charges related to falsifying the time stamps on slaughtered chickens sold to the U.S. Army.
May 5, 1955: Friedman is paroled.
Early 1960s: Friedman starts trading agricultural commodities on an orange crate at the Livestock Exchange in Sioux City, Iowa.
November 1964: Chicago Mercantile Exchange begins trading cattle futures.
June 29, 1966: President Johnson pardons Friedman for decade-earlier felony.
October 1969: Ray Friedman & Co. is formed in Chicago as a partnership between Friedman and stepson Thomas Dittmer.
1974: Friedman sells his Refco stake to Dittmer.
July 1978: Refco client Hillary Clinton, now a U.S. senator, cashes out $99,000 profit on a $1,000 short-term investment trading cattle futures.
Feb. 17, 1983: Commodity Futures Trading Commission fines Refco CEO Thomas Dittmer and the firm $525,000 for allegedly attempting to corner certain farm commodities markets.
March 12, 1992: CFTC fines Friedman, at 78, and Refco $590,000 for allegedly attempting to corner the frozen pork-bellies market.
Aug. 7, 1996: Securities and Exchange Commission orders Refco to pay $3.5 million for "concealing" $80 million fraud by former California money manager Steven Wymer.
October 1997: Emerging-markets crisis deals several Refco clients big losses.
August 1998: Russian default crisis deals more losses to Refco clients.
September 1998: Refco Chief Financial Officer Phillip Bennett is promoted to CEO, replacing Dittmer.
March 1999: Dittmer relinquishes chairman's post to Bennett and retires.
May 24, 1999: CFTC fines Refco $6 million for massive record-keeping violations and lax internal controls related to trades by discredited Beverly Hills money manager Jay Goldinger.
August 2004: Thomas H. Lee Partners invests $453 million in Refco for 51% stake.
Nov. 23, 2004: Friedman, 91, dies in Palm Beach, Fla.
May: Refco discloses the firm and one of Bennett's top aides, Santo Maggio, are targets of an SEC investigation into illegal short selling of Sedona shares.
Aug. 16: Refco makes initial public stock offering at $22 a share.
Sept. 7: Refco stock peaks at $30.12 a share.
Oct. 10: Bennett steps down after being confronted by an internal audit that concludes he disguised a $430 million debt to firm.
Oct. 12: Bennett is charged with one criminal count of securities fraud for allegedly manipulating the firm's financial statements. He denies wrongdoing. Refco halts customer withdrawals at unregulated Refco Capital Markets unit due to cash squeeze.
Oct. 13: New York Stock Exchange halts Refco share trading at $7.90.
Oct. 17: Refco files for bankruptcy-court protection from its creditors.
Today: Refco, the original regulated business, is to be auctioned off. The parent Refco and unregulated Refco Capital Markets remain frozen in bankruptcy court.

Source: USA TODAY research

As for Friedman, he died last November, at 91, after an uproarious life and career. "I think he'd be spinning in his grave with all this mess," says Elliott Wooldridge, 85, who was a close friend of Friedman and is a retired Sioux City insurance agent. "He and Tom built an empire. He was the hardest worker you ever saw. It's a shame that a company like that — that had all the attributes of a top-notch company — is going out of the picture. I can't believe they are going to survive."

Egg-truck trader

With wavy red hair, a dimpled chin and gregarious grin, young Friedman — the son of a Jewish grocer — grew up poor on the predominantly Protestant plains.

When he was a boy, Friedman's parents bought eggs and chickens in the countryside and sold them in town, teaching the youth his commodity-trading acumen. "He was raised on the back of an egg truck," says Ben Shapiro, 81, a friend who lived one block from Friedman in a low-income neighborhood of Sioux City.

As a man, the powerfully built 6-foot-2 Friedman married Eve Dvorkin, bought a used egg truck and built his own trade into American Produce, a farm-products wholesaler. But in March 1952, Friedman and three brothers-in-law were indicted for falsifying the time stamps on a batch of slaughtered chickens American Produce supplied to Army troops in Korea.

In a decision he regretted, Friedman pleaded guilty, expecting to pay a modest fine. American Produce was penalized $10,000, and the brothers-in-law were paroled, the court record shows. But the presiding judge made an example of Friedman. Shapiro recounts the judge saying: "You're trying to poison our men in the armed services. You're going to go to jail for five years."

Robert Waldo, 77, a veteran of the Army's Veterinary Food Inspection Service, who gathered evidence against Friedman in an investigation that stretched from Korea to Japan to the USA, says, "They could have gotten him on 20-some counts, but he pleaded guilty to the one that was necessary to convict him."

Unsuccessful legal appeals led to Friedman's incarceration at a farm camp in Terre Haute, Ind., and then at Seagoville, Texas. Two years later, at 43, he was paroled. He returned home, broke and jobless, and his wife was about to leave him for another man.

Friedman briefly sold neckties door-to-door, then went back to selling eggs. Driving an old car whose front bumper was attached by baling wire, he, too, fell in love again, with Evelyn Levine, a married woman who worked at Sam's Delicatessen across the street from American Produce. This twice-married waitress, ambitious and smart, was Dittmer's mother.

"She had a little money saved up, and she always joked that Ray married her for her money," says Reifler. Dittmer observes, "Together they were unstoppable. They were a great team."

It is not recorded when Friedman began selling farm commodity contracts through the Chicago Mercantile Exchange. But contemporaries remember the circumstances. At the Sioux City Livestock Exchange, he started with an orange crate to sit on and a big chalkboard on which to write the day's quotes for cattlemen who walked by. Later, he erected an office of sawed lumber in the livestock exchange lobby, with a plate-glass window to showcase his chalkboard prices.

Former Livestock Bank president Stanley Evans, now 87, says Friedman came to him to finance one of his first trades. Friedman, he says, had lined up a half-dozen local clients who had written checks to fund a shared commodities contract but needed to wire cash to the broker in Chicago.

Says Evans: "I looked at the checks and decided, 'I know these people.' And I told Ray to give the checks to my secretary every day and we'd advance funds on those checks."

The Chicago Mercantile Exchange was moving beyond its base of selling agricultural hedges to farmers when Friedman and Dittmer formed Ray Friedman & Co. as a partnership. Sophisticated investors were beginning to see the futures market's potential.

"The center of the universe at that time was Chicago," says Dittmer. "You'd stand in the middle of the road and people would stuff money in your pocket."

The partners' problem was that Dittmer wanted to re-invest the firm's profits to make Refco a global player — with commodities exchange seats and offices in Chicago, New York and London — while Friedman wanted to enjoy his newfound wealth.

"He wanted to take the money out and spend it," Dittmer says. In 1974, he bought out his stepfather, though Friedman continued to trade at the firm.

Las Vegas visitor

Friedman became a frequent visitor to Las Vegas, where he bought a hotel and casino. He hobnobbed with celebrities and showcased his card-playing skills. Back home, he showered gifts on a local panhandler who awaited him each day and a Native American youth for whom he arranged college tuition.

Whatever he spent, he made back in the markets.

But Refco's principals gave preferential treatment to some customers over others, according to some of the nearly 300 Commodity Futures Trading Commission enforcement actions, arbitration cases and customer reparations complaints brought against the firm and its principals since its founding.

One beneficiary of Refco's trading prowess in the late 1970s was Hillary Clinton, the wife of then-governor of Arkansas Bill Clinton and now a U.S. senator from New York. She converted a $1,000 short-term investment in cattle futures at Refco's Little Rock office into a $100,000 portfolio. Clinton's profits provoked a flurry of controversy on Capitol Hill after her husband was elected president, but neither she nor Refco were formally charged with any related wrongdoing.

Friedman and Dittmer also benefited by trading for themselves, relatives and friends. In 1983, the CFTC fined Refco and Dittmer $525,000 and suspended him from trading for four months for allegedly trying to corner some farm commodity markets.

Friedman and his wife retired to Palm Beach that year, but he continued to trade commodities. At 78, he, too, was sanctioned by government authorities in March 1992 when the CFTC issued fines of $590,000 against him and Refco, and suspended the septuagenarian for two months for allegedly trying to corner the frozen pork-bellies market.

Friedman's grandson, Reifler, also got caught up in the family trading frenzy, according to a customer-reparations complaint filed with the CFTC at the same time. Texas business executive Perry Esping, now deceased, complained that he lost $2.3 million by following a family trading strategy through Reifler that Friedman's grandson allegedly boasted "never fails, it works 100% of the time." Reifler disputes the recollection. The complaint was settled privately.

In 1994, Dittmer moved Refco from Chicago to Wall Street, reflecting his global ambitions. But the firm's rough-and-tumble regulatory history accompanied it and grew apace. In 1999, the CFTC fined Refco $6 million for massive record-keeping violations and lax internal controls and ordered it to pay $1 million more to fund an industry study to curtail customer abuses.

Under pressure, Dittmer resigned. Bennett, the smooth-talking, Cambridge University-educated financial professional whom Dittmer recently had promoted to CEO, added the title of chairman.

With Bennett at the helm, Refco pushed harder into fast-growing unregulated markets that served hedge fund and institutional customers, and further away from its traditional base of buying and selling agricultural commodities for individuals.

Bennett negotiated the acquisition of 16 smaller competitors and grew Refco revenue by nearly 24% a year through 2004. The firm's reach grew to encompass 200,000 customers in 14 countries.

Troubling cracks

Even so, troubling cracks appeared as Refco prepared to sell stock to the public in August.

Lawyers for the initial public offering documented two significant weaknesses in the firm's internal controls and described a Securities and Exchange Commission investigation into a short-trading scandal that implicated one of Bennett's top aides.

The prospectus also disclosed that Bennett and a private equity partner he'd invited to buy into the firm, Thomas H. Lee Partners, had pushed Refco's debt above $1 billion, in part to fund a special dividend to the owners. The document said that Refco's board and internal accounting functions would have to be strengthened and that its financial systems probably would not meet SEC standards until February 2007.

Refco's subsequent disclosure that Bennett hid personal obligations to the firm of at least $430 million — and possibly up to $545 million — provoked an instant, and devastating, evaporation of confidence on Wall Street. "When all this happened, some of the deficiencies the auditors identified in the IPO document became excruciating," says lawyer Arthur Hahn.

It remains unclear how the debts originated, though Bennett personally approved large extensions of firm credit to investors who suffered reversals during the 1997 and 1998 emerging-markets crises, according to civil lawsuits against Refco. It also is unclear why the debts weren't charged off, though lawsuits say that Bennett was extending credit as the firm's CFO and that some loans turned bad around the time he was promoted. Writing off the debts likely would have strained the capital cushion at Refco's regulated brokerage arm and might have imperiled Bennett's standing at the firm. The debts roughly correspond to the period when Dittmer sold his stake back to the firm.

In Sioux City, people still remember Refco's founder, Friedman, as a poor youth who used his savings from a paper route to buy his mother a washing machine. And they remember the rich man who, before moving to Palm Beach, shucked his expensive winter coat, stuffed it with cash and gave it to the local panhandler.

Dittmer was forever impressed by his stepfather's happy-go-lucky nature in the face of so many bitter disappointments. "He said, 'Hell, it's easy. There's happy or sad. I choose to be happy,' " Dittmer recounts. But Dittmer is not happy that Refco may be remembered best for its devastating finale. "This didn't have to happen," he says.

Chicago attorney Robert Byman remembers Refco differently. Byman, who has sued the firm and some of its brokers on behalf of individual trading clients, says, "Refco made a lot of enemies over the years. And a lot of those people are probably pretty smug right now."

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