Spotlight on Grant Thornton in Refco Bankruptcy

The announcement on October 18 that Refco, Inc., the giant futures broker, would seek bankruptcy protection for $48 billion in liabilities just one week after the company revealed an accounting problem, and only ten weeks after their initial public offering, has focused attention on their auditor, Grant Thornton LLP.

Philip Bennett, Refco’s CEO, who is currently on leave, has been charged with fraud relating to $430 million in Refco debt that he had allegedly hidden over a period of years in a company in his own name. Refco announced on October 9 that financial statements of the Company which has been audited by Grant Thornton since 2002 could not be relied on. Grant Thornton is currently the plaintiff in several shareholder lawsuits, according to the New York Times.

Questions have arisen about why the nation’s fifth largest accounting firm failed to uncover transfers of debt among three entities: Refco; a company controlled by Refco’s former CEO, Philip Bennett; and a third party, Liberty Corner Capital -- transfers that succeeded in hiding the $430 million dollars of debt for years.

Grant Thornton, the U.S. arm of Grant Thornton International (GTI), has defended its position, claiming it was misled by Bennett. A Grant Thornton LLP spokesperson forwarded a statement to AccountingWeb which said, “We are continuing our investigation related to the matters reported by Refco in its press releases. While our professional consideration is still underway, it appears to be a purposeful deception that required participation by senior management, hidden well enough to also evade numerous other detailed financial inspections performed by many of the most well-respected financial institutions in the country.”

Edward Nusbaum, chief executive office of Grant Thornton said, according to the Times, “We want to find out exactly what happened. I think companies are judged by how they deal with these situations because, even with Sarbanes-Oxley, there’s no guarantee of catching all fraud.”

Grant Thornton had disclosed in August that Refco lacked “formalized procedures for closing its books,” and that it needed to increase its finance department resources “to be able to prepare financial statements that are fully compliant” with regulatory requirements, the Times reported. One issue for Grant Thornton is whether these “red flags” were sufficient warning to potential investors of accounting problems in the company, the New York Post says.

Bennett is alleged to have transferred receivables from his own company at the end of quarters to Liberty Corner Capital. Liberty, a hedge fund, paid interest to Refco on the receivables it held. The receivables were then returned to Mr. Bennett’s company in the following quarter, effectively disposing of them. As auditor of Refco alone, Grant Thornton never saw the documents that showed these transfers. When questioned on the interest by Grant Thornton, Liberty confirmed that it held the receivables, the Times reports. After an August spike in interest paid by Liberty, the debt problem came to the attention of Grant Thornton who began their own investigation in September, the Times says.

“The odds are high that the auditors were hoodwinked, but it’s an open question as to the size of any red flags which were missed,” Christopher Bebel, a former U.S. securities and Exchange Commission (SEC) attorney told Reuters. “The plaintiffs [in the shareholder lawsuits] are going to argue that these deficiencies which existed at Refco . . . served as red flags and a more thorough investigation was warranted once these flags were discovered,” he said. But these same disclosures can provide a way out for the auditors and underwriters, he added.

Refco said in its August SEC filing that its auditors had warned it in February of deficiencies in internal controls due to inadequate resources at its finance department, Reuters reports.

In fact, a new hire in the finance department, Peter F. James, initially questioned the interest spike from Liberty, according to a report Monday in the New York Times. James brought it to the attention of the company’s chief financial officer, Gerald M. Sherer, who had joined Refco in January. Answering James’ questions led to the discovery of the unacknowledged debt and subsequent collapse of the company.

GTI is standing by its U.S member firm, Global Chief Executive David McDonnell announced on Thursday, according to Reuters. “There is absolutely no question of separation and I don’t believe there will be,” McDonnell said. GTI broke with its Italian arm in the wake of the Parmalat scandal in 2003. “We separated from our Italian unit because they were unable, unwilling to cooperate with us,” said McDonnell, who said that he believed Grant Thornton LLP was investigating the problems at Refco thoroughly, Reuters reports.