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The Wreckage of Refco

Why turn to television when Refco (NYSE: RFX  ) provides a true-life soap opera?

When the futures and derivatives brokerage went public Aug. 16 -- yes, just two months ago -- it was seen as a pure play in the commodities market boom. Investors who missed the boom in the Chicago Mercantile Exchange (NYSE: CME  ) shares had a second chance at big gains.

Then the plot twists began.

On Monday, Oct. 10, the company disclosed a $430 million receivable that was not properly recorded on the company's books -- but was repaid by the CEO in cash. Suspense hung in the air as the CEO was asked to take a leave of absence and the company talked about its excess regulatory capital.

The following day, the company said it had the capital to run its businesses, while the evening news covered the CEO's arrest for securities fraud.

By Thursday, Oct. 12, the unregulated Refco Capital Markets subsidiary imposed a 15-day moratorium on its operations because it didn't have sufficient capital to continue operations and it wanted to "protect the value of the enterprise." The company hired Goldman Sachs (NYSE: GS  ) as a financial advisor.

On Friday, while the folks holding the $1 billion in company debt met, the company said that its Refco Securities subsidiary would initiate a process to unwind proprietary and client positions.

Yesterday, the final twist arrived: Refco and its non-regulated subsidiaries announced that they had filed for bankruptcy. An investors group offered $768 million (103% of the net capital to be acquired), via a memorandum of understanding, to buy the futures brokerage business.

Where does this leave Refco shareholders?

Their stock is still suspended from trading on the NYSE, although it opened at $0.75 on the Pink Sheets this morning. That's high, considering that the futures brokerage deal could fall through. Even if it succeeds, the money on the table doesn't cover the company's $1 billion in debt, plus the cost of years of legal wrangling ahead.

The soap opera will run for months. The lead "joint book-running managers," as they're called, of Goldman Sachs, Credit Suisse First Boston, and Bank of America (NYSE: BAC  ) will almost certainly be quizzed about the due diligence they performed before unleashing Refco's IPO upon the market.

The company's other serious issues include its lack of the necessary liquidity to serve in its capacity as a clearinghouse entity. As its clients and investors stampede for the exits, the company requires more capital than ever to act as counterparty to trades in which its clients are currently engaged. This will likely require copious amounts of emergency financing, which probably won't come too cheap. Remember also that equity holders land at the bottom of the chain in the bankruptcy pecking order. I just can't see a positive outcome emerging here.

Still, the company didn't file to liquidate -- it filed under Chapter 11. Stay tuned. The drama's just beginning.

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Fool contributor W.D. Crotty does not own any shares of the companies mentioned. Clickhereto see The Motley Fool's disclosure policy.

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