Refco Meltdown is Black Eye of Futures Industry

The U.S. futures industry has gained new respectability in recent years but is bracing for a hit on its reputation as leading broker Refco Inc. (RFX) melts down in a financial scandal.

Shares in the Chicago Mercantile Exchange (search), the largest U.S. futures exchange, have fallen about 14 percent this week in what dealers said was panic selling amid "guilt by association" with-based Refco, through its regulated Refco LLC futures commission merchant, is the largest independent U.S. futures broker.

Refco's former chief executive Phillip Bennett (search) was charged Wednesday with securities fraud over hundreds of millions of dollars owed to the company by an entity he controlled.

Thursday, Refco said it would halt activities at its non-regulated Capital Markets unit for 15 days because its liquidity was no longer sufficient to continue operations.

But Refco LLC as well as Refco Securities LLC, its regulated broker dealer, have so far been "sustantially unaffected," it said.

Trading in Refco shares, which have fallen more than 60 percent this week, was suspended.

"To my Mom and to Joe Sixpack on the street it's those greedy futures flimflam artists at it again. The dark cloud will hang over all for a while, including the innocent," said one former exchange official.

Futures exchanges, the butt of jokes for years about pork belly trading and comedian Eddie Murphy in the 1983 movie "Trading Places (search)," have moved into the financial mainstream over the past decade.

Futures exchanges allow companies and individuals to speculate on, or protect against the movement of, changes in the price of assets as diverse as U.S. Treasury securities, foreign currencies and live cattle.

The CME's initial public offering in late 2002, the first for a U.S. exchange, was a roaring success that paved the way for other exchanges to go public. CME shares had risen to almost $350 on Oct. 3 from an original $35.

Some investors who missed the boat on the CME story saw Refco's IPO in August as a way to get exposure to a growing industry. Refco peaked at $30.55 per share before news of the scandal sent shares below $10.

The situation has also cast a cloud over next week's initial public offering by the Chicago Board of Trade (search), the No. 2 U.S. futures mart. The CBOT did not return calls seeking comment.

At both the giant Chicago exchanges Refco, a firm that has gobbled up more than a dozen smaller futures brokerages in recent years, is a leading contributor of volume.

"As people read these articles they'll assume this kind of thing is going on everywhere in the futures industry," said the chairman of a Chicago futures commission merchant. "The whole industry is getting a black eye."

Many of Refco's customers were said to be switching to other clearing firms to stay on the safe side.

Still, the executive said that in most cases business would not simply disappear and that the exchanges would be unscathed in the long term.

"In many cases, particularly for institutions, it's business they have to do for risk management purposes," he said.

U.S. futures industry regulations are designed to protect customers when financial instability hits clearing members through which they conduct business. Customer positions and funds are segregated from those of the clearing member.

The CME declined to comment on movement in its share price. CME's Clearing Division since 2004 has also cleared trades for the Board of Trade.

The Board of Trade plans to price its initial public offering for 3.2 million common shares on Oct. 18 for trading on Oct. 19, and now finds itself unwittingly pulled into a maelstrom.

"Futures industry IPOs will be guilty by association for a while, and my guess is that the Refco IPO scandal may take some of the wind out of the CBOT's first few days of trading," the former senior exchange official said.