Friday, October 14, 2005

REFCO, or Why I Learned to Love The Bomb

REFCO is apparently shuttering its offshore operations, obviously because now that it has had to fess up to its massive contingent liability, which it had shunted off to a special purpose entity to get the liability off-balance-sheet, it is essentially insolvent. That's my bet.

From a Newsday article today comes a hint of things to come: "In addition, the company's credit ratings were slashed, with Standard & Poor's warning that there was "substantial doubt" about the entire company's liquidity. And analysts said that although its other subsidiaries appear to be running normally, Refco's customers may decide to move their accounts elsewhere."

Substantial doubt. About the entire company's liquidity. Got it.

That's Wall Street's way of saying run for the hills, turn off the lights, it's all over but the lawuits. At least that is how I interpret it in my current pessimistic mood.

There are a couple of noteworthy observations to make here. The first is that *supposedly* everyone involved in the IPO missed looking for special purpose entities used to hide contingent liabilities, now turning out to be mainly naked short sales.

They could have read this editorial blog, where it was hypothesized repeatedly that exactly that is going on, at ALL the publicly traded investment banks and prime brokers, to hide the ex-clearing nightmare.

In fact, I recently had a chit chat with a regulator wherein my message was that I would bet a dollar that the ex-clearing larceny would make the S&L fiasco look like a trip to Club Med. I opined that special purpose entities were being used to hide the billions of dollars of failed shares being kited back and forth in the brokerage community outside of the DTC system, just ledgered back and forth, creating countless effective counterfeit shares for which the contingent liability, should the brokers ever have to cover them or deliver them, could easily outstrip the resources and NAV of that august community, in toto.

And then REFCO blows up, a week or so after that chat. And it turns out that their NAV is inadequate to cover the contingent liability, by all accounts.


My question is, how did the accountants and the investment bankers all miss what the Easter Bunny felt was clear as the whiskers on his face? Aren't these really smart guys? It's the same question I had when Enron and Worldcom and Adelphia were blowing up. Is it possible for accountants and Wall Street MBA's to completely miss fraud and larceny on a panoramic scale?

I don't think so.

I think that REFCO was taken public so that the investment bankers who were invested in REFCO, one way or another, either via equity, or relationships, or credit lines, could foist their bad bet off on the investing public. They laid it off on the rubes that bought the stock, and by the time the smoke cleared, they were whole and the investors were holding the bag.

I think that the investment bank that took them public had to understand what a lovable holiday rodent who specializes as a delivery system for chocolaty treats intuited the first time he got a good look at the system's true outline.

I think that the accountants had to know that there was a systemic, long term problem at the firm that was key in the Rhino/Operation Bermuda Shorts sting, that did Hilary Clinton's questionable commodity trades, that worked hand in hand with Laderman on so many PIPE deals.

I think that REFCO will mark the true end of innocence for many who believe that the financial markets are safe, and that regulators, accountants and investment bankers are any sort of a protection against wholesale fraud. I believe that this will signal the commencement of a run on the stock bank, as confidence in the system is deservedly adjusted to a realistic level - i.e. none at all.

There is no assurance that any of the shares traded today in your favorite company are actually shares. There is no assurance that you will ever receive what you are paying your hard earned money for. There is no assurance that you aren't being lied to, regularly and fluently, by a system that lies habitually and then pretends that it doesn't have any idea what you are talking about.

Witness that the folks being brought in to consult on how to manage the explosion at REFCO are the same folks who took them public, supposedly missing the entire scandal. Doesn't this look a trifle like they are being brought in so that they can cover their tracks and the tracks of the rest of the gang? I mean, you bring in someone else and they might pull the fire alarm within an hour and demand that everyone be arrested - at least if you are managing the process you can apply the same awe-inspiring skill set that cost investors everything, and likely find no fault in your own actions.

The fact that the SEC is allowing this farce to continue for even one more day is more shocking than the depth of the betrayal by the company and their underwriters and accountants. It signals that at all costs, the interests of criminals on Wall Street will be protected, even if it costs the investors (and ultimately taxpayers, if I'm right) hundreds and hundreds of billions, before this is all over.

If you think that's inflammatory, here's the math. REFCO has about half a billion of contingent liabilities largely in the form of naked shorted shares that they have never covered, as far as I can tell. As their liquidation takes place those shares will get bought, and the first shares will be bought for a dollar, the next for two, the next for five, the next for ten. Half a billion could easily go to tens of billions, and REFCO is just one small company.

Now imagine if I am correct, and this type of problem exists on a massive scale throughout the Wall Street community, as the FTD's and ex-clearing problem suggests. Let's say that it is a $25 billion problem today, marked to market. So then the first shares have to get bought in, and it becomes a $50 billion dollar problem. Then the next shares get bought in and it becomes a $100 billion dollar problem. And only 5% of the liability has been covered.

Starting to catch on to how the math works against the market pretty quickly, and how the interests of that market are in ensuring that certain "hot" stocks never go up very far?

Dr. Byrne couldn't get a lousy 25K shares he bought on August 8th delivered for two months because his OSTK shares were "hot". His dad, who bought 200K or so, still hasn't seen any, also because they are "hot".

There is an entire list of "hot" stocks, called the Reg SHO Threshold list. A lot of heat there.

So who deals with the fallout once this blows wide open? Guess what - it will be you, the taxpayer. The bad guys using offshore hedge funds won't be there to cover - their capital will be expended in the first few rounds of covering. The huge insurance companies that use those hedge funds to re-repatriate cash from their offshore subsidiaries sure as hell aren't going to step up to the plate. The dirty money being laundered through them isn't going to double and triple down to cover the cost of their past flim-flams. And Wall Street will quickly run out of NAV to cover the bill - all that money has already departed for accounts in places unknown, and it isn't about to come back to pay the piper.

No, what I see happening is some "Federal Investor Protection" boondoggle wherein the American taxpayer covers the cost of years of rampant larceny, to "protect the interests of American free markets" or some such horseshit. No doubt it will feature a grandmother holding a puppy baking an apple pie while singing the national anthem to a newborn draped in a flag. Fists will be shaken by "outraged" Senators who will ignore that the Senate Banking Committee had for years elected to sidestep holding hearings to find out WTF is up. The reason is because they know WTF is up, and it isn't good, and they are hoping to be gone by the time it all goes south. That's my opinion.

Alternatively, we the shareholders will get the pork put to us, and instead of forcing the community to make good on its liabilities, the elected officials will do some sort of back room workout, wherein they don't have to pay the bills - for the good of God and Country.

Either scenario, we, the investing and taxpaying public, lose big, and the bad guys walk away with our money.

Mark my words. REFCO and Dr. Byrne's lawsuit mark the beginning of an ugly period of revelation for an industry run badly amok.

Now you can ask yourself, or better yet, send Shelby on the Senate Banking Committee an email, and ask what it is going to take to get them to hold the hearings they should have a year ago, and that Bennett lobbied for? How many more REFCO's and OSTK's?

And where is the special prosecutor to go after the miscreants that have engineered this national fiasco in the first place?

Get your shares in paper form. If you are on margin, transfer your account, including margin, to another broker, forcing your old one to come up with shares. This isn't a game anymore, and you have been warned of what the future holds.

And try to have a nice day.


Blogger Askinstoo said...

This comment has been removed by a blog administrator.

9:39 AM  
Blogger rvac106 said...

REFCO, one of the top 10 Brokerage houses that I've never heard of, is effectively gone, and, like it or not, kind of backs up what NCANS and Byrne and Sanity Check have been saying for a few months. That's an observation. The question is; How will this effect more well known brokerage houses, such as Morgan Stanley, or even TROWEPRICE? That's my $64 brazillian question for the day. Any comments?

10:07 AM  
Blogger bob obrien said...

My hunch is that first the brokerages will put the squeeze on their hedge fund customers to start covering, and that will cause a wave of blowouts in the hedge fund community, and likely the derivatives markets, as they are highly leveraged players in those as well as in the stock markets. Next, you can expect the brokers to lobby their Washington protectors to either grant them yet more special exemptions from the rule of law, or else. The or else will be "we are too important to the country to be allowed to fail." Next will come the insurance companies who are backing the IB's getting into the act, also lobbying for someone else to pay the bill.

The first thing that will happen, though, is that the community of brokers will divvy up the damage from REFCO and quietly cover it themselves.

That's unitl this gets bigger, at which point, see the above.

At the end of this rainbow will be the American Taxpayer, who will be required to commit $5 to $10K per person to bail out the financial markets, for the good of the country.

It won't be like the S&L's where there was federal insurance. It will be structured differently, but the end result will be the same. because otherwise the crooks will have to pay the brunt, and as we learned from the S&L crisis, the crooks are adept at never paying their share.

The SEC should be dismantled as it stands when this happens, as it is as useless as a paperweight in safeguarding against participant malfeasance and such, which will be borne out by the unfolding saga.

I'm now going to commit to finishing Symphony of Greed, as this will become the biggest story of our financial lifetime, and folks will likely want to know what the hell happened as it is unfolding.

The odd part is that individual stocks may do surprisingly well as their billions of lost market cap are regained.


10:39 AM  
Blogger nabrum said...

Hurry up with the book. Timing is great AND it just might be the straw on the camels proverbial back that get's the public involved, since the media/politico's are doing anything.

Hope it has perp walks in it - it is fiction - right?

10:59 AM  
Blogger bob obrien said...

The fiction novels are both done, in the can, as 'twere, and ready for an agent/publisher. They stand up and read well.

Symphony is slow going as the depth of research is daunting.

But now I'm at the fun part.

The challenge is that every day something new and significant breaks in the story and renders prior work obsolete, or old news.

It does a good job in explaining the market system and how it functions, and spelling out the roles that all the entities have, and chronicles the shenanigans of Wall Street over the last century, so as to contextualize the current culmination of decades of abuse.

I'll try to get it done over the next 30 days.

I think I said that 30 days ago.

There are no guarantees in life.

Thanks for the interest and support. Any interested agents should email me ASAP - the two fiction novels are so serendipitously times so as to be scary.

11:14 AM  
Blogger Tommy said...

Whiskered one,
were have you seen that the contingent liabilities are in the form of outstanding short shares, naked or not?

11:42 AM  
Blogger bob obrien said...

The NY Post.

1:02 PM  
Anonymous Anonymous said...

The real question is, how long does it take to become a big story? LTCM could do major damage without widespread publicity, because it all hinged around financial instruments. For the stock market to blow up, it's got to be bigger than Enron. You'll notice public furor over Enron is a wee bit tepid of late.

Could be big, though, no doubt.

-Dave Navas

6:22 PM  
Blogger bob obrien said...

I think you are watching in real time as this comes apart, and becomes a big story.

It's like dominoes. Once the first criminal subpoenas are served, the rats start to roll on each other, as they realize that the other smart guy in the Canali suit has already figured out that the early whistleblowers get deals, and the later ones get time.

And with REFCO, the first arrests have been made.

From that I would expect more rats to start scurrying, and further would expect the prime brokers to want to disengage from allowing their hot hedge fund clients to leverage any more of the brokers' money defending bad bets.

The story is already becoming huge, and I would expect next week to really see some attention as further revelations break - that's always how it works.

Of interest is the way this has become a mainstream NY Financial press against the rest of the country issue - it sort of illustrates how polarized the interests are. On the one hand we have the collective silence of the WSJ, Barron's, etc. on the Byrne stock scandal and the REFCO naked short selling issues, and on the other we have some bloggers in the hinterlands doing the heavy lifting to break the stories.

That is messed up.

But it is what it is. The machine will first try to destroy that which threatens it, and then try to distance itself from the worst offenders out of self-preservation.

We are still in the destroy and deny mode.

It's not easy being the Easter Bunny. This week especially. But bunnies are a industrious lot. And they tend to persevere long after many other creatures would have called it quits.

I think this may become one for the record books. Call it a hunch.

9:58 PM  
Blogger Jer. 9:24 said...

It is interesting to contrast the Commodity Futures Trading Commission ("CFTC") against the SEC. The CFTC-regulated Refco, LLC (a futures commission merchant) is, according to all the news I have seen, financially stable and out of danger as a "stand-alone" entity (see, e.g., Friday's Refco must have respected this regulator's authority, at least.

The SEC, on the other hand, (i) allowed Refco's brokerage, market making and clearing operations to become the disaster they appear to be through regulatory neglect or worse, and (ii) allowed Refco to go public and thus as Bob speculated try to throw the mess into the lap of the investing public while enriching its owners (for a time) beyond belief, while (iii) knowing all the time that Refco's securities operations had been involved in patently illegal behavior in at least one (originally NASDAQ listed) public company (Sedona Corp.). But does anyone believe that the manipulation of SDNA was an isolated incident for Refco's securities/clearing divisions? Or that the SEC didn't know about other victims?

Is it really possible that, just this one time, the Badian brothers who ran Rhino Advisors (allegedly) called their brokers at Refco and said, "Of course this is a one-off thing, we have never asked before and will never ask again, but will you, on behalf of our offshore hedge fund clients, destroy just this one company for us by illegally shorting it to death?"

If SDNA was not a one-time manipulation, oh, just as a favor to those friendly Badian brothers or their offshore masters, then how many other NASDAQ and OTC victims did the scum at Refco help rape and murder?

A quick search of the offshore funds (from Panama, Switzerland, etc.) that the Badians "represented" on the SDNA deal and then a cross-referencing with the other companies these funds "invested" in over the years might--just might--give a glimpse as to some of what resides in that off balance sheet debt that has caused Refco and Mr. Bennett so much trouble. Considering also that Thomas Badian was associated with disgraced investment bank Ladenburg Thalmann ("L-T"), it could open a wider potential group.

Then, if sources are correct that L-T has some convoluted cross-ownership with Berliner Freiverkehr (the Berlin market maker that listed--without their knowledge or consent--all those companies on the Berlin-Bremen Stock Exchange in 2004 when the NASD attempted to shut down the Canadian naked shorting loophole), then the list of possible companies grows by at least 1,000.

Refco said in its prospectus it had set aside $5m to settle any SEC charges regarding the SDNA manipulation scam. The SEC by approving their registration statement and allowing Refco to begin trading on the NYSE obviously accepted this as a sufficient penalty, in my mind indicating the SEC had no intention of probing further than--or even more deeply into--SDNA. Meanwhile the Texas-based attorneys for SNDA have sued the manipulators for over $2 billion in damages.

To my knowledge, no indication has been given that the SEC was or is looking at any other illegal shorting-related activities by Refco Securities et al. Maybe there were none. But one must ask, how could the SEC not have known about the unsettled trades allegedly hiding out there in special purpose entities and other "off the books" machinations? Doesn't the SEC regulate the brokerage industry and the clearing firms? Was there no one at the SEC to connect the dots?

Then again, perhaps the SEC just figured, like everyone else in the game, that eventually this little bad debt would go away--eventually all these little victim companies will die off, their shares canceled or de-registered by an ever-helpful SEC (the saga of EagleTech Communications comes to mind); then the potential liability for settling these illegal trades will vanish--like magic! That may be what Mr. Bennett et al. (including the regulators) had planned and expected.

Would it not be interesting to see how many Refco unsettled short positions involve companies that did death spiral financings, Badian-connected and otherwise, that were either bankrupted or that the SEC has or is trying to de-register? (again EagleTech comes to mind.) Does anyone think the SEC will allow such information to become public knowledge?

Of course, if the bad debt has nothing to do with unsettled short sales, of SDNA or otherwise, then all the above is moot. But the coffee that accompanied this post was great.

Another thing, was the NYSE asleep on this, too? Or did they simply rely on their government not to let a company in an SEC regulated business go public—not on the NYSE, never!—with rotting corpses in the closet?

If inclined to feel sorry for Mr. Bennett, as I was there for a while when I first saw his photo in the WSJ, remember, the Apostle Paul said (on behalf of the ultimate Regulator) "whatsoever a man sows, that shall he also reap." An unimaginable amount of money has been stolen from the United States--its companies, their shareholders, the investing public, the federal and state revenue departments; untold jobs have been lost (or were never created); and technological, scientific, medical, etc., advances have been stopped in their tracks, all by those who have perpetrated and aided and abetted this scam. Not that they give a damn, of course. But EVERYONE involved in this market-wide scam, from corrupt government or SRO regulators on down to the weasels who "bash" companies (for a few scraps from the manipulators' tables) on Raging Bull and the like, will ultimately reap what they have sown. For their own sakes I hope their reaping comes in this life, rather than the next.....

9:32 AM  
Blogger mfairview said...

Gotta give David Patch his props. He called this back in July.

3:21 AM  
Anonymous Anonymous said...

The problem is that those that are too big to fail, know that they're too big to fail.

12:34 PM  
Blogger n-tres-ted said...


Have you tried pursuing your concerns through Senator Bennett of Utah? I've seen your reports about the chairman from Alabama, but what about Bennett?

2:02 PM  
Anonymous Anonymous said...

I agree with David Patch and others that naked short selling is out of control for some time.
Parlux is another stock that was on the SHO list at one time.
With 5.4 million in the float and over 3 million shares short someone has a vested interest in the stock going dow.
Coincidence that Greenberg slamed,slamed and slamed Parl on Mad Money.
Better yet the stock will get dragged down 60 cents on very little volume. Than towards the end of the day and/or after hours 100k-300k will be traded with a 2 cent swing.
I think the hedgies have been trading the stock amongst themselves to stay of the SHO list.
The sec is useless.

4:17 PM  
Blogger Reintarnated said...

Notice the Reg SHO list, as of Friday 10/14/05, has only 47 Nasdaq stocks. ABLE, which has been on the list since inception, has been dropped. 34 symbols were removed from the Nasdaq list on Friday.

Might be the start of something.

9:08 PM  
Anonymous shorty2 said...

the sec and cftc had some information regarding a key piece/player in all the refco fire, for about a good year. Perhaps the player was just too big to look into. If they had just done their job we would have avoided the refco implosion. But that , my friends is for me to know and the movie producers to tell. What I have reads better than any john grisham!!!

1:35 PM  

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