Wednesday, October 26, 2005

The REFCO Smoking Gun?

(Note: When this was first published late at night two days ago, I had bounced the $10.5 billion liability marked Securities Sold But Not Yet Purchased off a few savvy folks, and first pass was that it was likely partially FTD's. Upon reviewing the prior filings, it became obvious that it was neither mostly FTD's, nor mostly legitimate short sales - both takes were incorrect. The prior filings articulate much of it as Treasuries, which to his credit, Alan Newman caught early on, or rather hypothesized early on, and the next day's digging confirmed it. So the column was modified to reflect the more accurate take, but still poses the very valid question: If the books are cooked and you can't believe what they represent, why won't the regulator simply tell us what is on the balance sheet so we don't all have to guess? Self-proclaimed experts on brokerage balance sheets got this wrong in the prior blog entry, as did my guys (and thus so did I), and frankly nobody easily agrees on most of what they are looking at - even to the total liabilities of the company from week to week in their declarations. So the call to action is the same - tell us what is going on, and settle the trades. Below is the newly modified piece.)

The listing for the assets and liabilities of REFCO was just made available, and guess what just happens to be hiding in the liabilities column?

A $10.5 billion liability, at TODAY's mark to market valuation, called "Securities sold, not yet purchased."$10,590,379,000 - to be precise.

Securities that have been sold. But haven't been bought. And they haven't been borrowed, either. At first I thought that this must be obvious evidence of a huge FTD position - which was reinforced by some of the early folks who offered their take on it. Upon further digging, there is a benign explanation, and yet one which itself raises troubling issues.

Most of the $10.5 billion liability are legitimate short sales and government securities. At least per their filings.

Which then begs the question at the heart of the matter: Can one believe anything in the filings of a group which routinely hid and played shell game with almost half a billion of liabilities, and whose numbers seem to shift like the wind? I'm sure there are arguments in favor of doing so, but frankly, I have a hard time swallowing many of them. If a management team is educated and larcenous enough to go down the road of outright fraud at a pretty sophisticated level, what reason would anyone have to believe that they confined their willingness to obfuscate and deceive to only one liability?

We don't know what in the 10Q we can believe, as they are now known to be a fiction - the books have been cooked. As with Enron, it becomes a game of "which part of the story would you like to believe today?" Some unknown percentage of the liability is likely FTD's, given the company's history and the reluctance of Wall Street to buy the company when it was offered to them, per the NY Times. The question is what percentage.

But why speculate?I think it's time that we find out, no? Why guess any longer - let's get it out on the table.

These guys were being sanctioned for being involved in a prior naked short selling scheme, and were known as the go to guys for questionable types desiring greater "flexibility" in their trading. They lied to their auditors, the SEC and the public about their financial condition. Their CEO has been cuffed. They've had a reputation as "loose" for a long time - consider this from tomorrow's NY Times:"In 2003, Pershing, a unit of Credit Suisse First Boston that offered clearing services for equities, was sold to Bank of New York for $2.5 billion, an indication that greater value was being placed on such services. Lee had taken a preliminary look at Pershing. That year same year, Mr. Bennett approached investment bankers about selling Refco. The bankers canvassed Wall Street, trying unsuccessfully to find an industry buyer.

A senior Wall Street executive who attended a meeting where Refco was pitched said that the biggest concern was that it cleared transactions for many small customers in the United States and overseas whose practices might pose a risk to Wall Street firms (emphasis mine)."I think there's reason to believe that REFCO is the smoking gun the industry has been dreading. Wall Street wouldn't touch REFCO with a ten foot pole a few years ago because of "risky practices" of some of their overseas and domestic customers, so the management laid off the risk on the investing public instead. Nice. And the SEC let them.

You heard about this here first. Many months ago. In March, when I was speculating about a catastrophically large level of fails in the system, being covered up by the brokers and the SEC. When I was writing about special purpose entities being used to hide the size of the problem.

And here we are.The whole BK filing can be viewed here.

I'm not going to go into the $1.25 billion of their claimed assets that are intangibles and "goodwill." Or the offsetting assets which collateralize the FTD's (cash, which is what you'd expect with FTD's). It doesn't really matter. If I'm right about the industry's use of leverage and the risk posed, covering substantial FTD's at REFCO could vaporize the leveraged customers beholden to them.

This is the systemic risk issue I've been warning about.

And this is just REFCO. One company. Only one.

I think we need to know an accurate breakdown of what the composition of the REFCO liabilities actually are, and be turning over rocks to find any other hidden liabilities. Because once a liar...The problem is now one of credibility. The SEC and DTCC's penchant for hiding all the FTD data, and refusing the vast majority of FOIA requests has to stop. There is no reason that the level of fails in a fraudulent company like REFCO justifies secrecy rivaling the Manhattan Project.

I'd like to see a list, by security, of REFCO's FTD's. There's no point in keeping them secret anymore. I'd like to see how many NFI shares, and OSTK shares, and TASR shares, and NAVR shares are in there. And I'd like to understand who is violating the rules. I think that is reasonable. The hackneyed platitudes that the SEC "doesn't want to cause volatility or give away the trading secrets of the participants" are hollow. We don't want speculations and more guesses. We deserve facts.

And guess what? We know the trading secret now. You just print shares in the back room to your heart's content. It isn't a secret. And frankly, IT NEVER SHOULD HAVE BEEN.

I'd like to see a Congressional hearing immediately, and I'd further like to hear Shelby share with us why he didn't feel that it was time yet to convene the Senate Banking Committee about the matter, when Bennett was pushing for it.

I'd like to see a special prosecutor cut through the secrecy and BS and tell us how many billions, hundreds of billions, have been stolen from us, and by whom.

And I'd like to see the system do its bare minimum job, and settle the trades.

This is going to be the biggest crisis to hit Wall Street in our generation. Mark my words. Cat's out of the bag now. And the SEC and Wall Street have some explaining to do. And some stock to buy, seems like.

The class action attorneys are going to go crazy over this. What do the other, larger brokerages have hiding in the back room? How much bigger can this get? Can anyone even guess at this point?

With REFCO, we have one of the known aggressors in the naked short selling game, now failed, its investors defrauded. We have financials that are a fiction. We have uncertainty over what their actual liabilities and assets are. We, in short, have no idea what was going on there.

If a large portion of the hidden liabilities at REFCO are FTD's, it's time to settle the trades, and make the perpetrators start paying their bills.

Settle the trades. As 17A mandates.

The law should not be selective nor preferential


Anonymous Anonymous said...

Bob read my blog pronto.. Something stinks on Mad Money tonight and it was directed at

5:47 PM  
Blogger Wicked World said...

In all the years that the laws have been on the books has there been even one case in which the SEC acted to force a brokerage to buy-in and settle the trades?

9:08 PM  
Blogger bob obrien said...

This comment has been removed by a blog administrator.

11:02 PM  
Blogger bob obrien said...

This comment has been removed by a blog administrator.

11:53 PM  
Blogger bob obrien said...



And therein lies the problem - not so much that they don't, but that the public has the naive expectation that the SEC is defending their interests. It is provable that they aren't. And haven't for at least 20 years. And didn't in the beginning, either. They have never gone after the participants. So to believe that they would here is foolish - it ignores history. A better way of framing one's expectations would be that the SEC is there to shield the participants to the extent that they can, while providing the illusion of keeping fair markets.

That's why I've been saying for months that it is the states and the DOJ and the elected officials that will do the heavy lifting here - the SEC will be the last one to the dance and will do the bare minimum to keep from being humiliated and revealed to be a sham, IMO.

Roberto: It stinks alright. And nobody does anything about it.

This is the latest article from the London Times, quoted in part:

"Refco to be questioned over claim of 'naked shorting'
James Doran, Wall Street Correspondent

26 October 2005
The Times

INVESTIGATORS working on behalf of Refco creditors are examining whether the bankrupt commodities trading firm engaged in more than $10.5 billion (Pounds 5.9billion) worth of "naked shorting", a trading practice that is illegal in the United States.

The investigators became concerned when they found reference to a $10.59 billion item listed as "securities sold, not yet purchased, at market or fair value" in Refco's balance sheet filed in its quarterly report with the Securities and Exchange Commission on May 31. Such a notation is used to describe stock that is sold "short", but the investigators have been unable to find which shares, if any, were involved.

Traders must borrow a stock, or determine that it can be borrowed, before they sell it short. However, some professional investors and hedge funds take advantage of loopholes to sell shares without making any attempt to borrow the stock. This practice, which has been illegal in the US since 2003, is called naked shorting.

Goldman Sachs and Credit Suisse First Boston, both investment banks among the underwriters of Refco's August flotation, are also said to be looking into the allegations. However, a Goldman spokesman declined to comment.

The allegations follow further claims of accounting irregularity at Refco. Two commodities funds backed by investor Jim Rogers are suing Refco demanding the immediate return of $362 million seized in the Refco bankruptcy.

Refco was unavailable for comment."

And here I was thinking that my naive take on the $10.5 billion was being unfair to REFCO, and that we should trust in God and Country and their 10Q - now it appears I may have been the first to the party after all.


7:16 AM  
Blogger Wicked World said...

Bob, thank you for your response. I do now recall reading your thoughts on the matter regarding who actually might step up: SEC or States, etc. (BTW, I've been following your various online contributions since mid-summer and appreciate them immensely.) So what if the States don't come through? What if nothing changes? I mean with the case you've laid out, next to inheriting lotsa wealth, naked-shorting seems like the smartest thing in the world to do. Not that I can just start doing that. From what I understand it requires in excess of 25 years investing experience and I'm a tad shy there. So if nothing changes what can a company realistically do to fight this?

10:08 AM  
Blogger Jer. 9:24 said...

Interesting news about Refco in the WSJ today (10/28/05 - Section C, Page 3). Santo Maggio has decided to cooperate with the government. If I recall he's the guy looking at individual sanctions/penalties for his role in the Sedona manipulation. [Notice the bias of the reporters, evidencing Bob's "cone of silence" by the major financial press, as they describe the investigation of Sedona as "allegedly improper bearish bets on the stock of software maker Sedona Corp."] "Investigators are probing beyond the allegedly hidden debts into other financials (sic) matters at Refco--another area where Mr. Maggio's insider knowledge could prove crucial."

Maggio was head of Refco Securities, then took over the Capital Markets business. He has to know where the bodies are buried, or rather the FTD's are buried, and who is or should be on the hook for the margin required to "defend" the illegal short sales Refco facilitated--and the cash needed to cover those illegal short sales.

According to this article, the SEC probe of Refco and Maggio has been going on for SIX years. One has to wonder what the hell is taking so long. Can't the SEC get the books and connect the dots in six years? Could it be the friendly folks at SEC are purposely taking their time, as more and more manipulated companies die off or are killed by bankruptcy or timely "de-registration" proceedings by the SEC, a la EagleTech Communications? Just a query. It's not as if the SEC has given the investing public a lot of confidence in its willingness to deal with these matters. But let some little OTC company mis-spell a word in a 10-Q -- funny how there's always plenty of time to nail the little guys to the wall, while Wall Street steals billions in plain sight....

Finally, notice the prosecutors' words in arguing against a reduction of bail for Bennett: "We have reason to believe he is sitting on a pile of cash somewhere." If I recall, the feds can't get Thomas Badian, the scumbag who ran Rhino Advisors and used Refco for some of his clients' dirty deeds, extradited from Austria. Wonder if that is why Bennett planned a little wine tasting adventure in Austria just before hell broke loose? Maybe they all planned to have a celebratory bottle at the offices of Bawag in Vienna.

3:17 PM  
Blogger Jer. 9:24 said...


Here are two questions for you, surrounded by some information gleaned from today's WSJ:

On page B3 of the WSJ's Saturday edition (10/29/05) is a little story about some of Refco's creditors who are "disputing the company's claim that their funds are in unregulated accounts that offer few protections in bankruptcy proceedings."

For example, two of Jim Rogers' commodity funds are listed as creditors (for a total of approx. US$360 million) in the Refco bankruptcy, but have filed lawsuits saying they should have been listed as customers of the regulated (in this case futures) side of the business, not creditors of the unregulated entities that filed bankruptcy, and thus the funds' moneys should have been--and should still be--accessible to them.

Now this seems to be a simple issue: were Rogers' commodity funds customers of the (regulated) futures business, or were the moneys his funds deposited with Refco a loan (whether in reality or "de facto") to the unregulated entities run by Refco (such as its capital markets division)?

Shouldn't the account opening documentation and documented trading activity easily resolve this issue? Would a smart guy like Rogers sue Refco saying he should be a Refco Futures customer (thus entitled to withdraw his $360m) if he did not have a paper trail showing that to be the case? This is curious.

(I do acknowledge that it is a smart move for anyone with a colorable argument, since to be a regulated customer rather than an unsecured creditor will likely mean he ultimately gets the money back; but such customers/creditors--and especially the lawsuit filing attorneys--are asking for a world of pain from the federal judge if there is no legal justification for such a lawsuit. Think Rule 11 sanctions, assessment of costs, fees, etc., and possible severe penalties from the bankruptcy trustee as well.)

I suppose I am wondering this, and I hereby pose it as a question to Bob, since he is the brains behind this blog: Do you think that Refco is improperly listing some customers as creditors for purposes of holding on to the cash for as long as which is or may be needed to defend "naked" short positions that the (unregulated and Bermuda-based) Refco Capital Markets Ltd. ("RCM") has established but not settled?

To restate and simplify the question, could it be that Refco was mis-appropriating customers' money, that is, mis-allocating regulated funds to unregulated subsidiaries (such as RCM), for some reason?

The article also said that the creditors' lawyers were asking when Refco would make "fuller, more detailed disclosures regarding its main unregulated unit..." [RCM]. I suppose we are all wondering that as well.

Finally, I note from the same WSJ story that Bawag PSK Group, the Austrian bank that quickly loaned Mr. Bennett the $340m or so when the dung hit the fan, was excluded from the creditors' committee in the bankruptcy, even though it is the fourth largest unsecured creditor and is owed (according to the story) $234m, and even though it filed a request with the appropriate U.S. Trustee to be included on the committee.

Why would the 4th largest creditor, an Austrian bank, be excluded from the creditors' committee? From my own knowledge of bankruptcy proceedings, this is rather unusual, when such a creditor (a bank no less) requests to be included. Neither the officials who rejected them nor the bank's attorneys would comment. Bob you do you have a comment or theory on this?

OK, one more thing. Wouldn't it be "funny" if Refco's offshore customers/comrades had begun naked shorting the common shares of Refco Inc. when--or truer to form, just before--this whole thing started to unravel on or about October 10? Want to take bets on whether it happened? Once again they would be laughing all the way to the (Austrian?) bank....

8:05 AM  
Blogger bob obrien said...

Wouldn't it be funny if the Austrian bank had naked shorted REFCO all the way into the ground, thereby having shareholders effectively pay for the "loan"?

One thing is for sure. Every day new revelations and the manner in which things are being handled emanate a more noxious stink.

I think it is intirely possible that REFCO is co-mingling funds in order to defend the naked positions, that many irregularities exist, and that if we ever get to know what went on we would all pull our money out of the market.

As to what if the States don't step up, My response would be to just get out of the market, buy bonds, and consider yourself lucky to have escaped the clutches of a criminal system with your skin.

9:43 AM  
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