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Investing 101 - Oct 23, 2005 - Printable Version
- The $10.5 Billion REFCO Smoking Gun?
by Bob O'Brien
(Article correction: Oct. 24, 2005. Upon further analysis of REFCO's balance sheet, and with thanks to Dave Patch for bringing it to our attention, Bob O'Brien has updated this commentary to correct some errors in his original article. As he put it "it was good late night rhetoric, but overstated. I've tempered the piece to reflect early morning analysis." We humbly apologize for any misleading information that might have been originally printed. Note to SEC: Pay close attention here. If you make a mistake, you take responsibility for it, acknowledge it publicly, apologize to those who might have been misled, and take immediate action to correct it. See how that works?)
(Editor's note: Thanks to Bob O'Brien for putting the REFCO meltdown and pending bankruptcy into perspective. We've been telling the world about this massive scandal for over a year and a half, and in fact, said that it could be "the biggest financial scandal in the history of the world" in June of 2004, and now the major media has just "discovered" the issue, as if by magic. So what else is new?
In our opinion, REFCO is not the tip of the iceberg in this issue, it's nothing more than an ice cube floating in a sea of icebergs. I wonder if Dateline regrets selling their souls to the corporate devil and sitting on the naked short selling story for over a year, or if Senator Richard Shelby, who killed the Senate Banking Committee hearing on stock counterfeiting, is beginning to squirm in his Big Business owned suit? I hope so.)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 - see item 3 below.
There are three possible explanations:
1) Mr. Thompson parsed the truth with such dexterity that the number he advanced was incorrect in the extreme.
2) The number Mr. Thompson advanced did not include ex-clearing FTD's. For a complete primer on the implications of this, as well as the terminology, Click Here.
3) Those are all legitimate short sales and government securities. Possible. Somehow though my gut says that isn't the entire case. Legitimate short sales would have shares borrowed prior to selling, and would have the borrowed shares shown as an asset, offsetting the sold shares - but there's only about $2.5 billion as a receivable for "securities borrowed." The rest is collateral in the form of receivables.
A friend of mine had an interesting take on the matter:
"Considering consolidated balance sheets, such as Goldman's; When it contains assets labeled "Securities borrowed", I understand such would be related to securities borrowed and sold short. And, the offsetting liability "Financial instruments sold but not yet purchased" would be the value of those same securities on the effective date of the balance sheet; ergo, the price to cover. The difference would therefore be a snapshot of the net value of the short position.
However, with Refco, we see a consolidated statement of assets and liabilities where there is no line item for "Securities borrowed". However there are two line items that may be related. There's "Receivables from securities borrowed", 2,631,989,000, and "Receivables from broker-dealers and clearing organizations", 10,770,348,000. It's my guess that the 2.6 billion is the amount related to selling borrowed shares short, and the 10.8 billion is the amount that is due to be received when shares are provided to cover naked sales. Therefore, the sum of the two numbers would be the net from selling short and selling naked; 2.6 billion plus 10.8 billion equals 13.4 billion. Note, however, that it's all 'receivables'. This brings us down to "Securities sold, not yet purchased", 10,590,379,000. This is probably the entire marked to market short position at Refco. Subtracting the liability from the 13.4 billion receivables indicates a net plus of 2.8 billion.
Not bad--up 21%.
But, wait! If all the sales were legitimate short selling with a borrow then there would not be 'receivables' of 13.4 billion. That 13.4 billion would be available cash that could be used to purchase shares to cover. But it isn't. It's 'receivables'. Therefore there's no cash and no chance of covering."
Looking at the 10Q, I note that much of the liability is broken out as being Treasuries and the like. That would be the 10Q that we have been advised isn't worth the paper it is printed on. So the amount of FTD's is unknown - all we know is that there is a big number articulated. 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 it 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 $10.5 billion actually is, 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.
If you've been wondering why your stocks don't ever seem to go up much, you now have a likely answer. The system has been printing billions and billions and billions of dollars worth of shares and selling them with predatory, unbridled aggression.
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.
This article is reprinted by permission from Bob O'Brien at:
http://bobosrevenge.blogspot.com/
For more information go to:
http://www.NCANS.net/
Sign the petition at:
http://www.investigatethesec.com/
It's vital that we keep the pressure on Senator Richard Shelby, who sold us down the river when he cancelled a pending Senate Banking Subcommittee hearing on naked short selling and stock counterfeiting. Email him or call him, and tell everyone you know to do the same. Post this information EVERYWHERE:
Call Senator Shelby at (202) 224-5744, or email him at senator@shelby.senate.gov
Tell him how simple this issue really is....you pay for your stock, your broker goes out and buys it, and delivers it to you. The end.
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