RE: RamjetSTOCKGATE TODAY October 20th, 2005
An online newspaper reporting the issues of Securities Fraud
SHO-ing a crack in its Armor, the cast of Refco puts the SEC on Notice – October 20,
2005
David Patch
In a New York Times Article earlier this year, Floyd Norris discussed the Securities
and Exchange Commissions sweeping reform on short sales [Regulation SHO] with
then Director of Market Regulation Annette Nazareth. Ms. Nazareth now a
Commissioner of the SEC.
In the discussion Mr. Norris asked Ms. Nazareth about the critics of Regulation SHO
concerning the apparent lack of change in the markets reaction to short sales post
SHO. The response by Ms. Nazareth was, well, less than sympathetic to victims of
abuse. Ms. Nazareth dismissed the critics of Regulation SHO by belittling their
intelligence by simply claiming that critics are merely disappointed that Regulation
SHO did not create short squeezes in the industry. After all, those critics are mere
retail investors and small business and they want nothing more than to cheat the
markets – looking for free handouts.
Today, on center stage, is a cast of characters comprised of Securities Regulators,
stock manipulators, and disgruntled wealthy investors. Today, the SEC is responding.
Today it may be too late. The damage to investor confidence may have toppled as yet
another Wall Street Institution harmed our investments and our reputation as being
the ‘golden standard’ of quality and integrity.
Refco is the most recent securities scandal to litter our newspapers. While the
undertone to the scandal is about accounting fraud associated with the regular
quarterly transfer of $400 - $500 million in bad debts between Refco Capital Markets
and a NJ Hedge Fund the low level evidence is amassing that will illustrate the
“systemic” problem Ms. Nazareth dismissed for so long. Pedigree of complainer
played a part in Nazareth’s earlier acts of dismissal; it will be harder this time around.
On October 10, 2005 Refco announced the accounting problems associated with a
$430 million payment made by CEO Phillip Bennett back to the company to cover ‘bad
debt’ that appeared back on the ledger. Just prior to that announcement, Refco was
listed as trading at nearly $29.00/share with a total of 127,500,000 shares
outstanding [$4 Billion Market cap]. According to SEC documents, only 26,500,000 of
those shares were free trading with the remainder locked up.
On the day of the announcement, Refco traded over 24 million shares and closed at
$15.60 with an opening price at $20.00/share and never seeing the light of day
thereafter. The volume representing near 100% public float changing hands.
For the following days Refco traded yet another 55 Million shares closing at $7.90 in
pre-market trading prior to the NYSE trading halt on the morning of October 13,
2005.
In total, the stock traded 79 million shares, with a 26 million share public float, over
a span of 3 days. It traded down a total of over $20.00/share or over $2.5 Billion in
market cap losses. Refco Form 4 filings with the SEC show only one reported sale by
Insiders and that was Credit Suisse First Boston which sold 85,000 shares at $20.00/
share on August 16, 2005
When trading resumed on Tuesday October 18, the day after Refco filed for
bankruptcy, the stock opened at $1.50 a share and closed at $0.65 on the sale of
over yet another ten million shares. Wednesday’s volume trading continued with
another 11 Million shares traded as the stock closed at $0.85.
The question that remains is who are all these sellers?
By my calculations, Refco has traded the entire public float a minimum of 4 times in
5 trading days and has traded down more than 97% in market capitalization. Will all
these trades settle within the 3-business days as required by law? I doubt it.
If only half the trades were sold without initial settlement, and the profit on those
was only half of the $20.00 loss, you are still considering nearly $3 Billion in illegal
profits.
Soon, those critics of Regulation SHO expect to see a new name on the list of
companies with excessive settlement failures. That company will be Refco.
If refco does show up, it is expected that Refco will be listed on the NASDAQ list
since the NYSE has already seen fit to de-list the company from their exchange and
relegate Refco to the penny stock world of the ‘Wild West’ where anything goes. Now
the SEC may even try to hold Refco off this listing for appearance purposes but
Congressional leaders will soon be breathing down SEC necks for answers. This is a
scandal the Senate Banking Committee and the House Financial Services committee
will also be held ultimately accountable for as well and to capture the SEC with intent
to defraud could only make a bad situation worse.
But what does being on this list mean?
Well, think of it like this.
To be on the list, the company must have greater than 0.5% of their shares
outstanding in a fail status for 5 consecutive trade days. In Refco’s case that is a
minimum of 600,000 shares. For the record, a minimum 600,000 share fail at
$10.00/share profit is $60 Million in ill-gotten gains.
Now since Refco was not on the list previously, and has not yet qualified as of this
writing, we can assume all trading leading up to this accounting news was being
settled in a timely and appropriate manner. It should. After all, who wants to sell
stock they do not own when a stock is on the rise. Selling naked is for falling stocks
and Wall Street rarely feeds on their own unless it is ripe for the taking. Refco trading
was averaging 500,000 shares a day prior to the scandal and the trading leading up
into the news had reduced to 200,000 shares daily.
But when bad news hits on Wall Street, everybody that knows cereal tastes better
with milk knows a stock goes down. Jim Cramer of CNBC’s Mad Money just told us
last week, when you hear accounting problems – SELL, SELL, SELL!!!
Cue in the Wall Street predators – Hedge Funds.
Somehow the entire public float of Refco traded on October 10, 2005 and the stock
traded down on the news nearly 50%. Did everybody really get out? No way. So who
else was trading down the float?
The trading volumes continued and the word on the street was – no shares to borrow
to short Refco. No shares, so where is all this sell side volume coming from? With the
company looking for a buyer, these $20 - $30 shares must be worth more than the
$.85 they now trade at. Since the trading halt, the entire float has traded below the
$1.00 levels.
Understand a few concepts here.
First, in a bona-fide market making capacity, specialists cannot be naked shorting
into a collapsing market as their responsibility is to ‘smooth out’ the market from the
buy side. To go on the sell side first would be ‘piling on’. Fails generated by
Specialists should therefore be discounted.
Second, since Refco does not qualify for the Reg SHO Pilot Test on the up tick rule,
Refco could not be shorted during a downtick in the stock. With a collapse like what
Refco went through, finding an up tick would be a struggle.
Finally, day traders cannot trade into the market by shorting first and buying later if
no shares are available to borrow. Without shares, the risk to a day trader is greater
as they would be buying into the collapsing stock with little guarantee of recovery.
Yet word on the street was that it was Hedge Funds that were all over Refco and were
selling short anyway. The ‘Lucy and Ricky’ skit “sell first; deal with settlement later”
applies here.
If these trades were done on a preferential status and were naked shorts [sale
without settlement] the profits and practice would be illegal according to the SEC.
Known intent to trade into a fail is in direct violation of 15c3-3 and 15c6-1.
The SEC very eloquently identified in the background to Regulation SHO that “naked
short sellers enjoy greater leverage than if they were required to borrow securities
and deliver within a reasonable time period, and they may use this additional leverage
to engage in trading activities that deliberately depress the price of a security.” In a
collapsing stock it is called a “bear raid.”
So what happens if Refco hits SHO time? The questions dismissed so frequently by a
conflicted Commissioner will now need to be answered as the victims come with
clout.
Who sold shares the shares that created the fails?
Who were the Institutions willing to sell for their clients on shares they did not
possess or borrow for settlement?
What profit has come by selling settlement failures into a collapsing market? [Ex. If
one third the 75 Million shares traded since Oct. 10 was sold without initial
settlement, and the profit on those was only a third of the $30.00 loss to date, you
are still considering $2.5 Billion in illegal profits.]
How much did the unsettled trades have to do with the 97% collapse in stock price
and the rate of decline in the stock?
How much additional investor loss was created over the excessive volume and selling
that eventually took place in this stock on shares that failed settlement?
How did SHO fail in protecting against this abusive leverage identified in the SEC
proposal for SHO?
With all this speculation surrounding Refco it will only be a matter of days before the
curtain falls on this SHO. The SEC will have to explain to a higher pedigree of
investors why it was acceptable for them to take un-necessary losses and let those
investors eat it, as so many lesser people have had to deal with in the past. I already
see the lawsuits cropping up so something tells me these losses will not be ones the
SEC can simply dismiss as ‘part of doing business’. Maybe even the SEC will get
named in a few lawsuits, as it was after all the SEC who was negotiating with Refco on
securities fraud [naked shorting] when they allowed Phillip Bennett to take the
company public. [Ref. May 2005 Refco SEC filing]
How do companies remain on the Regulation SHO threshold list for nearly 200
consecutive trade days?
Simply ask the SEC to explain. The SEC will tell you there’s no harm in purchasing
stock in January and getting delivery in October. “You can always sell it” and pass that
imaginary share on to the next guy for yet another delay in settlement. Soon that
share has a life of its own and everybody treats it as real. It is what Hedge Funds and
the liquidity they create bring to the party – settlement failures. It is also what makes
Hedge Fund managers wealthy and the middle class investor poor. Then again,
middle class doesn’t buy politics.
Commissioner Nazareth, like Director Nazareth has been a thorn in the side of many
victims of securities fraud. Her willingness to look the other way and to protect the
criminals will be a legacy we hope is short lived at her present position. This collapse
has international ramifications and much of it comes from the ineffectiveness of Ms.
Nazareth’s responsibilities and direction.
Chairman Cox went to China just last week and asked Chinese companies to list in
our exchanges as a safe haven for their operations. The US markets representing the
‘golden standard’ of regulatory control. Chairman Cox, in my opinion, should be
cleaning house before bringing in visitors and our new found Commissioner would be
first of several on my list to go. With Commissioners like Annette Nazareth, who
needs criminals?
BTW...Has anybody heard any more about the SEC ‘Wells Notice” against Refco for
stock manipulation and fraud? Do you think maybe that can be handled by the SEC
prior to the sale of the company such that the victims of the 2001 fraud can be first
in line to receive their due compensations or is the SEC figuring that since the Refco
negotiators are all gone [Bennett in Jail] there is nobody left to negotiate with? Be
damned with those prior victims – I guess they too were ‘grandfathered’ out of rights
by Ms. Nazareth.
For more on this issue please visit the Host site at www.investigatethesec.com .
Copyright 2005