Big boys and market manipulation

No, this is not about that ASIC/Citigroup story, but more on that later. Actually, this post is just to make good on a notion Guambat had some time ago to follow up on the Refco story.

To remind, Refco was, at the time, one of the world's largest derivatives traders and a financial power house. To get to that heady height it wasn't staffed with Wal-Mart check out guys. These guys were the top guns of the banking and broking world. Blue blooded pedigree from start to finish. Well heeled. Very wealthy. Impeccably connected. Its blow-up put it at the 4th largest bankruptcy in US history. It takes some very big boys to hit the market this hard. In fact, it is only the big boys who have the entree, the coziness with the regulators and the money to truly push around and manipulate markets (apart from the garden variety fraud that any little thief can do).

I'm sure someday it will be a very good film (providing Tom Cruise doesn't feature), or at least a tantalizing book.

Take this story as just one little crumb from the table. The setting is the tropical, velly British, tax haven of Bermuda. Because a great deal of Refco's dealing were based in Bermuda, much of the legal fall out is being played on that pitch.

Financier could lose Bermuda property to Austrian bank

Last week Austrian prosecutors requested arrest warrants for former Refco chief executive Philip Bennett and Mr. Flottl, as part of an investigation into alleged fraud.

The future of an idyllic Tucker’s Town estate now owned by Austrian financier Wolfgang Flottl is in question after a secret agreement to hand over the property to a bank he is indebted to was unearthed. The pact, hatched in 2000 and only now coming to light, gives Austrian Bank for Arbeit und Wirtschaft (Bawag) the right to recoup some of its losses stemming from investments made with Mr. Flottl more than a decade ago.

The revelation that Bawag has the right to some of Mr. Flottl’s property comes a week after the bank admitted to hiding the loss, stemming from investments in several funds run by Mr. Flottl.

The losses were brought to light in an ongoing investigation of Refco Inc., a commodities broker that went into a death spiral last year after its then chief executive admitted to hiding losses. Although the losses that Bawag sustained from its investments with Mr. Flottl date back to the period between 1995 and 2000, they are now coming to light as part of Refco’s investigation because the losses were reportedly hidden in offshore shell companies as well as accounts of the collapsed brokerage.

Under the agreement, Bawag was handed the right to Mr. Flottl’s Bermuda estate, and another in the Bahamas. Other valuables, including paintings by the likes of Picasso and Cezanne, were also included in the list of goods to be handed over. The deal was sealed in a secret London meeting between Mr. Flottl and then Bawag chief executive Helmut Elsner, and only yesterday revealed in Austrian weekly newsmagazine Profil.

At the London meeting, under pressure from Mr. Elsner, Mr. Flottl signed a confession admitting he ran up losses for Bawag of more than $1 billion. He also agreed to hand over property and valuables worth several hundred million dollars, Profil reported, citing sources within Bawag.

Amongst the valuables Mr. Flottl agreed to hand over – Castlepoint, a property valued at in excess of $22 million, that sits on the end of the peninsula that makes up the elite, gated community of Tucker’s Town. A review of Bermuda land valuation records last week showed that Mr. Flottl still owns Castlepoint. And there is no known attempt by the Austrian trade union federation – the owners of Bawag – to seize the estate.

An adjacent Tucker’s Town property, Sounion West, is also reportedly listed in Bawag’s agreement with Mr. Flottl. The property is currently valued at about $15 million, according to the Profil report, citing Bawag assessments. Bermuda records list the Sounion property as being owned by a Julie Jones, while Profil reported that Mr. Flottl has the full right-of-use of the property, and that he and his guests frequent it.

Attempts to reach Mr. Flott’s New York lawyer, Martin Goldenberg, were yesterday unsuccessful. Mr. Flottl, who is understood to spend much of his time in Manhattan, does not have a published telephone number.

This is real juicy stuff from a pulp fiction standpoint. The Bermuda connection just makes it all that more big screen. Here's more. Enjoy.

Refco failed to execute trades

Two former Refco Inc. employees said there were times the company failed to execute trades on behalf of customers because it had used the securities in client accounts to support other transactions.

The employees, Adam Weis and Vera Kovar, were deposed by lawyers for Moscow-based hedge fund VR Global Partners, which has lawsuits pending against two Refco subsidiaries to recover $750 million it had deposited with the units.
The testimony was disclosed on the second day of hearings on a request by customers owed $1.7 billion, including VR Global, for a liquidation of Refco’s Bermuda-registered Refco Capital Markets Ltd. subsidiary. Refco, a committee for unsecured creditors, and a second customer group oppose such a move, saying it would lead to costly litigation and reduce recoveries in the bankruptcy case.

“On occasion Refco was short and could not make the delivery,” Kovar, who worked on VR’s transactions, said in her deposition. “If a counter-party didn’t deliver the security to us we could not deliver it because we didn’t have it.”

Lawyers for VR Global, Inter Financial Services Inc., and other pro-liquidation customers have accused Refco of misrepresenting how it would treat cash and securities in customer accounts.

Kovar said Refco failed to execute a trade on behalf of a client “once every three or four months.” She said the securities the customers had deposited in their accounts were not available to execute the trade because “I believe they were loaned out.”

The other former Refco employee, Weis, said in his deposition that VR Global executives, including President Richard Deitz, knew some trades were failing. He said they may not have understood Refco was loaning out their securities for its own benefit. Deitz “was aware securities in the account were unavailable because of fails,” Weis said. “I’m not sure he knew why they were failing.”

The deposition testimony was disclosed one day after Thomas Moloney, a lawyer for Inter Financial, accused Refco Capital of operating a “Ponzi scheme”. In a Ponzi scheme, people are promised high returns on their investments, with the money coming from new investors.

Tracing Refco’s ruin leads probe to Bermuda

When Refco Inc. filed for bankruptcy-court protection in October, many headlines focused on Phillip R. Bennett, the brokerage firm’s since-departed chief executive. Investigators are still examining the actions of Mr. Bennett, who faces criminal-fraud and wire-fraud charges related to Refco’s implosion.

But six months on, the inquiries into Refco’s demise have broadened and are leading down another path, too, according to court documents filed in bankruptcy court in New York and interviews with lawyers and others involved in the matter. The second path: the flow of money through Refco’s vast operations, including its unregulated Bermuda unit, which some investigators are treating as the epicentre of Refco’s problems.

Mr. Bennett denies wrongdoing as the Justice Department and others parse aspects of his personal life, including his trading accounts. Mr. Bennett’s lawyer, Gary Naftalis, declined comment. David Esseks, the assistant US Attorney for the Southern District of New York who is prosecuting Mr. Bennett, declined comment.

Lawyers and others working on behalf of Refco creditors are scrutinising intercompany money transfers at the Bermuda unit, Refco Capital Markets Ltd., which offered Refco clients higher rates of return, less scrutiny, and more generous loans for trading than did Refco’s regulated futures or stock-trading units.

The purpose of the Bermuda unit was to allow sophisticated investors to trade securities such as emerging-market debt, with Refco acting as an informal exchange and providing loans so that the traders could increase their risk. The unit attracted hundreds of clients, including hedge funds and other big investors from around the globe.

But people familiar with Refco Capital Markets say bankruptcy lawyers are trying to determine whether some of the unit’s client money was tapped by Refco to fund its expansion, specifically a string of acquisitions of trade-processing, or clearing, firms. Refco was founded in 1969 and became one of the world’s biggest brokerage firms, focusing on commodities, derivatives and foreign currencies.

Among Refco’s purchases was the 2005 acquisition of the global brokerage operations of Cargill Investor Services. Refco paid about $208 million for those operations, plus future considerations, according to a person familiar with that transaction. Refco’s transfer records show that $170 million came through Refco Capital Markets, the person says. Investigators are looking into other intercompany transfers between the unit and Refco Inc., the parent company, that total hundreds of millions of dollars.

The event that led to the bankruptcy-court filing by Refco only weeks after the company went public was an admission October 10 by the company that Mr. Bennett had hidden $430 million in bad debts, removing them from the company’s books and parking them elsewhere, including in an entity tied to Mr. Bennett.
After that revelation, customers rushed to get their money out of Refco Capital Markets, leading Refco to freeze customer accounts.

Court documents show that Refco Capital Markets didn’t have the financial wherewithal to meet those demands. At that point, the value of client collateral and other assets held by the unit was supposed to total $3.7 billion, but the unit’s actual assets were about $1.9 billion, according to the documents.

Elsewhere, investigations have turned up links between Refco, Mr. Bennett and other entities, including Bawag P.S.K. Group, an Austrian bank that once owned a ten percent stake in Refco and lent Mr. Bennett 350 million euros, or about $420 million, which he used to pay off the hidden bad debts just before Refco revealed them. Bawag subsequently sued Refco, saying it was misled when it agreed to provide that loan.

Bawag’s chairman said last week that he and other executives failed to disclose losses totaling more than 1 billion euros between 2000 and 2005 after investments by the former chief executive officer’s son went sour.

The bank and its current and former executives are under investigation by the Austrian financial regulator for not informing regulators about losses run up by Wolfgang Flottl, a New York investor and son of Bawag’s former CEO, Walter Flottl.

Refco in chaos after Bennett disclosure, witness claims

Refco Inc., the bankrupt trader, operated in “chaos” as customers sought to retrieve funds in the days after the company’s former chief executive officer Phillip Bennett disclosed he had hid $430 million in debt, an executive testified. Customers withdrew roughly $600 million from accounts after Bennett in October revealed he had hid the debt and the company said its financial statements couldn’t be relied on, Thomas Yorke, an executive vice president of Refco’s Refco Securities unit, said at a hearing in US Bankruptcy Court in New York.

“The customer calls kept coming in with questions and demands,” Yorke said during the fifth day of hearings on a request by customers to liquidate Refco’s Refco Capital Markets unit. “It was like nothing we’d ever seen before. “I would describe it as chaos.”

Customers contacted the New York-based company to retrieve cash and securities held in accounts at Refco subsidiaries, including Refco Capital. The company eventually placed a moratorium on withdrawals and said Refco Capital owes customers $4.2 billion along with an almost $2 billion shortfall.

Refco filed for bankruptcy protection one week after Bennett’s disclosure. Bennett pleaded not guilty to federal fraud charges in November.

“There was definitely an increase” in demands, Yorke said during his third day of testimony as a witness for Refco. “You couldn’t hang up the phone without having somebody leaving you with something they needed or wanted as a result of that phone call.”

Customers owed $1.7 billion have asked US Bankruptcy Judge Robert Drain to liquidate Refco Capital immediately to allow them to recover what remains in their accounts. The customer group has said Refco Capital sold or loaned some of its cash and securities without its consent. Parent Refco, a committee representing unsecured creditors and a second customer group owed about $2 billion oppose the request.

SEC Charges Filed in Sedona Case

Securities regulators on Tuesday filed civil fraud charges against three former Refco (RFXCQ:Pink Sheets - commentary - research - Cramer's Take) brokers and two officials with Pond Equities, a small Brooklyn, N.Y., brokerage. The government claims they all had a hand in a trading scheme that was designed to "clobber" the stock of Sedona, a small Pennslyvania software company.

The Securities and Exchange Commission alleges the defendants either aided or failed to prevent an illegal short-selling scheme that was carried out at the behest of Rhino Advisors, a now-defunct New York investment firm. Rhino orchestrated the scheme to enable one of its hedge funds, Amro International, to score a big profit on a $2.5 million investment in a 2001 private placement by Sedona, regulators say.

A short sale is a bet that a stock will fall in price.

The investigation into the Sedona 2001 PIPE deal, or private investment in public equity, has been going on for nearly four years. It has already led to an earlier $1 million settlement with Rhino and its former president, Thomas Badian. The Sedona investigation also is believed to have ignited a broad-based regulatory investigation into abusive trading by hedge fund investors in PIPEs, a type of financing that's often favored by small, money-losing companies.

The Sedona scheme predates the alleged accounting fraud that led to last autumn's collapse of Refco, once one of the nation's top commodities brokerages. But the charges offer a window into Refco's sordid past and its dealings with some of Wall Street's more unsavory players.

In the latest SEC action, regulators allege that two former Refco brokers, Mottes "Matt" Drillman and Jacob Spinner, carried out the manipulative trading through accounts they had at both Refco and Pond. In fact, the SEC alleges that both Drillman and Spinner were working for Refco and Pond at the same time, a highly unusual situation. Drillman and Spinner, who left Refco two years before its collapse, still work for Pond. Pond didn't comment.

Earlier this year, TheStreet.com reported that regulators were investigating Drillman and Spinner for alleged manipulative trading on behalf of Amro International. TheStreet.com also identified Drillman and Spinner as the two brokers who handled some of the trading for a group of hedge funds once affiliated with Austria's Bank fur Arbeit und Wirtschaft.

Bawag, as Austria's fourth-largest lender is known, recently announced that it will no longer be involved in PIPE deals. The bank, which once had a minority equity stake in Refco, has come under scrutiny for its role in the Refco accounting scandal.

There are no allegations involving Bawag in the SEC complaint. But people familiar with the investigation say regulators once questioned Thomas Hackl, a former Bawag executive and a former Refco executive, about the trading in shares of Sedona.

Meanwhile, Jeffrey "Danny" Graham, a third former Refco broker who reported to Drillman and Spinner but never worked at Pond, also was charged for his role in the alleged plot involving Sedona.

Regulators also charged Pond President Ezra Birnbaum and Pond Chief Compliance Officer Shaye Hirsch for failing to supervise Drillman and Spinner. The SEC, in the complaint, charges that the two Pond officials knew about Drillman and Spinner's dual employment status and permitted it, even though the arrangement "substantially increased the potential for abuse." Regulators also faulted them for failing to inquire about the unusual trading activity in Sedona shares.

Also charged was Andreas Badian, the brother of Thomas Badian, who was not charged in the initial SEC case against Rhino. Regulators contend that the brothers instructed the former Refco brokers to "sell short massive amounts of Sedona stock."

In one tape recording, one of the Badian brothers allegedly told the brokers to use "unbridled levels of aggression" in shorting the stock until it "collapsed."