Stockgate - Naked Shorting Scandal: The $10.5 Billion REFCO Smoking Gun?

» Kirk - The $10.5 Billion REFCO Smoking Gun?

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Was REFCO caught naked short and is now collapsing?

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.

Welcome to the wonderful world of naked short selling.

The $10.5 Billion REFCO Smoking Gun?

By Bob O'Brien
Oct. 23, 2005

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.

To read the rest of this article, go to:
http://bobosrevenge.blogspot.com/2005/10...

-- posted by Kirk