Now Here Are Some Guys Who Knew How To Rip Off A Client

One aspect of good salesmanship is that you have to offer an attractive proposition not merely to the abstract entity that is your nominal client - El Paso, Italy, Greece - but also to the specific human being who is your contact at that client. Telling a corporate treasurer who is five years from retirement that a trade will have a significantly positive NPV due to huge cash flows in years 11-15 is not always as effective a sales technique as buying him a nice steak and an evening of unclothed entertainment. I suspect, though, that the latter strategy is more highly correlated with whatever you're selling ending up on the front page/op-ed page/sec.gov. Anyway, I definitely admire these guys for this particular con*: The SEC alleges that Argyll Investments LLC’s purported stock-collateralized loan business is merely a fraud perpetrated by James T. Miceli and Douglas A. McClain, Jr. to acquire publicly traded stock from corporate officers and directors at a discounted price from market value, separately sell the shares for full market value in order to fund the loan, and use the remaining proceeds from the sale of the collateral for their own personal benefit. Miceli, McClain, and Argyll typically lied to borrowers by explicitly telling them that their collateral would not be sold unless a default occurred. However, since Argyll had no independent source of funds other than the borrowers’ collateral, Argyll often sold the collateral prior to closing the loan and then used the proceeds to fund it. Got it? Argyll gave corporate executives margin loans at 50-70% loan-to-value based on the market price of their stock (based on the volume weighted average price over five days leading up to the closing of the loan). They took the stock as "collateral." They then trousered the stock and sold it for, y'know, 100% of the market value, with 50-70% of that funding the loan and the remaining 30-50% funding miscellaneous expenses that presumably included unclothed entertainment for themselves. The loans had three-year terms and were not prepayable for 12-18 months, so the expected life of the scam was at least 12 months (but see below).
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One aspect of good salesmanship is that you have to offer an attractive proposition not merely to the abstract entity that is your nominal client - El Paso, Italy, Greece - but also to the specific human being who is your contact at that client. Telling a corporate treasurer who is five years from retirement that a trade will have a significantly positive NPV due to huge cash flows in years 11-15 is not always as effective a sales technique as buying him a nice steak and an evening of unclothed entertainment. I suspect, though, that the latter strategy is more highly correlated with whatever you're selling ending up on the front page/op-ed page/sec.gov.

Anyway, I definitely admire these guys for this particular con*:

The SEC alleges that Argyll Investments LLC’s purported stock-collateralized loan business is merely a fraud perpetrated by James T. Miceli and Douglas A. McClain, Jr. to acquire publicly traded stock from corporate officers and directors at a discounted price from market value, separately sell the shares for full market value in order to fund the loan, and use the remaining proceeds from the sale of the collateral for their own personal benefit. Miceli, McClain, and Argyll typically lied to borrowers by explicitly telling them that their collateral would not be sold unless a default occurred. However, since Argyll had no independent source of funds other than the borrowers’ collateral, Argyll often sold the collateral prior to closing the loan and then used the proceeds to fund it.

Got it? Argyll gave corporate executives margin loans at 50-70% loan-to-value based on the market price of their stock (based on the volume weighted average price over five days leading up to the closing of the loan). They took the stock as "collateral." They then trousered the stock and sold it for, y'know, 100% of the market value, with 50-70% of that funding the loan and the remaining 30-50% funding miscellaneous expenses that presumably included unclothed entertainment for themselves. The loans had three-year terms and were not prepayable for 12-18 months, so the expected life of the scam was at least 12 months (but see below).

Part of what I love about this is that it's a Nigerian scam for people who wouldn't fall for a Nigerian scam: instead of promising these executives a million bucks if they'd just make a small down payment, Argyll made a large down payment in exchange for a million bucks just a bit later. You could see someone being taken in by this and, in fact, people were, including "the former Chairman and Chief Executive Officer of a New York Stock Exchange listed-company involved in the development, leasing, and management of real estate" and "the President, Chief Executive Officer, and Chairman of the Board of Directors of an American Stock Exchange-listed company involved in the development, production, and exploration of crude oil and natural gas."

Part of what I love about it is that it's an object lesson in the whack-a-mole difficulties of regulating securities markets. It turns out that if you're corporate "affiliate" - like a CEO and major shareholder - of a public company, getting a margin loan is a fairly regulatory-intensive process. There are restrictions on loan-to-value, and the securities laws - which frown upon corporate affiliates dumping their stock to unsuspecting buyers without a registration statement or Rule 144 compliance - make hedging and liquidating collateral a legal-intensive business. All this means that margin loans for affiliates can be painful to obtain from reputable dealers. I suspect Argyll made the paperwork a breeze! So does the SEC; in addition to the more standard "just stealing collateral that you said you'd hang on to" charges, there's a count of selling restricted securities without a registration statement, which is a no-no.

Something similar is happening around private stock markets and IPOs of smallish companies. Congress may somewhat ease the requirements for small-company (I mean, sub-$1bn-revenue, which isn't that small) IPOs, and the SEC's Mary Schapiro thinks that's a dumb idea, and I'm kind of with her here, because either the SEC registration process is necessary to protect investors, in which case it's especially necessary for smaller newer companies, or it's not, in which case it's no more necessary for large companies than for small ones. But the alternative, of course, is for companies to trade on private secondary markets - which means that smaller investors are frozen out - which means that promoters develop back-door ways for them to invest in Facebook or whatever - which means, almost invariably, that there's lots of fraud and self-dealing in those quasi-legal products. Because if you're looking to get around the law, you're probably going to be dealing with people who make a business of breaking the law. Including to rip you off.

So, here, the borrower executives and their employers were unnamed in the SEC complaint, and maybe they were entirely on the up-and-up and shopped for similar margin loans from big reputable firms and decided to go with Argyll's 65% LTV, 4% interest, 3% up-front-fee, 4% back-end-fee margin loan based purely on price. Or maybe they wanted the most aggressive terms they could find, consistent with the law or otherwise. And they got otherwise. Also they got their stock stolen.**

And that leads to my favorite part of the scam. This requires noticing that it's in substance nothing more than a very levered (in the sense that your downside involves prison) short sale of the underlying stock. It has a short lifespan if the stock goes up: you take 1 share of stock worth $100, sell it for $100, hand over $70 to the "borrower," spend $30 on strippers and coke, and in a year the borrower wants to prepay his $70 and get his stock back. If the stock is at $150, and you have only the borrower's $70 to buy it back, then you get caught and go to jail.*** But if the stock is at $50, you can actually buy it back and pocket another $20 from the loan repayment. And of course if the stock is up the executive will want to prepay and use it for a larger margin loan, while if it's down he will want to keep the loan outstanding as long as possible - so a stock price decline at least buys you more time.

So is that risk right-way or wrong-way? Well, to me, a company whose CEO is putting his stock in hock with a shady broker because he wants to push the boundaries of legally aggressive margin lending - that is a great company to be short. I'm kind of surprised Argyll ever got caught.

SEC Charges Senior Executives at California-Based Firm in Stock Lending Scheme [SEC]
SEC v. SW Argyll Investments, LLC [SEC]
Jobs Act could remove investor protections, SEC chair Mary Schapiro warns [WaPo]
Scrap Over Easing IPO Rules [WSJ]

* Alleged con. I want this to be true though. I love it. It's almost The Sting-worthy.

** Or, just being cynical here, maybe they wanted to sell their restricted stock and couldn't find a legitimate buyer, and were willing to have Argyll take care of all the illegal selling in exchange for a 35% haircut. I suspect there are some corporate insiders with illiquid shares who would take that trade, eyes open.

*** Except these guys, so far, are just getting sued by the SEC, so not even jail. Also - for simplicity I'm assuming just one loan at a time, but you could of course just overlay a Ponzi on this by taking in new money all the time, that's good too.

Related

Greek Debt Management Guy Thought His Partners In Obscuring The National Debt Would Be The Last People To Rip Him Off

Bloomberg's story about the Greece-Goldman swap-debt-whatever kaboodle, so let's talk about the philosophy of derivatives for a minute. First the story: Greece’s secret loan from Goldman Sachs Group Inc. (GS) was a costly mistake from the start. On the day the 2001 deal was struck, the government owed the bank about 600 million euros ($793 million) more than the 2.8 billion euros it borrowed, said Spyros Papanicolaou, who took over the country’s debt-management agency in 2005. By then, the price of the transaction, a derivative that disguised the loan and that Goldman Sachs persuaded Greece not to test with competitors, had almost doubled to 5.1 billion euros, he said. There are at least three reasons to use derivatives. First you could be into some actual informed shifting of risks from those who want to pay to get rid of them to those willing to be paid to bear them, or from those who have Risk X and want Risk Y to those who etc. Boy are there a lot of textbooks that talk about this. And I suppose it even happens sometimes. You could imagine that a vanilla interest rate swap entered into by a corporation on its bonds or credit facility could qualify as this. I guess people who trade listed options to do covered-write strategies or speculate on takeovers or whatever fall in this category, maybe modulo the "informed." (Sometimes!) Then there's tax and regulatory arbitrage. This is time-honored and much of it, particularly the stuff with the best names, is focused on tax dodging, but there are also various other regimes - securities laws, accounting, whatever - that you might want to get around with derivatives. Paying $10 for CDS with a maximum payout of $10 purely to lower your capital requirements is a recent amusing/egregious example. The thing that wasn't mentioned in the CFA Level I derivatives primer is principal-agent arbitrage. This is ... first of all, let's say this isn't a derivatives issue, or a financial-industry issue, it's like a life issue. (Some would say it's why there's an M&A business, for instance.*) But it's also a derivatives issue! And you can see why if you're as baffled as I am by the Bloomberg story. So this:

That's Some Latency

BATS apparently reeeaally wanted those first few trades to be practice trades. This is amazing: Bats Global Markets Inc., the six- year-old equity exchange, canceled its initial public offering, stunning Wall Street after errors on its own computer systems derailed trading in the stock and forced a halt in Apple Inc. (AAPL) “We believe withdrawing the IPO is the appropriate action to take for our company and our shareholders,” Joe Ratterman, the chief executive officer, said in a statement. Asked if that meant Bats is no longer going public, Randy Williams, a company spokesman, replied by e-mail, “Yes, that’s correct.” It's nice to see Bloomberg as incredulous as I am - that paragraph means: the CEO said "we are withdrawing our IPO" and Bloomberg emailed to ask "wait, no, REALLY?" And got the response, "yes, really." Because what's weird here is not a withdrawn IPO but a withdrawn IPO that had already priced. And opened for trading - for a few seconds anyway - to print a few trades at $15.25 (down from last night's IPO price of $16) at around 10:45 this morning before halting, unwinding those trades and ultimately unwinding the IPO.