No Surprise: Gain Capital’s Sweetheart Deal Goes Sour

Refco announced today that the deal they had worked out with Gain Capital Group “has been jointly terminated.” I suspect the decision has less to do with the purchase agreement, than it did the adjournment to allow ... objecting parties more time to assess the so called “benefits of the transaction.”

Here’s the formal announcement.

Refco Inc. (OTC: RFXCQ) said today that the proposed agreement with privately held GAIN Capital Group (GAIN), under which GAIN was to acquire the Refco F/X Associates (RFXA) retail customer account information and related assets, has been jointly terminated.

While the parties had entered into a term sheet outlining the transaction, they were unable to reach terms on a final asset purchase agreement.

RFXA said that as a result of its inability to enter into a final asset purchase agreement, it plans to terminate its agreement with FXCM, the company that services RFXA's web-based platform, www.refcofx.com, and notify customers immediately that as of July 31, 2006, their RFXA accounts will be closed and locked from any further trading activity.

On June 30, 2006, RFXA announced that it had reached a preliminary agreement with GAIN Capital and that it had filed a motion in the Bankruptcy Court requesting that a hearing be held July 20, 2006 to consider the matter. That hearing was later adjourned to August 10 in order to allow the parties more time to document the transaction and give objecting parties more time to assess the benefits of the transaction.

New Flash: July 27, 2006, 3:58 p.m. - The Associated Press has just reported that Refco will be permanently shutting down its foreign exchange subsidiary this coming Monday. The press release apparently was distributed to news outlets yesterday but wasn't released until this afternoon.

Note: I had another interesting discussion with a fellow trader yesterday afternoon. We were discussing among other topics, how traders deposits can be safeguarded. In passing he mentioned that at least one broker he knows of says that it carries a fidelity bond that covers individual trader accounts up to $100,000. Now, as I understand it, while fidelity insurance doesn’t protect traders from a broker’s insolvency, it would protect them from losses directly attributed to fraud.

So what does this have to do with the Refco? Well, everything I’ve read seems to point to the fact that certain parties who were working at Refco prior to the firm's declaration of bankrupcy, have, in fact, been indicted for fraud. So has anyone bothered to find out if Refco had a fidelity bond in place prior to its filing? If so, was it a blanket policy or one that covered individual accounts?

If such a bond covering individual accounts existed and fraud is proven, wouldn’t it be reasonable to assume that the coverage would kick in and most traders would get a dollar for dollar return instead of an offer of, say, 27 cents on the dollar? I suppose payment wouldn't come until someone was actually convicted but I can't imagine anyone getting upset by the delay.

Admittedly, I only started looking into the Refco debacle when I heard about the pending deal between Refco and Gain Capital in late June so the question I’m asking may have long ago been asked and answered. If that’s the case, disregard. This being said, traders would be well advised to find out if their broker is carrying a fidelity bond and, if so, find out what's covered and who's covered.

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Broker Refund Falls Short of Reasonable Expectations

This morning I received an email from a trader in Arizona and I thought I’d share it with everyone. The writer recounts a trading experience that brings up a fascinating question.

“Last month I was helping my younger brother trade the payroll data for the first time. [To make a long story] short he got in late ..... and ended up putting in a market order to buy at ... 1.8510..... three seconds after his order hit, the price dropped 50 pips ....to 1.8458... and within a couple of seconds popped back to 1.8510. He lost a lot of money in the process.

Disregarding the fact that he was a dummy, I decided to research what the price really did, so I downloaded a demo account from two other brokers. I looked at their one minute charts around the same time frame and, sure enough, there was no drop whatsoever.

I instructed him [my brother] to call their “big shot” service guy [who after a bit of wrangling] refunded his money calling it a ‘glitch’.”

The writer’s story ends with a thought provoking question. “Do you think they called the other 5,000 people they screwed....?”

The answer to his rhetorical question is probably pretty obvious. Since they didn’t call the writer’s brother in the first place, it’s doubtful they took the initiative to contact anyone else and why would they? They’d have to give up the windfall profits that this “glitch” generated on their behalf. They could, I suppose, do a little research and credit the accounts of traders who suffered losses trading during that period, but I doubt that’s going to happen any time soon unless, of course, they’re prodded.

The idea that the broker’s server experienced an algorithmic fart is a bit of a stretch knowing what we know about the dealing desk industry’s propensity for stop hunting. Here’s what probably happened. The broker, recognizing that this particular trader was new at the game, spiked the daylights out of him thinking that he would write it off to inexperience.

Computer problems undoubtedly arise from time to time, but I have a hard time believing that a stray electron could or would generate such a pricing aberration. Granted, a programmer may have been working on pricing at the time but I doubt any broker would allow that to happen during peak trading hours unless, of course, the programmer is actively involved in “working the rates” on a daily basis. And if it’s a case of the latter, spiking is probably just part of the job.

We all know trading the news is a highly risky business even if you know what you’re doing and it’s probably a gross exaggeration to think that 5,000 additional traders experienced the same problem, but it certainly doesn’t stretch the imagination to think there weren’t at least a score or more who experienced similar losses during the same trading session.

Giving the broker the benefit of the doubt and assuming that this was a pricing aberration - a glitch beyond their control, would it be unreasonable to think that every trader taken out by that very same glitch be credited with an amount equal to his/her loss?

It’s probably wishful thinking to believe that this particular dealing desk broker will come to the plate on this issue but traders shouldn’t be surprised if they are thrown a bone or two - small credits on their statement in the coming months. Why? For no other reasons than all dealing desk brokers are under the gun and a number of them are keeping abreast of the postings in this blog and the postings of readers on various forums. If you’ve never seen a credit to your account in the past, my cynical nature leads me to believe that the bone you will see is more than likely to be the result of a PR effort rather than a legitimate desire to return ill gotten gains.

In the end, the writer’s question gives serious traders just one more reason to consider trading through a non-dealing desk broker, one who doesn’t stand to gain when the trader loses.

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