According to Reuters, Refco, the forex brokerage firm that filed for bankruptcy last October, reported yesterday that it has reached a preliminary agreement to sell its retail foreign exchange customer accounts to Gain Capital Group for $2.5 million. The deal which would bring an estimated 15,000 additional traders to Forex.com, Gain's dealing desk subsidiary, is subject to a bankruptcy judge’s approval. Like most offers one sees in the shadowy world of off-exchange, dealing desk trading, the proposed deal appears to offer investors the means to recoup the losses they suffered when Refco went belly up. When one examines the terms of the agreement, however, it appears that the real beneficiary is going to be Gain Capital Group. As described by Gain’s own press release published yesterday evening, Refco traders are only being offered "the potential to recover up to 100 percent of account balances."
Just how great is that potential?
Let’s take a look at the specifics which were partially disclosed in yesterday’s release. "Upon the closing date of the proposed transaction, approximately 40 percent of Refco's customers could receive a full recovery of their account balances, if they open an account with Gain and execute at least one trade. Customers who had larger deposits will also receive up to 100 percent recovery provided they meet certain trading thresholds, as outlined in the term sheet."
What this appears to mean is that Refco’s clients are going to have an opportunity to open an account at Forex.com (a Gain Capital Group subsidiary) and win back their losses and to my way of thinking that’s hardly an overture worth the paper its written on considering the fact that Forex.com runs a dealing desk platform and is free to skew pricing to its own advantage.
It doesn’t take a genius to figure out what’s happening here. Gain agrees to fund Refco’s clients with up to 150 dollars of funny money - funny money because no money can be withdrawn until all traders meet prescribed trading thresholds. Those who had Refco accounts with balances of $40 or less have to execute one trade to turn that funny money credit into real dollars which can then be withdrawn. Those who had larger accounts will be initially credited with up to 150 funny dollars and be able to recoup their losses on a quarterly basis if they’re willing to do more intensive trading. Obviously, those credited with the higher amounts are going to have to deposit additional funds to conduct any meaningful trading and I'm guessing that's what Gain Capital Group is depending on.
In all fairness, traders will be in a position to recoup their losses, but chances are this isn’t going to happen. If the industry consensus that 85% of traders are unsuccessful is accurate, the vast majority of those opting to participate in the program are going to end up on the short end of the stick again.
How can the bankruptcy court ensure that Refco’s traders don’t go from the fying pan into the fire?
The first thing the court should do is hire a knowledgeable forex, computer forensics expert to conduct a no-notice inspection of Gain Capital Group’s trading platform to determine if the company is stop hunting (spiking or stop phishing) its current trader clients positions. Should it be determined that the firm is manipulating rates to its own advantage, then not only should the pending proposal be quashed, Gain Capital Group should be reported to the CFTC and NFA for disciplinary action. Conversely, and if upon the completion of such an inspection, Gain gets a clean bill of health, then the court would have good reason to take Gain's proposal seriously.
To further protect the interests of those who suffered losses at the hands of Refco and to prevent further misdealings, the court would be well advised to consider requiring Gain to file quarterly, if not monthly, reports showing the following:
1. The number of Refco traders who have signed up under each category.
2. The number of Refco traders credited with $40 accounts who lost everything on the one and only trade they were required to execute to qualify for reimbursement.
3. The number of Refco traders who succeeded in meeting trading requirements and cashed out.
4. The number of times Gain responded to execution orders with a reorder.
5. The number of Refco traders who ended up depositing additional funds in their accounts.
6. The number of Refco traders who in the latter group ended up losing it all.
7. The number of traders who had sizable accounts, met trading requirements, and successfully cashed out.
Should the bankruptcy court approve Gain’s proposal and not require the firm to submit to a no-notice inspection and to submit periodic reports, it’s going to be up to traders to raise the red flag if they think they're being taken advantage of. If the proposal is eventually approved without condition, those who enroll in the program will have to take it upon themselves to report their concerns to the CFTC and the NFA.
Whether this proposed agreement eventually turns out to be a sweetheart deal for traders or Gain Capital Group is anyone’s guess but I’m putting my money on Gain Capital. The firm has everything to "gain" and nothing really to lose because, as a dealing desk broker, it controls the playing field.
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