Faith wrongly given
"It’s difficult to underestimate the ingenuity of complete fools.” The words are from Douglas Adams, author of The Hitchhiker’s Guide to the Galaxy.
He might well have been speaking about the collapse of Dealstream, a broking firm that dealt in fancy derivative instruments like contracts for difference (CFD) and single stock futures (SSF).
Dealstream’s demise has left 2700 investors up the creek, including companies like Vox and Control Instruments that should have known better than to sink shareholder funds into unregulated CFDs.
With a CFD, one party agrees to pay another the difference between the opening and closing price of a stock without owning it. But, unlike investments on the JSE, CFDs aren’t regulated — so when a broker fails, investors lose their shirts.
It’s anyone’s guess how much Dealstream’s investors have lost, though some estimates run to R300m. But the man best placed to answer this, founder Russell Leigh, has fled the country.
Says JSE director Allan Thomson: “A CFD is like you and a mate making a bet in a pub — it’s that unsafe. These things have never been regulated, and if one client defaults, it puts the broker and all other clients at risk.”
So why did JSE-listed firms like Vox and Control Instruments plough shareholder cash into Leigh’s Wild West show?
Vox said last week that, thanks to Dealstream, it will take a hit of “less than 5c/share”. That works out to R58m, more than Vox’s R43m profit at its half-year stage. Control Instruments’ maximum exposure is R10,4m — four times its R2,6m half-year operating profit.
Anger and disappointment fall short of describing the emotions of Vox executive chairman Tony van Marken. His company’s stock has lost 50% of its value (now at R1,05) and R30m of its cash has vanished from a trust account. Several Vox managers, who were also Dealstream clients personally, are out of pocket.
“I’m not happy with what happened here,” says Van Marken. He is particularly angry, he says, that Leigh lied about the state of his company to Vox CEO Douglas Reed, hours before Dealstream imploded. And he is furious at how quickly Leigh scarpered after news broke that Dealstream was flailing, and disappointed that (he claims) neither the JSE nor the Financial Services Board (FSB) exercised any oversight of Dealstream. “If they suspected irregularities, what did they do about it?” he asks.
Van Marken says Vox plans to lay criminal charges against Leigh, and will try to liquidate Dealstream.
But is Vox not simply looking for a scapegoat, after putting shareholders’ money into a risky, unregulated instrument? Shouldn’t heads roll at Vox?
Van Marken admits Vox was at fault for dealing with Dealstream in the first place, which it used as a broker to buy treasury shares in the market. He points to Leigh’s reputation, his appearance as a pundit on business shows, and the fact that he did business with Investec and Rand Merchant Bank (RMB). But this last excuse is like saying someone has credibility merely because he has an account with one of the big retail banks.
It seems Dealstream had a patchy record from the start. In 2003, Leigh and his wife Jeanne were drawn into a messy legal scrap with Global Trader, a larger CFD trading company where Jeanne had worked before. Believing its client records had gone missing, Global Trader got an Anton Pillar “search and seizure” court order against Leigh.
Dealstream’s only other director is Saul Cohen, who represents venture capital fund Argil. Argil invested R3m in Dealstream in exchange for 50% of the company, with Leigh owning the other 50%.
Cohen told the FM he too feels betrayed. “For Leigh to absolutely drop us, I can’t even tell you the sense of anger and betrayal we feel.”
As the only other director, Cohen is likely to feel a lot of heat. “My role was nonexecutive, and I was lied to. Russell told me client accounts were segregated and [hedged] against single stock futures,” he says.
So what actually happened? Though the FSB is investigating (and a curator will be appointed soon), it’s difficult to say whether Leigh got trapped on the wrong side of some wrong calls, or if there was genuine fraud.
Some investors are convinced fraud was involved. Says Control Instruments MD Richard Friedman: “It was a highly sophisticated, fraudulent scam, I’ve got no doubt about it. It’s clear that to cover Dealstream’s losses, these guys were stealing money from trust accounts of individual clients.”
Worse, Friedman says, the online trading system showed “we had money in our trust account, when actually it had been pulled out weeks before”.
Cohen is less convinced there is fraud. “That would surprise me. It’s more likely that under extreme pressure, a series of very bad decisions were made quickly. But I don’t know if the client accounts were segregated, as they should have been.” He says Leigh may have panicked, and “taken from Peter to pay Paul”.
As with every collapse (think Deel Smith in 2003 or Fidentia), investors are rounding on everyone short of Leigh’s grocer. But who is really to blame?
Charles Savage, CEO of Global Trader SA, says the focus shouldn’t shift from Dealstream. “It’s unfortunate that we’re having to defend the industry, when it looks like Dealstream was a failure of management, not of CFDs. The accountability for this sits with Dealstream and its risk controls.”
But the FSB, as the ultimate investment guardian, has also taken a lot of flak. As a trader of CFDs, Dealstream should have been registered as a financial services provider — but it wasn’t.
One investor says: “The FSB got complaints that Dealstream was pretending to be licensed, but they did nothing. They could have closed it down long before.” Only after Dealstream collapsed did the FSB warn people to “proceed with caution”.
FSB deputy CEO Gerry Anderson says the organisation became aware of the problems only after the failure. Anderson says the FSB had contacted Dealstream, which said it didn’t need to be registered as it only provided services that fall under the regulation of the JSE.
Says Anderson: “Now that the facts have emerged as to what Dealstream’s activities were, it is the FSB’s view that Dealstream did require authorisation by the FSB.” He says Dealstream’s assurances “were incorrect”.
Others blame the banks: RMB, which cleared Dealstream’s futures trades; and Investec, which held the client trust accounts. But, says RMB CEO Alan Pullinger: “Unfortunately we don’t have the ability to ‘look through’ into the brokers’ books to see the position of individual clients. The clearing member has no insight into the arrangements with clients.”
Investec investor relations head Ursula Nobrega says: “Dealstream deposited client money with us and we didn’t see what the individual clients were trading. It’s normal for money to run down in trading accounts anyway, and nothing happened to arouse our suspicions.”
Some client funds remain frozen in Investec trust accounts, which will obviously mitigate any losses.
But as one investor says: “There must be a lot of people feeling quite stupid right now.”
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