.Behind Stockwalk collapse, one trader, one stock
Eric Wieffering and Terry Fiedler
Star Tribune
Published Jul 14, 2002 WALK14
Nothing about Thomas Brooks even suggests a taste for danger, much less a willingness to risk an entire company.
Brooks, 38, grew up in suburban Cleveland and attended Northwestern College in Roseville, where he played football for the Bible school and earned a marketing degree. He married his college sweetheart -- who taught fifth-graders before quitting to become a full-time mother -- owns a six-year-old minivan and a two-year-old Jeep Cherokee, has two children and lives in the same Eden Prairie home he's owned since 1991.
And each weekday he went to work in one of the most obscure, ostensibly bland corners of the brokerage business.
Today Brooks is at the center of the biggest U.S. brokerage failure of its kind in the past 30 years, according to court documents related to the bankruptcy of Minneapolis-based investment firm Stockwalk Group.
As depicted in the draft of a lawsuit by the bankruptcy trustee for MJK Clearing -- a former Stockwalk subsidiary -- Brooks is a man with an appetite for outsized risk and a capacity for deceiving co-workers, bosses and even regulators.
Although the collapses of Enron, WorldCom and other firms in recent months have centered on boardroom accounting schemes by senior management, the role assigned to Brooks in this Minnesota corporate disaster is singular: a solitary trader with enough freedom to put his entire company on the line through his trades while senior executives adopted a see-no-evil posture.
If, as the bankruptcy trustee describes it, Brooks single-handedly took down Stockwalk, it is a feat that puts him alongside the Kidder, Peabody bond trader who manufactured paper profits to mask trading losses in 1994, forcing that firm's sale, and a Singapore trader whose unsupervised trades on the Japanese market in 1995 sank the more than 200-year-old Barings Bank in England.
The Securities Investor Protection Corp., which insures the securities industry, spent a record $200 million to cover the losses of Stockwalk brokerage account holders. And for many Minnesota investors who put their money in Stockwalk shares or debt securities, the damage won't be made good.
Stockwalk executives all along have put the blame for the collapse elsewhere, saying they were victims of fraud involving manipulation of the stock of GenesisIntermedia, a Los Angeles-based telemarketing firm.
Even if that is true, though, it doesn't explain what happened to Stockwalk. Somebody, knowingly or not, bet the firm.
Go-go guy
Brooks has denied being responsible for the collapse of Stockwalk, telling friends and investigators that he was just a salesman who bore no responsibility for monitoring the overall risk in the firm's stock-loan activities, despite his title as vice president of MJK Clearing and manager of MJK's stock-loan department.
"I'm as shocked and devastated as everyone else in this matter," Brooks said in a brief interview, adding that he has found the events "mind-boggling."
Brooks declined to discuss his activities at Stockwalk in any detail, citing ongoing investigations by the Securities and Exchange Commission (SEC), FBI and others.
Stockwalk General Counsel Chet Taylor rejects Brooks' assertion that he was only a salesman. "He was hired to create and manage the department from the ground up," Taylor said.
What's undisputed is that Brooks was hired in 1999 to turn the department -- which contributed just 1 percent of Stockwalk's total revenue -- into a steady money-maker.
Brooks, a lean 6-foot-1 man with dark, short-cropped hair and pale blue eyes, was a veteran of the stock-loan business, having spent six years in the stock-loan department at Piper Jaffray before taking a similar job at Dain Rauscher. Co-workers there described him as earnest, hard-working and generous.
"He was a first-class guy who'd do anything for a friend," said one person who knew him.
At Stockwalk, Brooks was given a salary plus an annual bonus of up to 30 percent of the profits from the stock-loan business.
His hiring looked like a brilliant stroke.
Revenue in the stock-loan department rose sevenfold in his first year to $4.2 million, and it soared to $15.5 million the following year, accounting for 11 percent of total company revenue.
Brooks' pay went from $140,667 in 1999 to $375,889 in 2000. He made $450,324 in the first nine months of 2001.
Brooks' department became a bright spot in an otherwise bleak picture. Stockwalk was losing millions from its online trading division and also was hurt by its costly acquisition of two larger Minneapolis-based rivals, Kinnard Investments and R.J. Steichen & Co. It bought them in 2000 just as the stock market began to tank.
By September 2000, Stockwalk's financial situation was so dire that it began borrowing money from its best customers, a practice met with stunned disbelief at rival firms.
Stockwalk executives began demanding more from each business line, including Brooks' department.
"The message was go, go, go," one person familiar with the situation said.
Fail-safe business
Stock loans aren't a go-go business. The profit margins are relatively small compared with other kinds of trading. The upside is that the loans can be done with little overhead -- at Stockwalk it was just four people on the eighth floor of the firm's former Golden Valley headquarters.
Best of all, when executed properly, stock loans are nearly fail-safe. Hundreds of millions of stock shares are lent without incident every business day nationwide because the practice follows an established set of rules.
When a brokerage borrows stock from another firm, it puts up cash collateral equal to the value of the stock. The borrower is then paid interest on its cash. If it lends out stock, the brokerage receives cash. Profit comes from the difference between interest received and interest paid.
At the end of each trading day, the firms "mark to market." If the stock goes up that day, the borrowing firm sends more cash to its partner to balance the equation. If the value goes down, it gets some cash back. Theoretically, the loan is 100 percent secured at the end of the day.
The chief risk is that a firm in a chain of loans becomes unable or unwilling to return cash collateral. In that case, the firm that borrowed the shares bears the loss.
Most brokerages protect themselves against that threat by only borrowing the stock of established companies and by setting limits on the number of shares they will borrow from any individual partner.
Those rules weren't in place at Stockwalk.
Stockwalk didn't limit the amount of credit Brooks could extend to another brokerage in a stock transaction, according to the draft lawsuit by MJK bankruptcy trustee James Stephenson. Nor were there any restrictions on the types of companies or the number of shares Brooks or his colleagues could borrow.
Overall, Stephenson concluded, "there was no supervision of stock-loan activity from compliance officers of the firm."
With no controls in place, a routine deal could become Russian roulette.
Uncorking the genie
In November 2000, Brooks got a call from a contact at a New Jersey firm called Freeman Securities. Freeman, which soon after became Native Nations Securities, had a net worth of less than $5 million, a minuscule amount for a brokerage firm.
But the network of people making stock loans nationwide is small and tightly knit, and Brooks had worked with Freeman in the past. He agreed to borrow $27 million of stock of GenesisIntermedia and reloan the shares to another New Jersey broker, Maple Securities.
Brooks has told friends and investigators that he never learned who lent the Genesis shares to Freeman or Native Nations. (Native Nations contends it was defrauded by several parties, including a rogue trader. It has agreed in principle to pay Stockwalk more than $200 million but isn't operating and doesn't have the money.)
Brooks also has acknowledged that neither he nor anyone else checked into the background of Genesis. If he had, he would have discovered that Genesis -- "Genie," as traders called it -- was the epitome of a risky stock. Founded in 1993, its primary business was hawking memory-improvement programs, get-rich-quick tapes and swimsuits on late-night TV. In 2000, it lost $33.5 million on sales of $42.2 million.
Ninety percent of Genesis' stock was owned by two men: CEO Ramy El-Batrawi and Adnan Khashoggi, a wealthy, Saudi-born arms dealer.
By April 2001, Khashoggi's Bermuda-based firm, Ultimate Holdings, owned 43 percent of Genesis' stock and had lent $50 million to the company to cover operating losses.
One investment executive familiar with stock loans said the dubious nature of Genesis' business was itself a red flag. Native Nations' small size should have served as another warning because a brokerage with less than $5 million in assets is "not a real firm," the executive said.
Brooks bet big on Native Nations and Genesis. By March 2001 he had borrowed more than $65 million worth of Genesis stock -- an amount equal to three times MJK's net capital and more than a third of the total Genesis shares available, according to court and SEC documents.
When Maple Securities decided to get out of the deal, a New Jersey man, Kenneth P. D'Angelo, and his firm, RBF Financial, were retained to help place the stock with other brokerages.
Stockwalk executives have said that they knew nothing about D'Angelo's dealings with their company. Brooks has told investigators and former colleagues that D'Angelo was enlisted by Native Nations and that he knew nothing about D'Angelo's background, which included a late 1990s agreement by D'Angelo and RBF Financial to return $425,000 in profits from what the SEC said were improper sales.
SEC documents also show that D'Angelo had warrants to purchase 50,000 Genesis shares and that RBF Financial had lent $500,000 to Holiday RV Superstores of Florida, a second stock that Stockwalk borrowed from Native Nations.
D'Angelo could not be reached for comment. The phone number for RBF Financial is no longer in service.
Through the summer of 2001, Brooks' big bet seemed to be paying off. Genesis' stock price tripled in the months following Khashoggi's purchases, trading as high as $18 a share.
It's still unclear who lent to Native Nations the large block of Genesis shares that set in motion the deal that devastated MJK and Stockwalk, but it is clear that between them El-Batrawi and Khashoggi controlled about 90 percent of Genesis' shares.
'White as a ghost'
By the summer of 2001, Brooks had borrowed almost $200 million worth of securities from Native Nations: $130 million of Genesis stock and another $64.5 million of bonds belonging to Imperial Credit Industries, a struggling California-based financial holding company.
Brooks' boss, Todd Miller, became aware of the huge exposure early in the summer. According to court documents, Miller called Brooks at home one night to ask whether Genesis and Native Nations were "real" entities. Brooks assured him they were, and Miller never followed up, documents say.
By then, the stock-loan division was earning $60,000 a month on the Genesis trade alone while Stockwalk itself was headed toward another money-losing quarter.
"We were making a lot of money off that one trade," said a person familiar with the stock-loan department.
Cracks began to appear in July, when other brokerages that had borrowed the Imperial Credit bonds from Stockwalk wrote down their value by $9 million. Stockwalk's MJK Clearing returned $9 million in cash collateral to those firms on July 19, but Native Nations did not return a similar amount to MJK.
In August, the value of the Imperial bonds was written down by an additional $6.8 million, and MJK Clearing returned that much in collateral to its partners. Again, Native Nations failed to return a similar amount to MJK.
A $15 million shortfall meant Stockwalk was in violation of SEC net capital requirements. Regulators likely would have seized the firm and perhaps shut it down had such a shortfall became public.
Stephenson, the court-appointed trustee, contends Brooks hid the loss by falsifying bookkeeping entries. Brokerage firm Ferris Baker Watts, which has sued Brooks and other current and former Stockwalk executives, says in its lawsuit that Brooks knew of the shortfall and didn't bring it to anyone's attention.
One person familiar with the stock-loan operation said that description seems out of character for Brooks.
"All I can think is that Tom got in trouble and kept hoping the market would get better and fix his problems," this person said.
Instead, they got worse.
Within four days of the reopening of the securities markets after the Sept. 11 attacks, Genesis shares had dropped to $9.08.
Each time the price fell by a dollar, MJK faithfully returned $7 million worth of collateral to the other brokerages that had borrowed Genesis shares from Brooks. By Sept. 24, MJK had returned $70 million to the other firms but received nothing from Native Nations.
Brooks has told investigators and others that neither he nor his colleagues knew about the $70 million shortfall until Sept. 24.
"He was as white as a ghost," said one person who saw him that day.
Miller made frantic efforts to collect the money from Native Nations, unaware that, a week earlier, Native Nations had alerted regulators to likely problems in its own stock-loan department, according to a person familiar with the investigation.
Federal regulators shut down Stockwalk on Sept. 25 and within days began to liquidate MJK Clearing.
Trading in Genesis stock was suspended Sept. 25 and later delisted from Nasdaq. The shares now trade privately for less than a penny.
In November, Genesis acknowledged that, by the summer of 2001, both Nasdaq and the SEC had launched investigations and that the FBI questioned some former executives.
Brooks left Stockwalk in October. Now working outside the brokerage industry, he is adamant that he did nothing illegal and has appeared before FBI and SEC investigators without a lawyer.
And although it may be no consolation to Minnesotans who lost their savings in Stockwalk, Brooks has told friends and former colleagues he kept his 401(k) plan invested entirely in Stockwalk's now nearly worthless shares.
-- Eric Wieffering is at ewieffering@startribune.com .
-- Terry Fiedler is at tfiedler@startribune.com . |
