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Resident trader
Opes Prime mess - who owns your shares?
Will Kraa, April 14, 2008
It sounds incredible – directors losing millions of dollars worth of shares in the companies they ran, and may even have founded. Some have gone from being very rich to, well, who knows? I remember not all that long ago reading a recommendation to buy ABC Learning Centres (ABS) because the directors were personally buying big parcels of shares in the company. The theory of course was that if the directors were buying up big, good things were on the way and it would be a good idea to follow suit.
So how did it come about that they lost so much? What may not have been so widely known was that they were using margin lending to do it. This means that the equity they had in shares they owned outright was held as collateral to guarantee the loan. Once the share price tanked they had to meet margin calls so large and so frequent that they could not get enough cash together to cover the margin calls. When their shares were sold to raise the cash needed, the price went even lower as they were sold in a market with few buyers.
The result was that all the equity in the shares they owned outright at the start was hardly enough to cover the money they had borrowed. And when it was all over, they owned almost no shares. Welcome to the world of margin lending.
But did it have to happen? I don’t know about these directors but for the rest of us there is no need whatsoever for this to happen to any investor or trader. Just employ stops to ensure that if the price goes down there is a point where you exit long before it gets to the situation where you have to meet a margin call.
The way to do this is to set stops at appropriate levels for all your margined positions and to calculate what would happen if all your shares were to hit your stop loss price. Would this mean that the ratio between the equity in your shares and the money you borrowed against this would dip below the required ratio set by the lender? If so, then it may be wise to look at reducing your holding to ensure this is not likely to happen – unless, of course, you have plenty of funds to meet a margin call. There are occasions when a sudden drop in the market can cause this to happen quite unexpectedly, so be prepared.
It may not be such a bad idea to ask yourself if margined positions are appropriate in a market which is in a downtrend.
However, an even worse event has happened to investors recently, and some hadn’t even experienced a margin call. I’m referring to the Opes Prime disaster and the unfortunate investors who were its customers. There is one very small company I’ve been interested in that’s very much involved in this tragedy. This company suddenly went into a trading halt.
It was revealed that a there was a group of investors who had contributed big sums of cash to get the company going. In fact, these investors owned a large proportion of all the shares in the company - and were so sure the company was going to do well that they wanted to own more. A margin loan seemed the appropriate avenue.
There was just one problem. Most providers of margin loans are not interested in taking shares in small companies like this as collateral on which to base a margin loan. But there was a solution. Opes Prime did provide loans based on shares in such small companies; so that’s where these folk went to get the funds required to buy a larger slice of the company. They got the money they needed and bought more shares and finished up with over 40% of the shares in the company. Just a few weeks ago this holding was worth more than $50,000,000.
As we all know Opes Prime went belly up and the people providing the cash now finished up owning all the shares held as collateral to cover the margin loans. In this case it was ANZ and so now ANZ has finished up being a very major shareholder in this company. Which is somewhat curious in a way seeing ANZ would not itself extend a margin loan with such shares as collateral. In fact, I’m very interested to see what they will do with them. I really fail to see the difference doing it in this roundabout way.
By my calculations and based on the turnover of shares in this company, it would take two years to sell the shares on the market even if nobody else wanted to sell any.
Some Opes Prime clients who used to own shares in this company have never had a margin call. Therefore, the whole problem is in the way the margin loan agreement was constructed.
Currently it seems they have lost their shares and may be lucky to get anything back at all. Yet they have done nothing wrong except to sign such an agreement, which basically gave the shares to the broker and left them as unsecured creditors. I have seen a suggestion that the customers may get 30% of their money back.
Seeing what has happened to the share price of this company perhaps that may be sufficient to buy back the shares. I wonder though what basis will be used to determine the value of investments on which any return of capital will be made. It’s all very interesting for those of us not involved directly.
Indirectly we are all involved as it has affected many share values. I notice that many small companies have started issuing statements outlining the extent of their exposure to this mess. ANZ regularly issues statements listing the companies whose shares they now own and the size of the holdings. If you are interested in investing in or trading any small company it would pay to consult such a list since it may have an adverse effect on the share price.
Now I would expect that people investing so much cash (as in the case of the company I have used as an illustration) would have some lawyers on hand to make sure that whatever they signed was all fine and that there were no traps hidden in the fine print. But, alas, either they did not consult a lawyer or maybe even the lawyer did not realise what could happen.
There may be no problem with margin agreements as usually written but it pays to read any such agreement very carefully and make sure you understand exactly what you are getting into. Anything that suggests that the agreement gives someone else the beneficial ownership of shares offered as collateral would make me back off very quickly.
I think it would be prudent for anyone who has a margin loan to be sure to read any agreements again and make sure you understand very clearly what it means. Any agreement of any kind should be clearly understood before it is entered into. Don’t under any circumstances rely on the person offering the agreement to explain it to you and give assurances that there is little risk in signing it.
More articles from this edition of CompareShares:
Investing: Is the big Asian sharemarket boom over, or has it just begun?
Shares: 5 Experts' 1-5 year outlook for the Aussie sharemarket
Resident Trader: Opes Prime mess: who owns your shares?
Investing: Stocks that beat leaving money in cash
Stocks: Stock of the Week – Saferoads Holdings
Analysis: What’s in store for the Aussie dollar and local equities?
CFDs: Top ten share CFDs for the week
Retirement: Global turmoil hits retiring baby boomers
Companies: Another Opes Prime? Lift Capital collapses
Superannuation: Aussies reluctant to put extra in super
Whatever your views, you can discuss this article - or any of Will's articles - on our message board Your 2 Cents.
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