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Reasons For Opes Prime Collapse

By Sandy Naidu | April 18, 2008

Opes Prime collapse in March 2008 left a lot of its clients in the mud.

A sad day for all who trusted Opes Prime with their savings. These type of financial collapses seems to have become more common than we like them to be….

Meanwhile in this post I am trying to understand (myself) what happened….

What Is Opes Prime?

Opes Prime was formed in 2003 by Laurie Emini (former ANZ executive) and Julian Smith (former Ord Minnett executive). Opes Prime was formed as a specialist securities lending and margin lending broker. ANZ and Merrill Lynch were Opes Prime’s bankers.

So How Were They Making Money?

They offered margin lending facilities to their client. They lent money to clients - clients used the borrowed money plus a lot of their own money to buy stocks - the money lent by Opes to their clients’ was secured by these stocks - so all the stocks were held by Opes. Nothing unusual here - everything seemed to be as per the margin lending definition.

They then used the stock (stock that the clients left with them as security) to borrow money from ANZ for a lower interest rate. So in return for the loan, Opes gave all the stock as security to ANZ. The differential in interest rates between what Opes lent money for and what it borrowed (from ANZ) was one of their primary income earners.

ANZ is the secured creditor of Opes Prime. So in case of any problems it has first claim over all the stock (stock that is Opes clients but is now used as security for borrowing from ANZ).

Opes did not always use the stock to borrow money from ANZ - It sometimes lent the stock to shortsellers (who actually short sell the stock hoping the price of the stock is going to fall). Short selling was one of the main reasons for the collapse in ABC share price. As I had mentioned in that post as well - this kind of selling your clients’ stock to short sellers seems unethical - you are selling your clients stock to people who are punting that price will fall - in whose interests is Opes Prime acting?
But the sad truth is by lending to short sellers it is not doing anything illegal - Lot of fund managers do it.

To summarise the two main sources of income for Opes - Interest differential plus money made by lending to short sellers…There were other source of income like fees for providing margin lending facility etc.

Some Basics Before We Dig Deeper

Every margin lending facility has a loan to valuation ratio - The LVR is different for every stock. The LVR of a stock mainly depends on the valuation of that stock..The LVR for every stock will also differ from lender to lender - but the difference will not be huge its all usually within 15%. Assume the LVR for a stock, XYZ, is 75% with one lender. With another lender the LVR for XYZ could be 80% and with another it could be 70% and with another it could be 75%. Now assume you decide to buy XYZ by using the margin lending facility offered by a lender whose LVR for XYZ is 70%. So you can borrow up to 70% of the value of your purchase from the lender. Assume you borrow $7000 and you put in $3000 of your personal money and with the total $10,000 you buy the stock. Say the stock is priced at $1…So you are basically buying 10,000 shares of XYZ for $10,000. You have to leave the stock with the lender as security.The lenders’ system will keep monitoring your portfolio - Your LVR for ths stock always has to be 70% or less. It should not rise above 70%. The LVR will go above 70% if the price of XYZ falls below the purchase price of $1. The LVR will fall below 70% if the price of XYZ increases above the purchase price of $1. The minute the LVR increases, the system will issue a margin call - When a margin call is issued you have to deposit more money into your account (which will reduce your debt and thus reduce your LVR and it back to the 70% threshold). If you fail to deposit money then the lender has the right to sell part or all of your shares with the aim of bringing the LVR back to appropriate levels (in this case 70% or less).

So you need proper systems in place to monitor the portfolios so that margin calls are issued correctly and in time. Every portfolio has to be maintained independently of each other.

How Was Opes Prime Stepping Into Fraudulent Territory

Laurie Emini had six favourite clients - one of them was Chris Murphy, the former gambling buddy of Kerry Packer. Opes Prime (with probably full knowledge and instructions from Laurie Emini) was lending huge amounts of money to Laurie’s favourite six people. The money was used to buy some blue chip stocks and lots of speculative stock. To prevent margin calls from being issued for these portfolios, Opes kept transferring other people’s stock into the favored people’s portfolio. By doing this it was providing a false illusion of increase in portfolio value and thus preventing margin calls. And continued lending more and more money to its favored people. It has been reported that for some speculative shares the LVR was as high as 95%. The usual LVR level is about 65 to 75% per cent on blue-chip stocks and much less on mid-capitalised stocks.

So to summarize -

Opes was topping up some of the portfolios of the favored people by using other people’s shares (to avoid margin calls) and continued lending huge amounts of money to the favored people - for speculative share portfolios (LVR as high as 95%).

These Favored people portfolios/loans were all in the range of 100s of millions of dollars.

The First Alarm Bell

The first alarm bell went off in early March 2008.
Norman Seckold is the chairman of four junior mining companies. In 2004 he had to exercise some options in Bolnisi Gold company. He used the margin lending facility offered by Opes Prime and borrowed 4 million dollars to buy the stock and used the stock as collateral. At that time the stock was valued at $15 million. Over the next four years, Bolnisi Gold company, performed very well and by early March 2008 the stock Mr.Seckold used as collateral was valued at $100 million. In early 2008 Mr.Seckold got a bit nervous of Tricom collapse and decided to clear his outstanding loan and reclaim his stock. He should have probably done this much earlier because the loan amount was so small compared to the value of stock. But anyways - he finally did this in March 2008. He called Laurie Emini and told him of his intention. He cleared his loan and expected to receive his stock back straightaway- But Opes had double booked his stock - some or all of his stock was moved into a different account - And so Opes could not return the stock straight away but returned most of Mr.Seckold’s stock over a two week period. After Mr.Seckold’s phone call, Laurie Emini realised that the double booking of stocks is going to land him in a mess and so Opes Directors’ called ANZ and asked for help - ANZ agreed to lend them $95 million in return of a thorough examination of Opes’s books.

Alarms Go Off

Closer inspection of the books revealed all the double bookings. huge LVR’s…The huge loans to the favored people were not covered adequately by collateral….Money lent was much more than what they had in collateral - This could have probably been prevented if margin calls were issued at the right times to the favored people….

ANZ and Merrill Lynch are the secured creditors and so they moved in and started selling the stock to recover the money owed to them. The clients are the unsecured creditors -

They are the ones who lose everything….These are mum and dad investors - Hard earned money gone to a waste because of some people’s greed and dishonest practices.

Some of these investors had a very low LVR (as low as 7%)…But still they lose everything…Assume an investor with a 100,000 dollar portfolio and a LVR of 10% - ie he borrowed 10,000 dollars and put in 90,000 dollars of his money - but he now loses everything because the stock is with ANZ (and they sell/sold to recover their loan). There are many many real stories like this example in the Opes Prime disaster.

It has also been reported that some DIY super funds could be losing a lot of money as well - With the passing of a new legislation (late last year), DIY super funds are now allowed to use gearing/margin lending facilities….This debacle highlights that if gearing is allowed for DIY super funds then probably some sort of guidelines and limitations has to be put in place so that DIY super funds don’t expose themselves to huge loses (which can happen with margin lending).

Also I would like to know more about what ASX and ASIC were doing? Well they can say that there were no indicative signs - Then if so there should be some sort of mechanisms / guidelines through which these sort of fraudulent behavior can be caught before millions are lost.

What are your thoughts about Opes Prime Collapse?