By Sarah Danckert
It was on a dusty road in the far flung coal fields of South Africa's northern reaches that the future of Australia's largest private stockbroker, BBY, started to unravel.
Near the border with Botswana, BBY took a big punt six years ago that has finally come home to roost.
Six years ago, BBY took a punt in sub-Saharan Africa that led to dramatic repercussions.
Dramatic collapses don't often happen in the stockbroking world in Australia. After all BBY – run by Glenn Rosewall, the son of Australian tennis great Ken Rosewall – had opened its 10th office in Brisbane in January, adding to its premises in London, New York, New Zealand, and its five existing offices in Australia.
BBY's delivery into the hands of receivers and administrators this week has prompted consternation in an industry known for its big egos and bigger bonuses.
Illustration: Simon Bosch.
It has shone a light on an industry that has been indulging in deeply risky trading strategies and gorging on complex financial products that sources say not even most traders understand.
The group's demise has also highlighted how quickly these big bets by stockbrokers can destroy a business and, if accusations of shady trading activities within BBY prove true, raises questions about the regulatory oversight of Australia's stockbroking industry – especially as Glenn Rosewall sat on the Australian Securities and Investments Commission's markets disciplinary panel, the group charged with determining whether to issue infringement notices and enforceable undertakings for alleged breaches of the market integrity rules.
In announcing the group's expansion into Brisbane this year, Rosewall, who joined BBY in 2004, gave the impression his business was on the up, noting that while 2014 was a hard year in the financial services industry, "when the going gets tough, the tough get going".
Responding to questions from Fairfax Media, Mr Rosewall said: "I put my heart and soul into BBY for 11 years and I'm devastated by what's happened."
The tale of BBY's African foray begins on September 11, 2009, when the broker took an enormous bet on fledgling listed miner Firestone Energy, agreeing to underwrite a $25 million issue of convertible notes.
It was a big move for the firm, which was established in 1987 and previously known as Burdett Buckeridge & Young, because it strayed outside of the normal activities of a stockbroker.
Eight days prior to BBY piling its cash into Firestone Energy, the dual Australian and Johannesburg-listed miner and its joint venture partner, South African resources company Sekoko Resources, had just won government approval for their Waterberg coal project in Limpopo province.
If successful the project, which would mine the vast Waterberg coal seam in the region close to the Botswana border, promised a massive windfall to its investors and financiers, including BBY. The project's promoters believed the seam Firestone Energy had agreements over would deliver "internationally significant exports".
The industry is extremely well regulated and collapses such as we've seen this week do not often happen.
Stockbrokers Association of Australia - Andrew Green
But like many other junior miners Firestone Energy, despite its efforts, never lived up to expectations.
By early this year it emerged Firestone Energy was in dire straits with its largest shareholder, Waterberg Coal Company, struggling to fund the project and mired in a legal stoush in Britain.
At April 30 a subsidiary of the broker – BBY Nominees – was the holder of the convertible notes, which now had a face value of $22.145 million but in reality are probably worth very little, according to sources, because of Firestone's parlous financial position.
Company documents show that at 2011, Firestone Energy had burned through millions in loans with little to show for it. In January that year, BBY director David Perkins had joined the board and soon became chairman. By 2013 he was joined by another former BBY executive David Knox on the Firestone Energy board. BBY had also long been the company's corporate adviser.
Put simply, BBY had become a coal explorer as well as a broker.
As of this week, BBY Nominees is also the owner of $2.9 million in shares and 300 million options in Firestone Energy, a company that in April was suspended from trading due to its financial issues.
BBY posted a $2.6 million loss over the year to June 2014, due in part to a $3.4 million provision.
It is understood that provision relates to the company's Firestone Energy exposure. The broker's total assets at the end of 2014 were $69 million, of which $40 million was "segregated" assets including the $22.145 million of convertible notes to Firestone Energy.
Tough time for brokers
The death knell for BBY came this week when it called in administrators from KPMG. Soon after that BBY's main lender, St George, called in receivers from PBB Advisory to protect its interests. St George is believed to be seeking to recoup a $6 million loan it granted to BBY, but Fairfax Media understands the final creditors' bill will be around $15 million.
"It's a tough time to be a stockbroker," a senior options trader says.
Stockbrokers Association of Australia Andrew Green says the collapse of a broker in Australia is an "extremely rare occurrence".
"The industry is extremely well regulated and collapses such as we've seen this week do not often happen," Green says.
The ASX this week gave clients of BBY – many of whom were using complex trading instruments known as options to bet on both the upside and downside of a company's share price as well as currency and commodity fluctuations – until 5pm on Wednesday to move their business to a new broker.
Since then, the ASX has been cancelling or "closing out" options held by BBY clients, causing major losses for some investors, many of whom were retail clients of the firm.
Green says these clients could rely on the National Guarantee Fund set up by stockbrokers so that clients could avoid losses if their broker collapsed. The NGF holds $100 million in the event of a broker collapse, but concerns have been raised in the past about the willingness of the fund to pay out to people caught up in a collapse.
PPB Advisory receiver Stephen Parbery says the immediate priority is to ensure that BBY's operations are managed efficiently in the coming week.
"We understand the concerns of all stakeholders in this matter and we will be actively communicating with them throughout the process," he says.
"We are working closely with the voluntary administrators and other stakeholders to explore all options for the business."
Parbery says staff at BBY are expected to have their outstanding remuneration paid out through the federal government program set up to aid workers caught up in corporate collapses, though whether they receive their bonus payments will be dependent on how they are restructured. He declined to comment further.
Another hope for BBY – which made 50 per cent of its staff redundant on Wednesday, including Glenn Rosewall – and its clients is a rescue deal orchestrated by the executive chairman of AIMS Financial, George Wang, for the remnants of the business. This was being thrashed out at the end of the week.
"There were some commiserations on the floor between staff, some people went out for drinks, but mostly people were trying to protect their clients as the market was still open," one former insider says.
"When we found out about it [the collapse of the business] there were a lot of recriminations towards Glenn. It was a great business and no one understands it f...ed up."
BBY's balance sheet exposure to Firestone all came unstuck last week when the Australian Securities Exchange asked the broker to top up the amount of capital it has to hold under regulatory requirements put in place to safeguard investors.
When BBY tried to present its Firestone Energy shares as capital, the ASX baulked, according to sources close to the exchange.
The attempt to use BBY Nominees' holding in Firestone Energy shares as collateral caused much confusion. Several market watchers say it seems strange a nominee account would be used in such circumstances.
While most other nominee accounts hold the investments of clients and provide a level of privacy for their trades, Fairfax Media has learned BBY Nominees is a principal account that was used by the company for BBY's own trading activities. They included taking positions in a range of mining hopefuls and medical marijuana company Phytotech, another company with big promise that BBY took a large punt on.
Phytotech, too, has seen its shares plummet from a debut of 78¢ to a close of 27.5¢ on Thursday.
"It was not just Firestone that BBY took bets on. There were a lot of terrible bets. But there were also a lot of great bets," a former senior insider says.
The Australian Securities and Investment Commission is keeping a close eye on BBY's demise, with the regulator saying it was reviewing the circumstances surrounding the administration and receivership of BBY, "particularly those concerning compliance with laws on governance, disclosure and conduct".
"Under the law, including the Corporations Act and market integrity rules, licensees such as stockbrokers must keep client money separate from their own. This is an important safeguard to protect the interests of retail investors," the regulator said in a statement.
"Client money must be adequately protected."
While its run-in with the ASX last week over capital requirements garnered much attention, over the past year BBY has fallen short of its regulatory requirements on more than one occasion.
The company was fined $180,000 in January by the ASX disciplinary panel after it was found to have contravened ASX rules three times when it was unable to pay tens of millions worth of margin calls linked to a bungled trade in Aquila Resources seven months earlier.
"The contraventions appear to have occurred because of weaknesses in BBY's risk management and compliance framework," ASX Compliance chief compliance officer Kevin Lewis said in his determination of the matter.
In September 2014, the broker was fined $90,000 by the Australian Securities and Investment Commission for not having computer systems that allowed it to properly monitor the trades by its advisers. That followed ASIC placing conditions on BBY's financial services licence in 2005 over concerns about the quality of its research and the separation – or Chinese walls – of its advisory and research business.
On that occasion, ASIC found: "BBY did not follow its own procedures for the approval of research reports, nor was it able to demonstrate that it had monitored compliance with those procedures. BBY did not maintain a robust Chinese wall arrangement, nor was it able to demonstrate that it had monitored the effectiveness of the Chinese wall arrangement."
While the market's focus is now firmly fixed on the company's African adventure, speculation is rife that there were also structural problems in BBY's demise.
Sources close to BBY and the administration of the company have put the blame on the company running a model that did not keep up with modern times.
The insiders say BBY had a large overhead structure of office rents, wages and IT costs that required large profits to maintain. BBY also set up an options clearing business – a business that settles, or closes out, options – at a time when most other players were exiting the market, according to sources.
"It was a marginal and antiquated business that relied on high volumes of trades at low [profit] margins. It was a bad business model that took on too much credit risk," a source says, explaining that BBY gave its clients 10 days to settle their options trades rather than the standard three-day window. It meant that while the company was attractive to investors, without a huge balance sheet it was taking on huge risks.
It has also been speculated that a group of traders were working within BBY, operating out of rented desks and using private accounts to make trades using BBY's licence, earning the brokerage the nickname "Hedge Fund Hotel".
According to multiple sources, those group of traders had taken out large bets on the share price of Australia's big banks using extremely risky instruments and when the share price for the banks began to fall late last month they were left without the capital to make up for their failed bets.
Others put the company's woes down to a disastrous bet on the value of the Swiss franc that backfired in January when the Swiss government lifted its cap on its currency and it soared.
It was suggested that larger financial institutions would be able to wear losses on large trades that went wrong, but BBY appeared to not have the balance sheet to absorb such shocks, partly due to Firestone.
Sources close to BBY and the receivership process say that while they are aware of the rumour of the unusual trading practices, there was no evidence that it happened and the speculation could be being spread by disgruntled former staff.
Rosewall declined to answer questions about whether he knew of this activity and Fairfax Media is not suggesting that any staffer at BBY including Rosewall engaged in any wrongdoing. "I won't be commenting any further at this stage on wild speculation from anonymous sources and market rumours."