Four brokerage firms may have lost more than $100 million in a stock trading scheme involving a cast of characters including a global arms dealer and a woman who claims to have been the model for Mattel Inc.'s Pocahontas doll.
The firms, which include E-Trade Group Inc., the nation’s second-largest online broker, were involved in lending money to MJK Clearing Inc. in exchange for 7.2 million shares of Van Nuys-based GenesisIntermedia Inc.
GenesisIntermedia is a telemarketing firm. MJK, which failed in late September, was the securities clearing unit of Minneapolis-based brokerage Stockwalk Group Inc.
Genesis stock apparently was lent among the brokerages to accommodate “short-selling” requests. In a short sale, an investor borrows stock and sells it, expecting to replace the borrowed shares later at a lower price.
Genesis, which has lost nearly $16 million this year, became a target of short sellers as the stock soared from $6 to $18 amid the firm’s plans to expand its Internet business.
Two individuals--Saudi arms dealer Adnan Khashoggi and Ramy El-Batrawi, who resigned as chief executive of Genesis on Monday--combined control 85% of the company’s shares.
Genesis said Monday that the Securities and Exchange Commission has begun a formal investigation of the firm and its stock.
The lending of 7.2 million Genesis shares began with Native Nations Securities of New Jersey, a brokerage founded by Valerie Red-Horse.
Red-Horse, once an official at defunct brokerage Drexel Burnham Lambert, has been involved in a variety of Hollywood projects with Native American themes through her Red-Horse Native Productions. She also has said she modeled for the Mattel Pocahontas doll.
Native Nations lent the Genesis shares to MJK, which in turn lent them to other brokerages.
As Genesis stock began to collapse last month, falling from $16.20 on Sept. 17 to $5.90 on Sept. 25--when Nasdaq halted trading--the decline rippled through the daisy chain of transactions in the shares, said Matthew Kyler, executive vice president of marketing at Stockwalk Group.
Native Nations owed $60 million to MJK but defaulted on that payment and ceased trading Sept. 21. MJK, in turn, made some payments owed to other brokerages in the stock-lending chain but stopped when it fell into violation of SEC minimum capital requirements. The federal Securities Investor Protection Corp. took control of MJK in late September.
Kyler told The Times that MJK still owes about $30 million to E-Trade, about $18 million to Ferris, Baker Watts Inc. of Baltimore, $9 million to Pax Clearing Inc. of Chicago and $8 million to Robert W. Baird & Co. of Milwaukee.
What’s more, those brokerages may have to return tens of millions they received from MJK because the firm paid them using money from its customers’ accounts while waiting for Native Nations’ payment, Kyler said. With the plunge in Genesis stock, Kyler estimated the total losses involved will exceed $100 million.
“This is a very complex web of transactions,” said Ken Caputo, an attorney with SIPC, created in 1970 to handle brokerage failures. “We are investigating, but we only have half a story at this point,” he said.
Michael Mendelbaum, a spokesman for Native Nations, blamed the problems on what he called a rogue trader who conducted “improper stock loan transactions.”
Mendelbaum said the worker, who has since been fired, joined the firm as part of its merger with Freeman Securities this year. Native Nations is attempting to unwind that merger, he said, and leave any liabilities with Freeman Securities.
Red-Horse could not be reached for comment Wednesday.
For its part, E-Trade said it “continues to be hopeful that this matter can be resolved fairly and amicably.” E-Trade said Wednesday that it earned $9.3 million, or 3 cents a share, in the third quarter, excluding one-time charges. That compares with $7.2 million, or 2 cents, a year earlier. After charges, primarily for office closures, the firm lost $244 million in the latest quarter.