“Deception, Inc.” — profiting from the “World’s Largest Con Game”

Deciphering a tease for a "beat them at their own game" financial stock

By gumshoe, September 12, 2011

Here’s the latest pitch from the White Cap Research folks … and yes, they did apparently find a 3-for-1 deal at their local hyperbole store:

“Costlier than Madoff … More Scandalous Than Watergate … Harder to Detect Than Al Qaeda.


Inside the World’s Greatest Con Game

“Where governments and banks are mutual conspirators…

“Where ‘blackbag’ operations divert trillions of dollars into private accounts…

“Where capitalism itself is showing cracks…

“Where the biggest money grab in market history is now ONLY DAYS AWAY”

Sounds like the teaser for a conspiracy theory movie, no? Well, it at least works to get your attention — and it caught the attention of plenty of Gumshoe readers over the last couple weeks as this ad has been circulating.

So what are they talking about? Well, the ad is all a pitch for the “entry level” newsletter at White Cap Research, the White Cap Report, which is mostly run by Louis Basenese and, in my experience, has been largely focused on mid-size growth companies.

The “Deception, Inc.” stuff is all about how the financial game is rigged, the insiders, CEOs and bankers control all the money and raise their income year after year, and use the government to fix the system so they control the flow of cash in perpetuity.

And in the teaser it’s spun as almost a Trilateral Commission of intricately managed conspiracy — with the idea that there’s this “Deception, Inc.” at the head and the subsidiaries are all raking in the cash. Here’s a tidbit:

“Yet, a year after the financial crisis, one subsidiary of Deception, INC. paid its employees an average of nearly $600,000 per person, capping off its best year ever.

“Starting salaries for Deception, INC.’s big-time congressional or White House contacts has ballooned to about $500,000.

“In 2006, Deception, INC.’s top 25 trading managers earned nearly $600 million, on average, with the richest raking in $1.7 billion. ”

So yes, you can more or less read “Deception, Inc.” as shorthand for “big investment banks and their cronies” — that first one is almost certainly Goldman Sachs, and we know that the profits in investment banking are on the verge of obscenity, with the top traders and bankers pushing well over that verge.

What, then, is a little investor to do? Well, there’s some blather in the letter about getting word to policymakers that we’re mad as hell, but what they’re really talking about is getting a piece of that obscenity for yourself — using your knowledge of this “Deception, Inc.” and its inner workings to make yourself rich.

And the idea that they talk about the most in the ad is what they call a “countermeasure” and their first course of action: “Follow Deception Inc.s money.”

This is all based on the new financial regulation legislation that has been enacted and is now starting to impact the marketplace — and the particular part of it that we’re being teased about is the regulation of derivatives, the largely unregulated, over-the-counter-traded bets between institutions that almost destroyed the global banking system.

That’s where their bit in the teaser about the G-20 summit comes in …

“I’d like to show you how the G-20 Pittsburgh Summit just pushed an extraordinary event into motion.

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“Although the event will prove highly lucrative for some investors, before I go any further, I must warn you…

“This particular event exposes the truth behind a 7,500-person, ultra-discreet enterprise that I call Deception, INC.

“And how it controls the affairs of virtually the entire human race….

“In a moment, I’m going tell you about the chokepoint in this incredible story – the $615 trillion spinning around Deception, INC.’s new private wealth exchange.

“And how the recent G-20 Pittsburgh resolution…

“…and Congress’ subsequent legislation – Public Law 111-203 – gives us an irresistible opportunity to ‘skim’ that market for potentially life-changing gains.”

Well, the G-20 summit in Pittsburgh wasn’t all that recent, that was about two years ago. Still, the recommendations from that summit are taking a while to filter through the global regulatory frameworks, and they are starting to have an impact on the market more recently (though details have been pushed back again).

And particularly this “private wealth exchange” that the teaser talks about — this is all about the push to move the huge volume in derivatives trading onto regulated exchanges, creating a safer system where exchanges move and guarantee standardized derivative contracts so the back-door trades between banks can’t surprise us all with bankruptcies and massive ripple effects (ie, Lehman Brothers) when a counterparty fails or loses the confidence of the market, and so pricing can be more public.

So yes, all that and what we’re talking about is a company that runs or is launching some sort of derivatives exchange, and the promise that this company will make us rich as a result. Here are the clues, such as we get ’em:

“Course of Action #1:

“Follow Deception, INC.’s Money

“My analysts have identified an ingenious way to profit from Deception, INC.’s massive derivatives market without ever going within earshot of an actual derivative.

“So please take careful notice that within the past year, a milestone event occurred…

“A brand-new exchange was launched, exclusively trading the largest segment of the derivatives market.

“Only months old, early estimates put the potential value of the exchange in the neighborhood of $10 trillion.

“But why haven’t you heard about it? Why were there no cameras? No press? And no celebrities ringing the opening bell?

“Because the Benefactors don’t want you to know it exists.

“As I’ve been telling you, this market is the biggest moneymaking cog in Deception, INC.’s wheel….

“For now, forget about the fact that $12.8 billion in transactions passed through the exchange in its first week of trading and, instead, concentrate on the number ONE…

“As in, ONE tiny company runs the entire exchange, handling every single order over its brand-new electronic trading platform.

“Forty-one banks are presently live on the platform, with heavyweights like Barclays Capital, Deutsche Bank and JP Morgan providing streaming prices….

“… among the Goliaths there sits ONE small, virtually unheard of company facilitating Deception, INC.’s next decade of profits.

“Imagine earning a cut on every trade.”

The tease then goes on to compare this company to giants of the exchange world, like Intercontinental Exchange (ICE) and the CME Group (CME), which have certainly made money for many investors in their relatively short lives as public entities — but apparently this new company, though it may compete in the same markets, is an even better opportunity (so sez them) … some more clues for you:

“As a whole, the $615 trillion derivatives market dwarfs the futures, options and over-the-counter markets individually.

“The under-the-radar company executing the derivatives trades over its new electronic platform is tiny – only 1/30th the size of industry giants like Bank of America….

“Billions in unrealized trading revenue is still NOT priced into the stock….

“The electronic platform was nine years in the making.

“And this little company’s been an up-and-comer in international banking since the late 1990s.

“I expect the coming months to mark a historic turning point for the company….

“The report also reveals why BlackRock – the newly crowned King of Wall Street – loaded its house account with 32 million shares of this company’s stock.”

Wow … so who is this giant-in-the-making? Well, we feed those clues into the Mighty, Mighty Thinkolator … 32 million shares for BlackRock, startup electronic exchange, 41 banks on its network including those titans named, largest segment of the derivatives market … and bingo, our answer emerges: This is Icap PLC (IAP in London, IAPLY for the 1:2 ADR on the pink sheets — the pink sheets ADR represents two shares in London and trades every day at mostly fair prices, unlike some pink sheet stocks, but is still quite low volume).

If you want a quick primer on foreign ADRs like this, the general rule is that you want to trade them based on the fair price set on their home exchange, which is where most of the trading takes place, and if possible you want to trade them at a time when both the NY exchanges and the home exchange (the LSE) are open. (Depending on where we are with daylight savings time in UK time, that usually means the first hour or two of NY trading occurs when London markets are still open — right now, London markets remain open until 11:30am EST.)

So when trading these stocks, you check the current price or closing price on the foreign exchange — IAP closed at 468.5 pence in London — and translate that into pounds (GBP 4.68) and then dollars. At the current rate, that’s roughly $7.35. Then you remember that the ADR represents two shares in London, so we double it to $14.70. The last price on the pink sheets ADR was $14.61, so that’s what I mean when I say this one generally (or at least currently) trades at right around the fair value.

Some stocks, particularly smaller or lightly traded pink sheets representations of foreign stocks, trade at a substantial variance to their “real” value as set by the home market, either because the two markets aren’t open simultaneously, or because there’s not enough volume on the pinks to get fair trades, but this one appears to be fine on that front — doesn’t mean you can’t get shellacked if they happen to announce bad news and you want to sell in a hurry, since there isn’t a big trading volume to absorb quick sells, but compared to many this one looks reasonable for small traders and investors.

But do you want to buy it? Well, this is a perfect match for the “Deception, Inc.” tease, so if you find that argument extremely compelling perhaps you’ll want to dig deeper — BlackRock does own about 32 million shares, which is roughly 5% of the company, and they do have 41 banks on their electronic trading network, which they hope will be approved as an exchange under the new global derivatives rules. The big sector of the derivatives market that they’re active in is foreign exchange — they bought EBS a few years ago, and in so doing acquired the lead spot forex trading network.

The trading network that’s teased is about a year old, and it is an electronic euro interest rate swaps market — you can see the details here that’s the one where Barclays Capital, Deutsche Bank and J.P. Morgan signed on to agree to provide streaming quotes at the launch.

They’ve also been paying their principals a princely sum, if that bothers you — and one of them is also a political figure in the UK, so that helps to bolster the “Deception, Inc.” argument of shadowy links between big banks and government … not that anyone really thought otherwise, not after the big rescues that the banking system received with little or no penalty for the ne’er-do-well’s.

Icap is trying to build out electronic exchange-type systems that it hopes will qualify for whatever the European requirements are for listing of derivatives, but it’s already a pretty large company (not huge compared to other financial firms, but at a $5 billion market cap it’s hardly a “small cap” — about half the size of ICE, and a third the size of CME) that is primarily an inter-dealer broker. That means they’re already “sort of” like an exchange, they are the middleman, and increasingly an electronic middleman, in huge institutional trades and they take a very tiny fee relative to the huge volumes of trading they facilitate.

Which has been working pretty well for them so far — their last earnings report indicated that the new electronic brokerage platform is doing well and revenues were up, as were earnings per share and the dividend (the trailing dividend is roughly 4%). Trading volume on their networks has continued to grow, according to their monthly reports — up 35% in July and 28% in August, year over year. The profits were only up about 4% year over year, but revenue climbed nicely and I assume they must have done some share buybacks to improve that per-share number. You can see an interesting report and interview from Bloomberg TV on Icap from when the results were last released in May. The shares dipped a bit over the Summer, but are essentially in the same range as they were when earnings hit in May.

The company reported that their electronic trading, including the successful swaps network, accounted for more than half of their revenue last year for the first time ever — supplanting the traditional phone broking of OTC trades that regulators really want to do away with … so that’s a good sign, that they are strategically positioning themselves for growth in electronic exchange (or exchange-like) trading of derivatives, and they also have expanded heavily into emerging market trading in all kinds of financial instruments.

In some ways the argument could easily have gone the other way — governments are trying to stamp out OTC trading in derivatives, and Icap, the largest OTC dealer, might expect that this would crush their business. So the key is their ability to go from being the leading OTC broker-dealer, to being the leading operator of electronic derivatives trading — they’re certainly not the only big institution that’s trying to corner this business, but they do start from a position of strength given their big base of institutional customers and they do seem to be adapting well to the new expected regime so far.

The trick, then, is that the regulations are not really set yet — Icap has been saying that they fully expect to either be in compliance with the rules or to have a chance to get their markets/exchanges into compliance in relatively short order once details are released, but the final details of the regulatory overhaul keep getting pushed back, with real answers not likely until the end of the year. The latest word on Icap’s strategy that I’ve seen, from July, is that they are still strategically focused on expanding their electronic broking business.

Icap is pretty closely tied to the euro, which might not be a bad thing — much of their trading volume is in euro interest rate swaps and in euro forex pairs, so the volatility of the euro may actually be good for them. On the flip side, the move of the other brokers and the big exchanges into the emerging derivatives exchange business, including some big players like the Deutsche Borse/NYSE, CME, ICE and the Nasdaq, means they’ll probably have lots of competition from their fellow “Deception, Inc. subsidiaries” for this potentially huge business.

In terms of basic company valuation, they seem reasonable with a trailing PE of about 16, which means they’re slotted between not-quite-comparable companies like the CME Group (CME) with its trailing PE of 14, and IntercontinentalExchange (ICE) with a trailing PE of 19. They’re smaller than both of those exchange companies, but not that much smaller, and they pay a substantially higher dividend (ICE has no dividend, CME’s is about 2%).

If you’re interested in learning more about Icap, they explain themselves pretty well (and glowingly, of course) on their website here, and I’d expect that the next likely catalysts — absent surprising acquisitions — are their interim earnings, due in mid-November, and the details about emerging regulation of derivatives and whether those detailed rules let Icap’s network operate as an approved exchange, which will probably trickle out over the next six months if the pundits are correct.

So for now, I’m stuck at “I find this interesting” — exchanges and proprietary networks (like Visa, or the CME) can certainly be great businesses, but I’m a little nervous about how speculative the commentary about the potential “new world order” for derivatives trading has been … I think I’m going to spend a little more time looking at this idea, I’ll let the Irregulars know if I actually decide to invest after thinking it through, but if you’ve got an opinion on Icap or the beneficiaries of this move to trade derivatives in the sunlight, please let us know with a comment below. Thanks!


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