Tech Firm Serving Hedge Funds Shows Perils in Money-Losing IPOsBy
Liquid Holdings flounders despite Wall Street connections
Manager who leased software says he got $1 million to trade
Brian Ferdinand, a young financier who once managed 400 day traders from lower Manhattan, saw opportunity in the thousands of small hedge funds eager to make it big. Offer them a trading platform and free software, he thought, and then charge them for each trade. He founded a company, eventually pulling in former executives from UBS, Nymex and Goldman Sachs, to cash in on this combination of Wall Street and cloud computing.
It didn’t work out that way.
On route to its initial public offering, the company, Liquid Holdings Group Inc., became a pure software play. There were blowups between Wall Street alums. Backers made a last-ditch effort to woo customers with sunset drinks on the most luxurious yacht ever built in America.
That wasn’t all. Faced with big expenses, negligible revenue and plummeting shares, Ferdinand and another investor put up their own capital to offer hedge fund managers as much as $5 million each to trade. The hedgies could pocket much of the profits if they agreed to lease Liquid’s software, say people who took the deal.
The strategy made no sense, concluded Ben Weinger, a hedge fund manager who studied the company and its fundamentals even as he was offered money to trade. Weinger’s take: “This is the greatest turd ever sold."
Since their debut at $9 two years ago, shares of Liquid Holdings have plunged to less than 10 cents. Some of its early backers have knocked heads, walked away and been sued.
Ferdinand said he did nothing wrong and that the problems arose when the company deviated from his original strategy.
The company, under new management, declined to comment on previous problems, and Chief Executive Officer Peter Kent said his focus was on technology and not on being a brokerage. If Liquid Holdings can generate revenue from hedge funds, cut costs, invest in technology and strengthen its balance sheet, he said, "I’m enthusiastic about our future potential."
The tale of Liquid Holdings -- assembled from company and court filings, as well as interviews with company insiders, investors and customers -- is singular. Yet in one regard, Liquid is like many other new public companies: It never made a profit. Since the beginning of 2014, more than 70 percent of initial public offerings have been for money-losing firms, the highest mark since 2000, according to research by University of Florida finance Professor Jay Ritter and researcher Diana Shao.
Liquid went from inception to IPO in less than two years, in part to satisfy agreements with early investors. Clearing its path was a government program that effectively lowered the bar for small companies going public.
The red flags weren’t hard to spot, said Weinger, who came across Liquid’s prospectus as he was looking for new issues to short in his New York-based 3-Sigma Value Investment Management LLC fund. Liquid was charging funds for trading software that many got free from their brokers. Weinger also saw what he believed were inflated assets, plus a tangle of related companies controlled by Liquid’s main investors. "It had the single worst prospectus I’ve ever seen," said Weinger.
A Deal to Remember
When he called Liquid to ask a few questions, Weinger was put in touch with a representative of an affiliated trading company. The representative offered to put $1 million into his trading account, with 3-Sigma taking half of any profits generated, recalled Weinger.
He took the deal, agreeing to lease Liquid’s software, and says he made money trading. But Weinger wasn’t done. He shorted the stock, too, riding it down and profiting even more.
The software didn’t live up to its billing as a quantum leap in technology. Weinger called it "a glorified Excel spreadsheet." Three other fund managers were equally dismissive. Investors who filed an Aug. 18 lawsuit cited the software’s deficiencies and named Ferdinand and others involved in Liquid of being the "architects and promoters of an elaborate multimillion-dollar stock fraud.” Liquid enriched its principals with shares and high salaries while it claimed bogus customers for subpar software, Jay Deutsch and Todd Deutsch said in the suit, filed in New York Supreme Court in Nassau County.
A company spokesman declined to comment on the litigation. Kent, who joined Liquid as chief financial officer in October 2014 and added the CEO role in March, said he couldn’t comment on matters before his arrival.
"We went public too early, and all the noise and bad blood hasn’t helped," Ferdinand said in an interview. He called the lawsuit filed by the Deutsch family “grossly inaccurate.”
Helping Hedge Funds
Ferdinand, a 38-year-old from Livingston, New Jersey, caught the trading bug from an uncle and cousins. The 2008 financial crisis, he said, created an opportunity to offer trading services to small hedge funds that together represented tens of billions of dollars under management and were underserved by big banks. He and two partners started by assembling companies -- a U.S. brokerage, a software developer -- including some they had started themselves or already owned.
What they needed was a big investment.
Ferdinand hit up Douglas Von Allmen, a onetime customer of his old day-trading shop. Von Allmen, an accountant from Kentucky, had built a fortune flipping companies including a sunglass retailer. After selling a beauty products distributor to L’Oreal SA in 2007, he lost $57 million in a Ponzi scheme. Von Allmen had recovered a substantial portion of those losses by the spring of 2012, when he invited Ferdinand into his colonnaded waterfront mansion in Ft. Lauderdale, Florida.
Providing software and trading services was a proven winner, Ferdinand told Von Allmen. Von Allmen offered to write a $12.5 million check on the spot. But there was a condition: If Liquid failed to meet Von Allmen’s deadlines for an IPO, he would get more shares. Von Allmen declined to comment on the meeting or his role in Liquid.
The Liquid team blew past Von Allmen’s first deadline in late 2012. It was also remaking the business on the fly.
Shift in Strategy
One of Ferdinand’s partners -- Richard Schaeffer, a former chairman of the New York Mercantile Exchange who led Liquid’s board -- pressed to bring in a CEO with big-company credentials. His pick was Brian Storms, who had run Marsh Inc. and UBS Global Asset Management’s U.S. operations.
Within months, the two were butting heads.
"This is my f---king company!" Ferdinand recalled Schaeffer yelling at Storms one afternoon in Liquid’s 38th-floor offices in Midtown Manhattan. Ferdinand was in the next room with a second employee who also said he heard the argument. Schaeffer, who stepped down as chairman shortly thereafter, declined to comment on the outburst. Storms didn’t respond to phone messages.
No Risky Business
Storms, more solidly at the helm, argued that Liquid should stay out of the risky business of handling trades and make its money leasing software. The shift would position Liquid as a "cloud" software company in a hot market for tech stocks.
The prospectus for Liquid’s July 2013 IPO reveals multimillion-dollar expenses and hard-to-define assets. In the previous six months, Liquid had lost about $27 million on $3.2 million in revenue. Its assets were valued at $66 million -- consisting mostly of intangibles and goodwill.
One of Liquid’s bigger pieces was a private software developer, originally owned in part by Ferdinand and another Liquid co-founder. In 2011, the developer reported assets of $12,000 and a loss of $342,000. Liquid bought it the next year using Liquid shares with a pre-IPO value of $20 million.
The software developer was more substantial than its financials indicated, Ferdinand said, because the private company had been mined for tax losses and hadn’t capitalized its software as an asset. Its valuation was supported by an independent analysis. Liquid’s credibility was also bolstered by a number of Wall Street veterans, including three directors and two executives who’d worked at Goldman Sachs Group Inc.
Liquid’s IPO prospectus bore other cautions. Then-auditor KPMG, which signed off on the books, noted that it didn’t have access to records that would support Liquid’s financial statements and untangle its related-party dealings.
Liquid also lacked "internal controls to safeguard and archive records" that would help support the valuation of the company’s pieces, according to the prospectus.
The auditor’s questions weren’t a deal-killer, though, thanks in part to a U.S. law passed the previous year. The 2012 Jobs Act allowed employment-creating small companies to tap public funding with a lower-than-standard level of accounting scrutiny.
KPMG declined to comment on Liquid, as did Sandler O’Neill, the investment bank that arranged the offering.
Liquid priced at $9 a share, making the company briefly worth $236 million. Because each share was backed by 59 cents in tangible assets, the prospectus warned, investors would face "immediate and substantial dilution."
At the public offering, Ferdinand and Schaeffer each received cash bonuses of more than $400,000. Ferdinand said the bonuses were for money owed to them by the company. Storms, the CEO, sold nearly $900,000 in shares and had his salary more than doubled.
In the months after the offering, Storms persuaded his board to pull the plug on Liquid’s brokerage. Ferdinand said he "went off the rails" over the decision, angering some fellow board members. He stepped down as an officer in April 2014.
But Ferdinand, still a major shareholder, had been working for months on another effort to build up Liquid’s customer base.
The vehicle was a private trading shop, QuantX Management LLP, funded largely by Ferdinand and Von Allmen. The pair put up $23 million in cash, using leverage with their broker to turn it into $100 million, Ferdinand said.
With the pooled capital, a QuantX representative started cold-calling hedge fund managers. It was a puzzling case of reverse leveraging: QuantX was tying up hundreds of thousands, or even millions, of dollars on unproven managers, to book a few thousand dollars of monthly revenue for Liquid.
Ferdinand said the arrangement was born from the need to ramp up sales. The Deutsches, in their suit, called it a fraudulent effort to fabricate customers. As Liquid reported rising customer counts in 2013 and 2014, well over half its licensing revenue came through QuantX customers.
Von Allmen mounted another campaign. In yachting circles, the ex-accountant had gained a measure of fame for his effort to create the most luxurious yacht built in the U.S. He and his 185-foot Lady Linda were the focus of a 2013 book -- "Grand Ambition: An Extraordinary Yacht, the People Who Built It and the Millionaire Who Can’t Really Afford It" -- by G. Bruce Knecht.
In October 2014, on the sidelines of the Ft. Lauderdale International Boat Show, Von Allmen hosted dozens of hedge fund executives on the Lady Linda in its art deco salons and air-conditioned outdoor deck. Ferdinand and a Liquid executive pitched the company’s new mobile-phone application.
But Liquid was already sinking. UBS Bank USA had sued Ferdinand and his wife in July 2014 for defaulting on a $2.3 million personal loan, and demanded the Liquid shares posted as collateral. They settled in September, a month before the boat show.
That December, Ferdinand filed a public statement of his displeasure with Liquid’s management. His bid to spearhead a restructuring went unheeded. The next day, Liquid adopted a poison pill. It also cut ties to QuantX. The trading firm folded, slashing Liquid’s official customer roll by more than half. According to a Liquid press release, Quantx and its customers had provided 95 percent of liquid’s software revenues in the quarter through September 2014.
For the roughly 100 hedge funds that traded with QuantX’s money, the results were mixed. Many lost money and were dropped. After QuantX folded, a handful of funds that had profited, including Weinger’s 3-Sigma, were owed money. Von Allmen personally covered the debts earlier this year.
Von Allmen, his combined $40 million investment in Liquid now worth less than $1 million, sold Lady Linda in March. "I believed in the company, the product and the people," Von Allmen, 74, said by telephone, declining to comment further. "I’d rather focus on positive things at this stage in my life."
Liquid, now demoted to Nasdaq’s small-cap market, faces delisting if it doesn’t file updated financial statements by September. Kent said Liquid was a classic startup, with classic hiccups.
"If I was making the decision today, I wouldn’t take this company public," he said. A startup’s growing pains, he added, are “usually handled better in a private setting. But we are what we are.”
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