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October 21, 2005

Stocklemon Reports on Fairfax Financial.

Where There’s Smoke There’s Fire … Could Fairfax Financial (NYSE:FFH) Be the Next Refco?????

Fairfax Financial has long been under scrutiny by many market players for their complex corporate structure and numerous related party offshore dealings. While this Canadian based insurance company flatters itself by inviting comparisons to Berkshire Hathaway, the differences are glaring. The following report will give a brief glance into one of the more convoluted corporate structures on any listed exchange.

Talk of the demise of Fairfax has long been a speculation among market participants. Stocklemon believes that the current circumstances regarding investigations and claims might be the final fatal blow to Fairfax Financial.

Currently, Fairfax is under investigation by the Securities and Exchange Commission. On September 7, 2005 Fairfax received a request to show documents regarding non-traditional insurance products.


But this is where it gets interesting … Fairfax then put out another press release on September 26, under the headline:

“Fairfax Receives Further Document Request As Part Of SEC Loss Mitigation Products Investigation”


Note how this headline is intentionally spun to give the impression that the new subpoena was just an extension of the finite insurance investigation. Yet in the text below the skewed headline, we read that the SEC is:

“…requesting documents regarding any transactions in securities of Fairfax Financial, the compensation for such transactions and the trading volume or share price of such securities.”

It appears the SEC is investigating the trading of Fairfax Financial and not just the use of finite insurance.

Corporate candor hit an all time low when the Wall St. Journal reported on October 10 that Fairfax was the target of a US Attorney’s Investigation. Instead of acting professionally and describing the details of the investigation, Fairfax was quick to put out a PR stating only that they did not receive a subpoena from the US Attorney.

Yet, the very next day Fairfax seemed compelled to issue this “clarification: that they are indeed under review from the U.S. Attorney’s office, yet they have not received a subpoena.


*…as always, all calls to the company from Dow Jones and Reuters reporters were not returned as noted in their stories.

The lunacy of these statements was best expressed on this White Collar Crime Blog:

Costs of Katrina

The recent devastation in the Gulf Coast region due to hurricanes Katrina and Rita might be especially expensive for Fairfax Financial. In typical fashion, Fairfax’s initial estimate of the damage was an understatement.

Initially the company estimated their net losses at $175 to $220 million.


And then 3 weeks later we learn the losses are estimated at $388 million

Who knows what the final tally will be, but if the company is facing a cash crunch that is being masqueraded by stock offerings and complicated offshore dealings, the huge unanticipated loss will accelerate and intensify the problem.

HIH Insurance and Fairfax Financial…too many similarities for comfort

For those Americans who are not familiar with HIH Insurance, it was the Australian version of Enron. Once the second largest insurance company in Australia, it was forced into liquidation and became the hallmark of corporate scandals in Australia.

http://en.wikipedia.org/wiki/Raymond_Williams_(Australian_bu… - Stock_Market_Manipulation

Here is an article from 2003, that discusses 10 remarkable similarities between Fairfax and HIH. This article must be a “chilly read” if you are a shareholder of Fairfax. These similarities have become more similar in the past 3 months, this is a must read.

Fairfax and HIH

Here is the 11th and most eerie similarity between Fairfax and HIH. After the collapse of HIH, the founder was charged with securities fraud as he purchased shares of HIH with a related company using the funds of HIH. We are not stating that executives of Fairfax have manipulated their security, but they are being investigated by the SEC for the trading in their securities. It is the experience of Stocklemon that all too frequently, where there is smoke, there is fire.

Recently, a new critic of Fairfax has emerged. This critic is famed hedge fund manager Jim Chanos. Chanos’s claim to fame was that he was one of the early critics of Enron, while it was still one of the most powerful companies in the US. In a recent interview, Chanos stated about Fairfax, “We think this is a zero”. Those are ominous words from a man who carries that level of credibility on Wall Street.


Would Buffet Act Like This ?

At the helm of Fairfax Financial is former Toronto based money manager Prem Watsa. Although Mr. Watsa likes to fancy himself as the “Warren Buffett of Canada”, the differences between the two men could not be more obvious. Whereas Mr. Buffet has successful track record based on high profile investments that have paid out in the long term, Mr. Watsa has kept most of his investments hidden from even his shareholders. If one word could describe the difference between Buffett and Watsa, it would be the same word that was the downfall of Enron and Refco”


Watsa has long been criticized for operating Fairfax as if it were a private company. This glaring lack of transparency is what has invited many to criticize Fairfax. Forbes warned of this back in 1997 in the following article:

Forbes on Fairfax

The lack of transparency was also addressed in a 2003 article in the Financial Post:

Financial Post

If you cant beat ‘em … confuse ‘em !

A common criticism of Fairfax Financial has been their complex corporate structure and web of transactions with related offshore units. The Wall St. Journal states that “ Fairfax has used finite-risk deals, often with affiliated offshore reinsurers, to limit its losses.



Yet, as an investor, it is extremely difficult to understand the nature of these transactions. We recollect Jim Chanos’s reason for warning investors off Enron: “… because I can’t understand their financials, and if I can’t, I don’t know anyone who can.”

Here is an excerpt from a Fairfax filing – a Luxembourg subsidiary … got to love the confusion they are sowing in here.

“During the period, the Company has received a dividend in kind from its Swiss subsidiary amounting to EUR 4,489,000 in form of all shares issued by a Bermuda group company. Those shares were contributed in the same period to a UK Subsidiary for an amount of EUR 5,293,836 in remuneration for shares and generating an income on disposal of investments of EUR 804,836 for the company. For the same UK subsidiary an amount of EUR 2,289,816 has been written off in correction of book entries realized during the year 2002.

Moreover, the existing valuation allowance for the UK subsidiary has been reversed for an amount of EUR 11,300,000 on the basis of an evaluation at the end of the year. Another valuation adjustment of EUR 10,300,000 is made at the end of the year concerning the Swiss subsidiary.”

Luxembourg Document


Disclaimer: Stocklemon is not a CFA, accountant, or even an MBA.

The Auditors: Price Waterhouse Coopers

Behind the wave of corporate scandals over the past 6 years, there have been a host of auditing firms that have been negligent in their duties. Most recently, Grant Thornton never questioned the true ownership of the offshore hedge fund that owed Refco over $400 million, even though they have audited Refco for over 3 years.

Stocklemon believes that Price Waterhouse has not exercised any professional skepticism in the auditing of Fairfax Financial and therefore is negligent in fulfilling SAS no 99 according to the American Institute of Certified Public Accountants (AICPA).

“SAS no. 99 reminds auditors they need to overcome some natural tendencies—such as over reliance on client representations—and biases and approach the audit with a skeptical attitude and questioning mind. Also essential: The auditor must set aside past relationships and not assume that all clients are honest. The new standard provides suggestions on how auditors can learn how to adopt a more critical, skeptical mind-set on their engagements, particularly during audit planning and the evaluation of audit evidence.”



Where there is smoke, there is fire. Stocklemon believes that Fairfax has too many red flags to explain away as coincidence. With the recent demise of Refco, it is becoming imperative for investors and auditors to look into all offshore dealings of a company and to validate their legitimacy.

On October 28, Fairfax if going to host a conference call to discuss its third quarter results. Next week Stocklemon will publish a list of questions that Fairfax should definitively answer for its investors if they are going to strive towards transparency in their business. And the next quarter is the year end – with audit required. The auditors are going to have to think long and hard about the liability Grant Thornton now faces for having cast a blind eye upon Refco’s self-dealing transactions. We’ll be watching with interest as this story unfolds (or unravels).

Until then, Cautious Investing To All.

Stocklemon.com does not guarantee in any way that it is providing all of the information that may be available. We recommend that you do your own due diligence before buying or selling any security. At any times the principals of Stocklemon.com might hold a position in any of the securities profiled on the site. Stocklemon.com will not report when a position is initiated or covered. Each investor must make that decision based on his/her judgment of the market.
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Autor (Datum des Eintrages): kfe1000  (24.10.05 18:40:38)
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