Monthly Archives: February 2010

Embattled businessman Tim Durham apparently will not oppose the appointment of an interim receiver for Fair Finance and its parent corporation, Fair Holdings. The story was first reported on Feb. 11 by the Akron Beacon Journal. The news comes one week after the law firms of Maddox Hargett & Caruso and David P. Meyer and Associates Co. filed paperwork asking a Summit County, Ohio, court to appoint a receiver for Fair Finance and Fair Holdings.

Attorneys for Fair Finance deny the company has been involved in any wrongdoing.

The offices of Fair Finance have remained closed since Nov. 24 when the FBI raided the company’s Akron headquarters and the offices of a related business in Indianapolis, Obsidian Enterprises. According to court records, federal investigators suspect that Fair Finance was being operated as a Ponzi scheme.

Meanwhile, a federal judge is weighing whether to unseal search-warrant documents related to the FBI’s November raids. On Feb. 11, during a court hearing in Youngstown, Ohio, a representative of the U.S. Attorney’s Office in Indianapolis argued that unsealing the search warrants could damage the federal government’s ongoing investigation.

Investment firm Morgan Stanley is facing an arbitration claim by the city of Burlington, Vermont, which alleges breaches of fiduciary duty and fraud involving something known as a wrap account. According to the claim, Morgan Stanley’s actions resulted in damages of more than $21 million for the Burlington Employees’ Retirement System – losses that were mainly due to hidden fees and commissions associated with the wrap account Morgan Stanley recommended.

As reported Feb. 11 by Investment News, the city alleges that the fraud occurred from 1981 through 2006 and that the Morgan Stanley employees in charge of its account engaged in a “pay-to-play” scheme. According to the claim, Morgan Stanley selected only managers who funneled a portion of their management fees to the brokerage firm.

In addition, the claim alleges that Morgan Stanley was charging per-trade commissions despite an initial contract that promised free trading. The allegedly excessive fees and mark-ups dramatically reduced the city pension fund’s returns, contributing to the $21 million in losses.

A Feb. 9 article in Forbes (Wrap Account Rip-Off?) highlights the potential drawbacks of wrap accounts. A wrap account is essentially an investment account in which clients are charged a flat percentage of their assets (usually between 1% and 3%) in return for unlimited trading.

Wraps have become an increasingly popular sales product on Wall Street – so popular, in fact, that brokerage firms now have roughly $1.5 trillion in assets under management in them, according to the Forbes article.

Critics, however, say wrap accounts have plenty of pitfalls and may be just as bad – if not worse – as commission-based accounts.

Burlington is asking a Financial Industry Regulatory Authority (FINRA) arbitration panel to order Morgan Stanley to pay the city, its board and the plan actual damages incurred as a result of Morgan Stanley’s alleged misconduct. The claim also is requesting punitive damages.

Morgan Stanley denies all the allegations.

Christopher Bass, an Albany investment broker and president and CEO of Swiss Capital Harbor/USA, was arrested Feb. 8 on federal criminal charges of securities fraud for an alleged scheme involving more than 200 investors and $5.5 million. 

According to the criminal complaint, Bass allegedly deceived investors with promises of high returns via investments in his company, which also operated under the name Revisco Finanz. Investigators say the alleged scheme dates back to January 2007. 

Investors’ funds were supposedly invested in several overseas projects, including power plants that authorities now believe may not exist. Court documents say that less than half of investors’ money was used for the purposes conveyed by Bass. Instead, the majority of money went to bankroll Bass’ personal expenses or to repay other investors. 

As reported Feb. 9 by Times Union.com, bank records show that Bass allegedly used $169,858 of investors’ deposits to finance the purchase of his upscale home in Menands, and that at least $700,000 of investors’ money was disbursed to Bass.  Another $550,000 of investors’ deposits was used for payroll expenses at Swiss Capital Harbor, including $200,000 in gross pay to Bass and at least $50,000 to his family members. 

The complaint also says that more than $1.25 million of investors’ deposits was used to repay investors who ultimately demanded to get their money back or income from their investments, which is indicative of a Ponzi scheme.

According to the Times Union.com article, several people who were solicited to invest money with Bass and Swiss Capital Harbor had previously warned state and local authorities more than two years ago that his company was “suspicious” and appeared to be inflating the rate of its returns to investors. 

Bass’ offices, as well as his Park Hill Lane home, were raided last August by U.S. Custom agents. 

Some investors now say they have lost their entire life savings because of Bass’ alleged scheme.

Securities America has a growing public relations problem. Last month, the broker/dealer was charged by Massachusetts regulators for allegedly failing to reveal key information to investors about high-risk notes issued by Medical Capital Holdings. Now, some of Securities America’s top producers are being sued by investors who say they were ill-informed about the risks of the Medical Capital deals that some Securities America advisers touted.

As reported Feb. 7 by Investment News, William Glubiak was named in December in a $7.7 million complaint from about 24 households of investors who purchased investments in Medical Capital Holdings.

Another leading Securities America adviser facing litigation connected to Medical Capital sales is Paula Dorion-Gray. In November, Dorion-Gray was named in a $254,000 complaint that alleges she recommended alternative investments in Medical Capital and another private placement, Provident Royalties LLC.

As for Securities America, it maintains its innocence.

“The Medical Capital situation is highly unfortunate for investors, advisers and broker-dealers alike, all of whom were intentionally defrauded by the principals at Medical Capital,” Securities America spokeswoman Janine Wertheim said in the Investment News article.

“Securities America performed extensive, industry-standard due diligence of Medical Capital, and every person that purchased Medical Capital through SA was an accredited investor, according to their financial suitability documents, and attested to that as well as to their understanding of the risks . . . We plan to vigorously defend our firm and our advisers that sold Medical Capital,” she said.

As investigations continue into the business dealings of Tim Durham and Fair Finance, a motion has been filed on behalf of some Fair Finance investors to appoint a receiver in the case. The motion was filed Feb. 4 by the law firms of Maddox Hargett & Caruso and David P. Meyer and Associates.

“The remaining Fair Finance assets are in imminent danger of being siphoned away by [Tim] Durham and [Jim] Cochran now that their Ponzi scheme has been exposed,” said David Meyer of David P. Meyer and Associates, in a Feb. 4 article in the Indianapolis Business Journal.

In December, Meyer’s law firm, along with the law firm of Maddox Hargett & Caruso, filed a class-action lawsuit on behalf of investors who purchased $200 million in unsecured investment certificates from Akron, Ohio-based Fair Finance. Fair Finance is owned by Durham and Jim Cochran.

Following the November FBI raids on Fair Finance, investors have grown increasingly fearful that the company’s owners may be spending what remains of the company’s finances. The Akron offices of Fair Finance have been closed since the FBI raids, with no word from Durham on when or if his company will ever repay investors.

In December, Ohio Congressman John Boccieri called for an asset freeze on Fair Finance and its owners. He reiterated that plea in late January at a town hall meeting held in Ohio. As reported Jan. 27 by the IBJ, Boccieri was seeking the asset freeze after learning Fair Finance co-owner Jim Cochran had posted an ad on Craigslist for an estate sale at his $3.5 million Naples, Florida, residence. According to the article, the sale went as planned, with Cochran selling off everything from Bentley and Porsche automobiles to a 28-foot boat and a large potted plant.

The Feb. 4 motion for a receiver was filed in Summit County, Ohio. It asks that the receiver take control of Fair Finance and its parent company, Fair Holdings.

Investments in Medical Capital Holdings have resulted in millions of dollars in losses for investors across the country and, in turn, ignited a rash of lawsuits and arbitration claims. The focus of investors’ complaints is on the broker/dealers that sold the investments – known as Medical Capital Notes – and the information they allegedly kept hidden.

Securities America is one of the broker/dealers facing legal action in connection to Medical Capital Holdings. Massachusetts regulators sued the Omaha-based company on Jan. 26, claiming it misled investors about the risks involved in the Medical Capital Notes and the financial health of the issuer, Medical Capital Holdings. According to the complaint, 400 Securities America advisers allegedly sold $700 million of the private placements, half of which are now in default.

One of the advisers is William Glubiak, who was named in a December 2009 complaint involving Medical Capital Holdings. The suit alleges causes of action as unsuitability, misrepresentation and omission of material facts, according to records with the Financial Industry Regulatory Authority.

Paula Dorion-Gray is another adviser for Securities America. She also is facing a lawsuit over private placement deals gone wrong. As reported Feb. 3 by Investment News, Dorion-Gray was named in a $254,000 complaint in November that accuses her of recommending alternative investments in Medical Capital and another private placement, Provident Royalties LLC.

Medical Capital Holdings and Provident Royalties were both charged with fraud this past summer by the Securities and Exchange Commission (SEC).

If you have a story to tell involving Medical Capital Holdings, Securities America and/or Provident Royalties, please contact a member of our securities fraud team.

Former Bank of America CEO Ken Lewis is in a category all by himself. Following the Feb. 4 filing of civil fraud lawsuit by New York Attorney General Andrew Cuomo filed, Lewis became the highest ranking banking official to face charges of wrongdoing as part of the financial industry’s meltdown.

Cuomo’s lawsuit accuses Lewis, former Bank of America CFO Joe Price (who now runs the bank’s consumer banking division) and Bank of America itself of manipulating both investors and the government by not disclosing the full extent of massive financial losses occurring at Merrill Lynch before shareholders voted on the firm’s pending acquisition. The suit says Bank of America then used Merrill’s financial predicament to get additional bailout funds from the government.

“Ken Lewis is the poster child – or scapegoat – for the excesses of the past,” said Mark Williams, executive-in-residence at Boston University and a former bank examiner in a Feb. 5 article in Bloomberg. While Lewis didn’t push as deeply as some rivals into mortgage-backed securities, “he made bad strategic decisions” by overpaying for Merrill Lynch and subprime home lender Countrywide Financial Corp., Williams said.

According to Cuomo’s complaint, Bank of America was given advice by its own legal counsel, Timothy Mayopoulos – as well as outside counsel – as early as November to tell investors about the current and predicted financial losses of Merrill Lynch. Deloitte and Touche, Merrill’s auditing firm, also suggested disclosure, the complaint says.

“ . . . Bank management failed to disclose that by December 5, 2008, the day Bank of America shareholders voted to approve the merger with Merrill Lynch, Merrill had incurred actual pretax losses of more than $16 billion. Bank management also knew at this time that additional losses were forthcoming and that Merrill had become a shadow of the company Bank of America had described in its Proxy Statement and other public statements advocating the merger,” the complaint reads.

Corporate Treasurer Jeffrey Brown also “urged Price to make a disclosure to no avail,” according to the complaint. “When Price dismissed the Treasurer’s advice, the Treasurer warned, ‘I didn’t want to be talking [about Merrill’s losses] through a glass wall over a telephone.’ ”

“Astonishingly, Price seemed to have forgotten this dramatic exchange,” according to the lawsuit.

Lewis also was aware of the disclosure issues, because Price updated him on disclosure and loss issues.

More of what Lewis did or didn’t know will likely come to light in the coming days and weeks ahead. In the meantime, however, the opening summary of Cuomo’s lawsuit may sum up the situation best: “Throughout this episode, the conduct of Bank of America, through its top management, was motivated by self-interest, greed, hubris, and a palpable sense that the normal rules of fair play did not apply to them. Bank of America’s management thought of itself as too big to play by the rules and, just as disturbingly, too big to tell the truth.”

State Street Corporation gave some “preferred” investors key information about its Limited Duration Bond Fund back in 2007, allowing them to jump ship and subsequently avoid millions of dollars in losses. As it turns out, the Limited Duration Bond Fund was almost entirely invested in mortgage-related securities. Investors who were not privy to State Street’s pre-warnings paid the price.

As reported Feb. 4 by the New York Times, State Street’s selective disclosure became public after agreed to pay more than $310 million in penalties and restitution to settle accusations by the Securities and Exchange Commission (SEC) and Massachusetts officials that it misled investors about the risks associated with the Limited Duration Bond Fund and other funds that invested in it.

According to a complaint filed by the SEC, State Street created the Limited Duration Bond Fund in 2002 and marketed it as an alternative to a money-market fund. Five years later, however, the fund was almost entirely invested in mortgage securities. State Street not only misled many investors about the fund’s exposure, but also provided certain investors with more complete information regarding the fund’s investing strategies, the SEC says.

“State Street gave preferential treatment to some investors over others, leaving many investors, including dozens of Massachusetts charities and retirement funds, completely unaware of key facts about the funds,” said Massachusetts Attorney General Martha Coakley in a statement.

Investors who received more accurate information from State Street included clients of State Street’s internal advisory groups, which advised some investors in the fund. The advisory groups recommended that their clients, including State Street’s own pension plan, redeem their investments. State Street sold the most liquid holdings to meet these redemptions, according to the SEC. As for the remaining investors, they were left with largely illiquid holdings.

The funds, which were managed by State Street Global Advisors, accounted for about $13 billion of State Street’s funds under management in 2007.

State Street’s settlement will be allocated among about 270 investors who lost money. It includes a $50 million fine and $8 million in forfeited advisory fees and interest. The payment is in addition to $350 million that State Street will pay to settle private claims. The bank also will pay an additional $20 million to settle with Massachusetts authorities.

State Street does not admit or deny the allegations.

College investments dropped 23% in 2009, with U.S. colleges and universities losing a total of $93 billion in endowment value in 2009. It was the most disastrous year since 1974, when the average college lost 11.4% of its endowment, according to a recent survey by the National Association of College and University Business Officers (NACUBO). NACUBO’s study, which was jointed conducted with the Commonfund, offers several important insights.

Institutions that focused more intently on using endowment funds as a way to provide long-term economic security – and thus invested in relatively low-risk, conservative investments – fared far better in general. On the other hand, institutions that may have viewed endowment money as a mechanism to generate capital and invested in riskier types of investments paid the price.

Harvard (the richest of the institutions that participated in the NACUBO survey) lost 30% at the end of 2009, followed by Yale University at 29%. Stanford University lost nearly 27% and Texas University nearly 25%.

By comparison, New York University (which also has an endowment greater than $1 billion) suffered a 15% decline in the value of its endowment at the end of FY 2009.

As reported Jan. 28 by Forbes, Martin Dorph, the university’s senior vice president for finance, credits the relatively positive performance to the endowment’s conservative asset allocation. NYU had $780 million – or about 35% of its endowment – invested in fixed income at the beginning of 2009. Another 30% was invested in hedge funds, 25% in equities and 10% in private equity.

“The reality for NYU is that, while our endowment is large on an absolute basis, it is not as large on a per-student basis as our peer institutions,” Dorph said in the article. “Our endowment is seen as more precious because we don’t have as much.”

Harvard Ignored Warnings About Investments?

Harvard’s questionable investing strategies have been well documented in the past weeks. In a Nov. 29 article appearing in the Boston Globe, a story reports that Jack Meyer, who headed Harvard’s endowment, had “repeatedly warned” Harvard officials that the school was being too aggressive with billions of dollars in cash, “investing almost all of it with the endowment’s risky mix of stocks, bonds, hedge funds, and private equity.”

The warnings, however, apparently fell on deaf ears. When the market crashed in 2008, Harvard found that $1.8 billion in cash had vanished. And, today, the university is still paying the price for its investing style via tighter budgets, deferred expansion plans, and big interest payments on bonds issued to cover the losses.

Larry Summers served as president of Harvard from 2002 to 2006. He also is one of the officials who allegedly failed to heed Jack Meyer’s warnings about taking on risky investments.

In 2004, Summers entered into an interest-rate swap agreement to finance a large-scale construction project. The notional value of the swaps involved was $3.7 billion, and the contracts had the university paying a fixed rate to, as well as receiving a variable rate from, a counterparty. At the time Harvard entered into the swaps in 2004, it assumed interest rates would rise. That assumption backfired when the Federal Reserve cut lending rates to zero in the wake of the financial collapse of 2008. In turn, the value of Harvard’s interest-rate swap contracts plunged, forcing the school to come up with almost $1 billion in cash to terminate the contracts.

Harvard needed a loan and it needed it fast. As reported Dec. 18 by Bloomberg, the nation’s most prestigious institution had to ask Massachusetts for fast-track approval to borrow $2.5 billion. Almost $500 million was used within days to exit the interest-rate swaps that Summers had previously approved.

Summers is no longer president of Harvard University. He now serves as an economic advisor to President Obama, heading up the White House’s National Economic Council. Let’s hope Summers has learned a lesson or two from the decisions he made at Harvard.

Bank of America execs, including former CEO Ken Lewis, are gearing up for a heated legal battle with New York Attorney General Andrew Cuomo. On Feb. 4, Cuomo charged Lewis of defrauding investors and the U.S. government when he helped put the wheels into motion for Bank of America to buy financially troubled Merrill Lynch & Co.

Specifically, Cuomo alleges that Lewis, as well as BofA’s former chief financial officer Joe Price, failed to tell shareholders about the $16 billion in losses that Merrill had incurred before it was bought by Bank of America. After shareholders approved the acquisition, Cuomo says Lewis then demanded government bailout funds to keep the deal afloat.

In total, the government injected $45 billion into Bank of America via the purchase of preferred shares, including $20 billion approved after the merger in January 2009.

“We believe the bank management understated the Merrill Lynch losses to shareholders, then they overstated their ability to terminate their agreement to secure $20 billion of TARP money, and that is just a fraud,” Cuomo said today at a press conference. “Bank of America and its officials defrauded the government and the taxpayers at a very difficult time.”

Separately, the Securities and Exchange Commission (SEC) announced that it had reached an agreement with Bank of America over the company’s decision to pay $3.6 billion of bonuses to former Merrill employees for fiscal year 2008. BofA agreed to pay a $150 million fine to settle the matter.