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Freedom Holding: The Red Flag Factory in Belize

Freedom Holding Corp. has some explaining to do.

The financial services firm has quite improbably become one of the fastest growing companies on the planet. It lists its shares on the Nasdaq, is incorporated in Las Vegas, but for all intents and purposes runs its operations mostly in Kazakhstan.

As a December investigation by the Foundation for Financial Journalism showed, Freedom Holding’s ballooning profits have resulted from baffling and opaque business practices that its management is not keen to discuss.

Among the arrangements is Freedom Holding’s close connection to FFIN Brokerage Services, a Belize-based securities trading firm owned by Timur Turlov. He also is Freedom Holding’s billionaire founder and majority shareholder.

Even the most seasoned investor has probably not witnessed related-party transactions of the scope of FFIN’s dealings with Freedom Holding.

Last year more than 56 percent of Freedom Holding’s revenue came from FFIN commission payments, and in 2019 they represented over 65 percent. What Freedom Holding does to earn the commissions is not readily apparent, however. Yet the two companies are so intertwined – Freedom Holding’s senior managers use FFIN email accounts – it’s not clear the two companies are separate in any real sense.

In June, Freedom Holding for the first time disclosed in its annual report its relationship with FFIN, categorizing this as a risk factor for investors to weigh before buying shares. Highlighted as a matter of particular interest: the portion of revenue that Freedom Holding received from Turlov’s company. In the annual report, Freedom Holding’s auditor, Salt Lake City’s WSRP LLC, acknowledged the FFIN connection as part of several “critical audit matters.” (Engaged by Freedom Holding to assess the accuracy of its accounting, WSRP did not weigh in on the propriety of Freedom Holding’s FFIN relationship.)

But FFIN’s own annual report, also released in June, ought to give Freedom Holding investors pause: In just a year, FFIN’s assets grew almost 1,100 percent, to more than $2.5 billion. That’s significantly larger than Freedom Holding’s $2 billion in assets.

Were FFIN ever to hit dire financial straits, Freedom Holding could be in real trouble.

And FFIN’s profits have put substantial cash in Turlov’s pockets: $12.8 million in 2019 and more than $30 million last year. (Although FFIN recorded a $16 million loss last year, Freedom Holding’s outside legal advisor Ron Poulton of Salt Lake City explained that no actual loss occurred. The $46.53 million in impaired trade receivables recorded by FFIN were not losses resulting from clients failing to pay but an “accounting convention” to document a charge like a noncash expense such as depreciation, he said.)

Keeping terms of a relationship under wraps

While the specifics of FFIN and Freedom Holding’s arrangement have not been publicly disclosed, the basic contours are clear: FFIN acts as a broker for Freedom Holding, primarily executing trades in popular U.S. exchange-listed equities and initial public offerings.

Peddling IPOs is Freedom Holding’s most aggressively promoted line of business, and FFIN handles the firm’s IPO-related customer service issues. For its part, FFIN has a distinctive business practice: requiring clients to observe a 93-day lockup period for any IPO shares they purchase. Customers cannot sell or even transfer to an outside account the newly purchased shares for that three month period.

This is starkly at odds with the typical U.S. and European brokerage practice, whereby clients are free to trade their shares immediately after receiving an allocation. Any other brokerage that tried to impose this constraint would likely be assured of an immediate customer exodus and a wave of litigation.

The Foundation for Financial Journalism asked Poulton several questions about the particulars of the Freedom Holding-FFIN relationship. (Poulton addressed one group of questions but refused to answer a second, more specific set.) He would speak only generally about FFIN, saying, “The functional purpose of FFIN Brokerage Services to its clients are diverse and private to them.”

Poulton also cited changes in Russian and Kazakh laws that might reduce Freedom Holding’s reliance on FFIN. Turlov set up FFIN in 2014 to offer Russian and Kazakh residents access to U.S. dollar-denominated investments, Poulton said. At the time, Russian regulators frowned on individuals owning British pound- and U.S. dollar-denominated investments. In 2018, however, the two countries started to ease such regulations.

The Foundation for Financial Journalism posed the same questions to Adam Cook, Freedom Holding’s corporate secretary; Askar Tashtitov, Freedom Holding’s president; and Turlov but did not receive a reply.

Generating huge profits via a small Cyprus unit

Notwithstanding the steady skyward march of Freedom Holding’s share price, its financial statements are surely catnip for short sellers and financial skeptics.

Embedded in the filings is the prominent role Freedom Holding’s Cyprus unit plays in the company’s growth. That subsidiary, which used to be the prime component of Freedom Finance Europe Limited, has been formally renamed Freedom Finance Europe Limited; the unit opened in 2017 and its main task is operating Freedom 24, an electronic trading system.

As described in the December article, the Cyprus subsidiary’s defining feature is achieving astronomical profit growth, unrivaled on Wall Street. Although in 2017 the Cyprus unit reported a $30,000 loss, by 2019 it had $33.8 million in earnings. In 2020, the subsidiary’s income rose to $80.4 million.

Freedom Holding’s earnings growth story is entirely a function of its Cyprus subsidiary. One way to track this is to compare the published financial results for both Freedom Holding and its Cyprus subsidiary from Jan. 1, 2020, through Dec. 31, 2020. (The Cyprus unit files a risk disclosure statement once a year that includes its annual net income, but corporate parent Freedom Holding releases its income quarterly and its fiscal year ends on March 31.)

For the nine months that ended Dec. 31, 2020, Freedom Holding reported $90.1 million in net income, with $80.4 million of this derived from the Cyprus subsidiary.

Thus, for nine months of Freedom Holding’s most recent fiscal year, the Cyprus unit contributed at least 56 percent of the parent company’s $142.9 million in net income.

And according to a recent regulatory filing, the Cyprus subsidiary achieved those results with minimal resources. Making that sum of money took only 13 employees and $6.3 million in capital.

Taken at face value, the Cyprus unit’s gaudy performance likely catapults it to the top of the list of the most profitable trading desks in history. (The distant second: Michael Milken’s high-yield trading operation at Drexel Burnham Lambert, which in 1987 generated a purported $2 billion in revenue, with Milken pocketing an estimated $550 million.)

To an outside observer, the fact that the Cyprus unit could generate profits at this scale is baffling. After all, it is a no-frills online trading operation that facilitates individual investors’ stock trades. It definitely is not an elite proprietary trading division; compensation for its 13 employees last year totaled less than $1.3 million.

Carrying out trades in a circuitous fashion

Freedom Holding employs a remarkably circuitous order execution process for its customer’s trades. It is labyrinth to a degree that suggests that obtaining the best possible price for the client is a secondary concern.

A transaction might look something like this, according to conversations with current and former Freedom Holding clients, as well as a former company executive: A client of Freedom Holding who attempts to buy shares online is promptly directed outside its platform to FFIN, which then routes the order to Freedom Finance Europe in Cyprus. But final execution of the client’s order appears to require another handoff, either to a Freedom Holding subsidiary in Moscow or (frequently) to a firm with a troubling regulatory history, Lek Securities U.K. Limited in London.

One possible reason for this complexity? Fee layering, the practice of charging a client multiple fees on a single transaction.

Layering is a legal, albeit controversial, practice that has fallen out of favor in the U.S. money management industry, given the rise of lower-cost index and exchange-traded fund investing. But for Turlov and his colleagues, elongating a trade’s life cycle in order to collect two or three sets of fees might be tempting since their largely Russian and Kazakh client base might have scant experience with Wall Street practices or robust consumer advocacy.

A further puzzle: The Cyprus unit’s 2020 risk disclosure statement noted that last year FFIN executed 24 percent of the trades made by the unit, up from 9 percent in 2019. This is odd since neither FFIN nor the Cyprus subsidiary hold any U.S. brokerage licenses.

Doing business with companies of questionable repute

One of the nicer things about managing an expanding and profitable company is having options. For example, if a customer poses a reputation risk or is too demanding relative to his or her economic value, ending the relationship is generally a low-risk proposition.

Timur Turlov and his managers do not seem to hold this view, however, because they have regularly done business with people and companies whose extensive legal problems would cause most U.S.-based managers to stop in their tracks.

Consider FFIN’s business relationship with two Moscow-based companies: asset manager QBF LLC and network marketer CityLife.

Both QBF and CityLife have attracted the scrutiny of the Russian government: The Ministry of Internal Affairs raided QBF on May 31 and arrested two of its principals for purportedly conducting a Ponzi scheme. And on June 1, the Central Bank of Russia’s Unfair Trade Practices unit added CityLife to a list of companies with identified signs of illegal activity for allegedly showing signs of running a pyramid scheme.

How does FFIN fit into all this? According to a translation of a Russian language press account of the Interior Ministry’s QBF raid, FFIN was one of several banks and brokerages the asset manager­­­’s executives were said to have used to move investor cash out of Russia. (Neither Turlov nor Freedom Holding were named in the article.)

While using a Russian language search engine, the Foundation for Financial Journalism found a CityLife co-founder’s FFIN wire instructions designating 16 separate bank accounts that were to receive funds. It is not clear who posted such a sensitive document online, but the root link is from a CityLife website. One of the banks listed on the form is Freedom Holding’s Bank Freedom Finance LLC.

Questioned about FFIN’s relationship with QBF and CityLife, Poulton confirmed that the two firms “at one time did have standard client brokerage accounts with FFIN Brokerage Services.” He said that FFIN closed the QBF account “in the fall of 2018” but did not provide a reason.

Poulton added that the CityLife account was opened in early 2021 and “conducted modest trading” and when the Central Bank of Russia added it to its list of companies with identified signs of illegal activity, FFIN closed the account.

Update: This story was updated on Aug. 8, 2021, to  clarify the relationship of the Cyprus unit to Freedom Holding’s Freedom Finance Europe; it used to be referred to as its subsidiary but now is simply called Freedom Finance Europe.




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Danny Guy, Derrick Snowdy and the Strange Wars of Confused Men

Derrick Snowdy is probably as close to a celebrity as Canada’s private investigator community has.

Starting in 2010, Snowdy burst into view as a prime mover in the political controversy colloquially known as “the busty hookers’ scandal.”

Snowdy proved to be a quick study at capturing an audience’s attention, ever ready to regale listeners with some of the inside stories from his investigations.

So when Catalyst Capital founder Newton Glassman brought a stemwinder of a defamation litigation in 2017 against a host of hedge fund managers and journalists, it was not surprising to see Snowdy involved.

(Foundation for Financial Journalism readers will recall our two 2018 investigations that looked into the quality of disclosures at Callidus Capital and Catalyst Capital, the two investment vehicles Glassman controlled. In July 2019 Catalyst amended the initial defamation claim to add Bruce Livesey, the article’s co-author, as a defendant.)

After all, given the numerous well-heeled defendants — and their lawyers, many sporting big litigation budgets — the prospects for an investigator with a knack for digging into corporate fraud seemed attractive.

There was just one thing.

A series of filings were unsealed late last week in Catalyst’s litigation revealed that Snowdy had indeed been hard at work on these types of issues for several years. (The filings were made by West Face Capital and the other defendants.)

But it had been for the other side.

So who bankrolled Snowdy’s efforts? A single client: Danny Guy, a veteran Canadian money manager and the general partner of Harrington Global Opportunities Fund.

Meet Danny Guy

Little about the arc of Daniel Gerrison Guy’s career in finance would imply a disposition towards garish conspiracy theories.

After starting in brokerage research in 1993, Guy joined Banfield Investment Management, a then prominent Toronto risk arbitrage fund in the late 1990’s. In 2001, Guy led a buyout of the fund and renamed it Salida Capital. Becoming Salida’s chief investment officer, Guy changed the fund’s investment strategy to a more directional, commodities oriented focus with a heavy emphasis on private equity.

(Salida is Spanish for “exit,” a commonly used term in private equity that means an investment was successfully concluded via a fund either selling an asset at a higher price or to the public through an initial public offering.)

From 2002 through 2007, Salida posted very handsome returns, but in 2008, the one-two punch of the global financial crisis and the collapse of Lehman Brothers, the fund’s prime broker, led to disastrous losses. Though Salida’s performance in 2009 and 2010 was stellar, restoring the fund’s assets under management proved much more difficult, and in 2013 it began to shutter its portfolios.

In 2011 Guy moved to Bermuda, but it is unclear when the Luxembourg-domiciled Harrington Global was formally launched, or if it has limited partners. The fund does not appear to report to hedge fund industry databases.

Snowdy told the Foundation for Financial Journalism that his connection with Guy began when Salida Capital’s then CFO asked him to perform some due diligence on an investment Salida had made that the fund was concerned about.

“It was to look at a company called StarClub. I did some work and determined it was pretty much a fraud,” he said. (StarClub’s product was a software application that purported to help so-called social media influencers track the reach and impact of their endorsements.)

Snowdy continued that he delivered a report and forgot about it until November 2016 when Salida’s CFO called him and said, ” ‘It looks like you were really right on [StarClub] and asked me if I could I help them build a case for a lawsuit.’ ”

Snowdy said in the course of investigating StarClub in 2016 he wore a hidden recording device while posing as a potential investor during a meeting at Goldman Sachs’ headquarters, and he identified and obtained photos of a yacht that StarClub’s founder Bernhard Fritsch allegedly owned. The FBI knew about and approved everything he did, Snowdy said.

In August 2017 federal prosecutors in Los Angeles unsealed an indictment that charged Fritsch with a series of fraud-related counts. The case is scheduled to go to trial in January 2022.

According to the indictment, Guy invested more than $22.4 million of Salida and Harrington Global’s capital in StarClub.

The road to vengeance

Guy’s experience with a pharmaceutical concern called Concordia Healthcare is why he became consumed by the idea of exposing how short sellers operate.

Concordia was a once high-flying company in which Harrington Global had a 2.7 million share stake, at one point amounting to over 5.2 percent of its shares outstanding.

Concordia’s business model was similar to that of Valeant Pharmaceuticals International, in that it used aggressive borrowing to fund purchases of established drugs. The goal was to simultaneously raise drug prices while avoiding costly (and recurring) research and development expenses.

It was a model that worked for a little while.

Unfortunately for both Concordia and Guy, when presidential candidate Hillary Clinton sent out a 21 word tweet on September 21, 2015, everything changed.

Clinton’s retweet of a New York Times article about a series of astronomical price hikes in a drug called Daraprim brought the issue of drug prices front and center in the 2016 presidential race.

And much of that ensuing dialogue centered on how constant drug price increases were forcing brutal sacrifices and trade-offs for many American families.

Congressional hearings soon followed.

A month later Valeant Pharmaceuticals came in for its own reckoning: On October 15 the Foundation for Financial Journalism exposed how the company’s Philidor subsidiary helped it keep certain drug prices artificially high, as well as evade pharmacy ownership regulations.

Concordia, with about $4 billion in debt and reliant on acquisitions to fund the revenue growth investors were demanding, was suddenly hamstrung in its ability to boost prices.

With a business model whose future had suddenly become an open question, Concordia’s share price soon began to slide. Moreover, it attracted numerous short sellers, including Marc Cohodes, an ex-hedge fund manager who uses his twitter account to offer unfiltered, often profane takes on companies he is short.

Starting in October 2015 Cohodes began building a short position in Concordia’s shares. In June 2016 company CEO Mark Thompson sued Cohodes for defamation; Cohodes happily fired back with lengthy letters to U.S. and Canadian regulators in July and August enumerating several ways he thought the company was misleading investors.

In August, six weeks after suing Cohodes, Thompson was subject to a humiliating  margin call, and two months later he quietly resigned. He withdrew his suit against Cohodes soon after.

Cohodes, asked for comment about Concordia, said he was happy to have shorted it, “in the $70 range,” but declined to elaborate more on the experience, beyond noting tersely, “[Concordia] was a piece of shit.”

(A word of disclosure: In 2017 Cohodes made a donation of $344,593.20 to the  Foundation for Financial Journalism. He is discussed further below.)

Guy approached Canadian securities regulators in 2016 to allege that short sellers were depressing Concordia’s share price through illegal trading tactics such as “spoofing” in order to trigger a wave of algorithmic selling. No regulatory action was taken.

Concordia sought protection from creditors in October 2017, and Harrington Global liquidated its Concordia position at an approximately $150 million loss. (After reorganization, the company is now known as Advanz Pharma Corp.)

Sustaining such brutal losses galvanized Guy’s thinking about Concordia’s demise: A cabal of short sellers spread disinformation about the company’s prospects while using illegal trading tactics to pressure its share price.

Central to proving this claim, Guy felt, was obtaining the identities of those responsible for perpetrating the “short-and-distort” campaign on Concordia. His attempts to get the information through hearings with regulators failed because of concerns over privacy.

To that end, Harrington Global petitioned for a Norwich Order — a motion delivered on a third-party in possession of material information — that would have compelled Canada’s brokerage regulator, the Investment Regulatory Organization of Canada, to disclose those names.

But Harrington Global’s request was denied in a 2018 Ontario Superior Court ruling.

In January Harrington Global sued a series of U.S. and Canadian banks in the U.S. District Court for the Southern District of New York. The claim primarily alleges that traders at large banks used illegal tactics that served to manipulate Concordia’s price downward.

Asked about Guy’s views on Concordia’s collapse, Snowdy assessment was blunt.

“I told Danny that [Concordia CEO] Mark Thompson was a lying sack of shit,” Snowdy said.

But, Snowdy continued, “Danny defended Mark Thompson. And then [Guy] would start screaming about naked short sales, Marc Cohodes’ role in all this, and that crap. I told him that [Cohodes] was right about Concordia.”

In a long, rambling letter to West Face’s lawyers in which Snowdy discusses his role in the Catalyst case, he said that his take on Concordia’s collapse antagonized Guy a great deal. On one occasion, when Snowdy was vacationing with his kids in the Bahamas, Guy accused him of being there to only to make secret financial arrangements — the implication being that Snowdy would only have said that because short sellers paid him off.

This darker turn in Guy’s worldview was on display in an April 2018 email to the Ontario Securities Commission. After Guy saw that Greg Boland, West Face Capital’s general partner, looked at his LinkedIn profile, Guy wrote an a threatening email to several OSC attorneys that promised “a fucking war” if short sellers targeted other companies he was invested in, or if anything happened to his family.

[Guy was not the only one being paranoid. In a phone interview, Snowdy related how in 2018, en route to a meeting with Nate Anderson — also a defendant in the Catalyst case — he detected two people following him. This led him to believe that perhaps Anderson’s office had been somehow compromised. Anderson said that in that period his office was at a WeWork, and he didn’t think that being infiltrated by private investigators was a very big risk.]

The Foundation for Financial Journalism repeatedly sought to interview Guy. His conditions — fly to Bermuda and interview him — proved unworkable. In a response to a text message about his opposition to short selling, Guy said, “I have no problem with shorting when it’s done right.”

Penetrating the wolfpack

There was nothing terribly complex about what Snowdy did.

Starting in 2017, Snowdy began posing as a sympathetic, knowledgeable fraud-fighting ally to many of the reporters and short sellers named in the Catalyst claim. More importantly, Snowdy leveraged this nascent rapport to obtain introductions to other investors and forensic analysts who were researching and shorting publicly traded companies.

A big part of Snowdy’s operating methodology was taping phone calls, according to emails he sent; one of his two phone numbers was set to automatically record and was stored on his home computer. That may pose a prospectively large legal headache for him since he described recording California resident Marc Cohodes, and the state’s  laws require both parties to consent to having a call recorded. (Cohodes strongly denied having given his consent for recording.)

The unsealed documents, however, do not specify what information he got from taping Cohodes. When asked about taping Cohodes and the absence of his consent, Snowdy did not reply.

In a recently unsealed, multi-month WhatsApp message exchange between Guy and Glassman, Guy called this strategy “penetrating the wolfpack.” This echoes the theme Guy began enunciating with his angry email to the OSC: Short sellers are dangerous people.

Simultaneously, Snowdy was providing what he overheard — the gossip, the sources, targets and methods – to a small group of corporate executives who felt short sellers were unfairly (or illegally) attacking their companies.

The pay for doing these infiltrations was at least decent.

According to a memorandum of an August 2017 meeting between Snowdy and private investigators working for Catalyst and its lawyers, Guy paid Snowdy $25,000 per month and covered his expenses.

What Snowdy found

What Snowdy told people he uncovered, according to the court filings, looks very much like a version of a common short selling conspiracy trope. It usually follows along these lines: A loose network of short sellers — taking their cue from one individual leader — manipulate the press with misleading information, and then game the greedy or incompetent prime brokerage units at investment banks to allow them to flood the market with improperly borrowed stock. The result is a rapidly sinking share price for any company targeted.

Elements of this idea have been around for decades, but it was not until former CEO Patrick Byrne, during a 2005 presentation he called “The Miscreant’s Ball,” that these disparate complaints about reportorial malfeasance and short selling perfidy were housed in a unified theory.

Byrne claimed a Sith Lord — later revealed to be former Drexel Burnham Lambert executive Michael Milken — was then orchestrating (somehow) much of the dubious short selling activity to his benefit. He also argued that a large group of business journalists were merely transcriptionists for short sellers, and that the miscreants preferred to wage their campaigns in groups.

Snowdy, during a September 2017 meeting where he presented his findings to Jim Riley, former Catalyst COO and general counsel and others, leveled allegations that seemed to check many of the same boxes Byrne had complained about.

There are “puppet masters” that control the network and their connections to shadowy foreign capital, as well as a slew of seemingly nefarious linkages between everyone he named. And for good measure, Snowdy touched upon regulatory capture, a favorite theory of Byrne’s, when he appeared to suggest short sellers had somehow neutralized the Ontario Securities Commission.

For his part, Guy seems to agree with Deep Capture.

Guy sent Glassman a link, and told him that the article will “make your head spin.” (Snowdy, speaking about Guy’s support for Deep Capture in a meeting with Catalyst’s lawyers in September 2017, said that he felt that 25 percent of it was so untrue it calls into question the balance of the work.)

And it ought to be recalled that making these types of allegations can have consequences, especially in Canada, where libel and defamation laws favor the plaintiff.

In 2008,’s Byrne and his then colleague Mark Mitchell published “Deep Capture,” a conspiratorially virulent expansion upon Byrne’s “Miscreant’s Ball” thesis. Altaf Nazerali, an occasional small cap stock promoter depicted in Deep Capture as an international terror finance operative, sued for libel in British Columbia’s Supreme Court. After a lengthy and expensive trial, Byrne, Mitchell and the other defendants lost the case, and in a scathing judgment, were ordered to pay $1.2 million dollars in damages.

Wearing a wire 

One company that appears to have placed great stock in Snowdy’s information is MiMedx Group, an Alpharetta, Georgia-based manufacturer of skin graft and wound care products.

MiMedx filed suit in October 2017 against a series of short sellers, claiming the company had been libeled and that its business prospects were interfered with. A month later, Parker “Pete” Petit, MiMedx’s outspoken founder and CEO, began making public remarks about short selling that were nearly identical to Guy’s.

Petit focused particular ire on Marc Cohodes, accusing him in an October 13, 2017, post on the company’s website of being the ringleader of a short seller “circus” and spreading misinformation. This was baffling in that, as Cohodes put it, “I had never heard of the company until that moment.” (Cohodes also won the fight against MiMedx’s management: On February 23, Petit was sentenced to one year in prison; the COO received the same sentence.)

To get more information on Cohodes and other short sellers, MiMedx’s outside law firm, Wargo French, hired Snowdy. (David Pernini, the firm’s Atlanta-based partner that directed Snowdy’s engagement, did not return a phone call seeking comment.)

Snowdy confirmed that he had worked in 2018 for MiMedx, but that it was not a standard engagement for him. He said that he was doing so within the context of “working undercover” for an unspecified federal agency.

“Any email or report I wrote for [Wargo French] was scripted” by this federal agency, said Snowdy.

Pressed on the identity of this purported agency over several weeks, Snowdy would only say this organization’s mission is, “criminal justice, with the power to arrest people.”

Asked how much MiMedx paid him to report on Marc Cohodes and other investors critical of the company, Snowdy said he didn’t get a dime. When Snowdy was asked why he would work for free, and if that triggered any suspicions at MiMedx, he declined to comment.

Incredibly, this story gets even more unusual, with Snowdy alluding to “settlement terms” in the U.S. and Canada that prevented him from discussing his MiMedx activities.

A call to the FBI seeking comment was not returned.

Vincent Hanna dials in

Guy initiated contact with Glassman on August 11, 2017, via email, and using the pseudonym “Vincent Hanna,” a character portrayed by Al Pacino in the 1995 movie “Heat.”

(In a strange aside, Snowdy, in his letter to West Face’s lawyers, recounted meeting a pair of individuals in a New York office lobby in early 2018 who introduced themselves as “Vincent Hanna” and “Neil McCauley,” the name of the movie’s Robert DeNiro character.)

While Guy used a pseudonym for an additional 12 days, he wasted little time in telling Glassman the names of short sellers he suspected were involved with Callidus Capital’s stock. Ironically, given Snowdy’s role, as well as Catalyst’s extensive use of Black Cube, Guy warned Glassman that private investigators were likely tailing him and that Russian hackers could be trying to disrupt his fund’s operations.

(There has been no suggestion Guy or Snowdy had anything to do with Black Cube’s operations; Snowdy, in remarks to the Foundation for Financial Journalism, said that he believed he was a target of Black Cube too.)

In notes from an August 23, 2017, conference call with Catalyst executives and lawyer’s, Guy — still using the “Vincent Hanna” moniker — continued to frame his objection to short selling along familiar lines: Arguing Concordia was “a dry run” for taking down the much larger Valeant Pharmaceuticals, making allegations of possible Russian and Hong Kong money laundering, speculating about organized crime money at work shorting stocks, and Marc Cohodes.

Glassman was not a fan of Snowdy

The unsealed documents show Catalyst executives and lawyers eagerly anticipating Snowdy’s research, and they afforded him three separate opportunities to present his findings.

But when Snowdy could not — or would not — produce the desired recordings and emails that Guy had assured them his investigator possessed, Glassman became a vehement critic.

Glassman, quoting his lawyer after one meeting with Snowdy, said he provided, “Two and a half hours of interesting but unusable bullshit — and two and a half minutes of food for thought.”

And Glassman appeared especially angry at Guy’s inability to force Snowdy to produce them since any of his work product would belong to Guy as the client.

“Right now [Snowdy] is using u and hurting u badly. U clearly r too stupid or blind to see it,” wrote Glassman.

Snowdy’s evidence, “was less valuable than what my dog’s left for me on my lawn this [morning.]”

All those documents? None of them are real

For six weeks the Foundation for Financial Journalism has been in frequent contact with Snowdy about his work for Danny Guy. Questions begat more questions and Snowdy’s response has never wavered.

He insists that almost none of it happened.

In other words, Snowdy did not work on behalf of Danny Guy to infiltrate any networks, and has not spoken to Danny Guy since “sometime in 2016.”

The Foundation for Financial Journalism showed Snowdy emails between himself and Guy discussing his assignment in April 2018, naming certain reporters and short sellers of interest to Guy and Catalyst.

“Forgeries,” he speculated in a phone interview. “But I can’t really be sure. You would be amazed at the shit I’ve seen go down up here in terms of corruption.” (He was entirely indifferent to a reporter’s speculation that no one would believe a word of what he said.)

What about Snowdy’s prominence in numerous documents written by Glassman’s own lawyers, which a judge – as part of a broader 55 page rulingordered submitted into discovery? Snowdy told the Foundation for Financial Journalism that he did not care to speculate “who got what wrong, or why.”

Snowdy did admit being at the meetings with Catalyst’s Jim Riley and the firm’s outside lawyers, but said he primarily discussed whether Catalyst had a role in some hacking attempts he had discerned on his own smartphone and computers.

Not so strong on the facts

There is a chasm between what Snowdy reported to Guy, Catalyst’s lawyers and investigators, and what can be objectively verified.

Snowdy said that he had worked with Carson Block on his Sino-Forest short and was an attendee at a Christmas party he threw. Block, however, said Snowdy had nothing to do with Sino-Forest — which he shorted in 2011, and which filed for bankruptcy protection in 2012 — and that apart from one breakfast with him in 2015 in San Francisco, he has never met him again.

[In disclosure: In 2020 Carson Block donated $5,000 to the Foundation for Financial Journalism.]

“Over the years, maybe from 2016 to 2018, we used [Snowdy] to help us track down documents on a handful of Canadian marijuana companies [Muddy Waters Capital] was considering shorting. I’m confident that we didn’t pay him over $10,000,” said Block. “And it’s been awhile since the fund worked with him, I can tell you that.”

Snowdy claimed Cohodes asked him to short stocks along side him, that he was invited to stay at his house, and, as “a loyalty test,” that he had been left alone with his son Max, Cohodes’ 33-year-old son with cerebral palsy. Nothing close to that happened.

“My God what bullshit,” said Cohodes.

“None of that happened. The part with Max is maybe the most insulting,” he said.

More stuff that Cohodes said didn’t happen: Having offshore bank accounts — something he denies in full throat — and using Anson Funds (a Canadian money manager named in the litigation) to manage his money.

“I don’t need help from [Anson] to make money,” Cohodes said.

The truth of the matter, according to Cohodes, is that Snowdy came to his house once for lunch. When he traveled to Toronto for business on several occasions, Cohodes said Snowdy drove him around.

For all that, Cohodes said he had been dragged into this controversy despite never having shorted a share of Callidus’ stock.

A personal disclosure and a mea culpa

One thing Snowdy was at least partially correct on: The introduction to Cohodes, an obvious ticket into the broader short seller community — came from me.

So some first person disclosure is called for.

First off: How did I get introduced to Snowdy? Carson Block.

According to Block, in early 2015 Snowdy contacted him out of the blue and pitched him on a story on Canadian Rail. He passed on it but suggested to Snowdy I might find aspects of the story compelling from a journalism standpoint. Block and I spoke briefly about why he passed on the story at the time and have never again discussed the issue.

I shelved the story for months. Later in the year I re-examined the parts of it that I found interesting, and in 2016 I began to report it. As part of that I reached out to Snowdy — there had been no contact between us since the year before — and he agreed to put me in contact with a man he said was his client. The client had a large cache of Canadian Rail documents that emerged from a litigation he was then involved in.

His client wanted to interact in person so I flew to Toronto. Snowdy picked me up and drove me to his client. We had a few meals in transit, and on two of the four days I was in the area, Snowdy gave me a lift to his client, and he discussed with amusement a judge’s attempt to prevent him from speaking about Canadian Rail. The story I wrote in December 2016 was almost entirely informed by my work in those documents.

It turns out Snowdy lied to me about his legal trouble in that case, having received a restraining order in 2014, according to the recently unsealed documents. (I recall looking for a mention of him in the court record and not finding any, but the ruling may have been sealed at the time or attached to a motion I overlooked.)

While driving with Snowdy, he repeatedly discussed his skepticism of Concordia and Home Capital Group, a then troubled mortgage issuer Cohodes was publicly critical of. Snowdy asked me for an introduction to Cohodes. I agreed, sent an email introducing them, and never thought of it again.

What emerged afterwards is personally and professionally horrifying: Cohodes took my word that Snowdy seemed like a regular, well intentioned guy; he proved to be the very opposite of that. Over the course of a few years Snowdy used Cohodes’s name to come into his own house, meet numerous investors and it is a fair bet that any number of the people Snowdy met through Cohodes were surveilled, recorded, and through no fault of their own, may yet have some legal headaches.

Worse, with a connection to Cohodes established, Snowdy eventually got work surveilling him from MiMedx, a company that took fighting short sellers to a new level. The campaign initiated by the company’s ex-CEO was so ugly that even baseless money laundering accusations became forgettable after he leveraged his political connections to a Senator who requested that the FBI visit Cohodes’ house and warn him about a threatening tweet.

And all from my brief email introduction. It is a mistake I deeply regret.






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Freedom Holding: After ‘Borat,’ the Silliest Kazakh Import of the Century

If one word could describe the U.S. stock market of 2020, it would be “improbable.” The S&P 500, for example, has risen about 14.14 percent this year despite a pandemic that is deadly to both people and corporate profits. Yet even after witnessing this year’s string of unprecedented developments, investors might be shocked to learn what lies behind the recent muscular share price growth of Freedom Holding Corp. This Las Vegas–incorporated bank and securities brokerage has its principal office in Almaty, Kazakhstan, and a major presence in other cities of the former Soviet Union. 

In Freedom Holding’s most recent quarterly filing of Nov. 19, management attributed the company’s earnings success to customers undertaking a higher volume of trades as a result of “the unique market characteristics surrounding the COVID 19 pandemic.” In other words, quarantined or marooned investors are day trading to pass the time as disease spreads across the world. And thus Freedom Holding’s astronomical revenue growth has seemingly made it the fastest-growing financial services company on Earth.

So why aren’t the big brokerage operations of the U.S. and Western Europe replicating this model? A clue as to why they are not can be found in Freedom Holding’s Securities and Exchange Commission filings. The Foundation for Financial Journalism has found that Freedom Holding serves up gaudy growth figures with few disclosures or incongruous explanations at best — and accompanies them with an operations structure akin to that of a penny stock company.

Despite the fact that Freedom Holding is incorporated in the States and its shares are traded on Nasdaq, nothing about its actual U.S. presence should give American investors any confidence. LinkedIn lists only one U.S.-based Freedom Holdings employee. And the company has situated its U.S. headquarters inside a Regus coworking space. The company’s auditor, Salt Lake City–based WSRP LLC, has just 16 partners and only four publicly traded clients, according to a Public Company Accounting Oversight Board filing. Similarly Freedom Holding’s outside legal adviser, the law firm Poulton & Yordan, has merely two licensed attorneys and no website. All the while, most of the company’s operations — taking place in its trading and retail brokerage division, Freedom Finance — are carried out thousands of miles away in numerous jurisdictions, mostly in Russia, Ukraine and Kazakhstan, but also Europe, and quite actively in Cyprus. 

Although Freedom Holding’s SEC filings do not reveal how it is making its great fortune, its subsidiaries’ audited financial statements do. These filings reveal that the company’s Cyprus unit is staggeringly profitable, having earned more than $33 million last year following a $30,000 loss in 2017. 

Additionally, Freedom Holding has a highly unusual relationship with a company based in Belize that’s owned by Timur Turlov, Freedom Holding’s founder and CEO. While little is disclosed about it in Freedom Holding’s SEC filings, this Belize entity, FFIN Brokerage Services, appears to have access to the funds of Freedom Holding’s clients for as long as 93 days, a major deviation from typical brokerage industry practices across the globe. 

Reporting earnings that might be too good to be true

Analysts reading Freedom Holding’s most recent quarterly filing will be hard pressed to explain its earnings growth. In the first six months of its financial year that ends on March 30, the company had its net income rise to $47.83 million, nearly triple what it reported for the same period a year ago — and more than double the $22.1 million it earned in all of fiscal 2019.

How unique is Freedom Holding’s almost 38 percent net profit margin? Goldman Sachs — long Wall Street’s most profitable company — managed only a 25.3 percent net profit margin in 2006, during the manic run-up to the global financial crisis.

Freedom Holding’s filings suggest that its managers have apparently solved an enduring mystery of the business world: figuring out how to turbocharge revenue growth without triggering a concurrent spike in expenses or risk.

Growing a business typically requires managers to invest in new hires, technology or plant improvements in the hopes that each $1 spent will net $1.50 before taxes in three to four years. But Freedom Holding’s income statements imply that its management can spend 75 cents to realize a return of $3 in just a few months, all without having to sell stock or take on a mountain of debt.

The universe of companies that claim to do this is limited to Freedom Holding. Even profitability and capital efficiency superstars like Google and Berkshire Hathaway cannot approach that performance.

Another factor that sets Freedom Holding apart is its apparent efficiency and productivity. A business in an aggressive expansion mode typically registers a depressed revenue-per-employee figure as it assumes front-loaded costs (adding head count, paying for technology updates) that do not immediately result in new revenue.

Not so for Freedom Holding, though. In fiscal 2019, it generated $81,649 in revenue for each of its 1,343 full- and part-time employees; in 2018 that figure was $65,105 for every one of its 1,141 employees. Adding only 202 employees in fiscal 2019 led the company to triple its net income.

Promising grand returns on IPO shares 

Marketing materials in English on the European version of Freedom Finance’s website present a simple proposition: Tap Freedom Finance to invest in U.S.-listed initial public offerings for a golden ticket to profits. (The website’s Russian text translates into this English prose with Google Translate.)

To whet investors’ appetites, a brochure posted on Freedom Finance’s website declares that since 2012, a set of 107 seemingly randomly picked U.S.-listed companies have reaped returns of 129 percent on average following their IPO.

And a YouTube promotional video for Freedom Holding’s Freedom Finance Europe claims that it secures 50 percent returns on IPOs (after a “three-month lockup” period ends).

Putting aside whether grandiose claims are true or not, Freedom Finance holds no U.S. securities industry registrations or licenses and cannot underwrite U.S.-listed IPOs or participate in the activities of syndicate selling groups. It must rely on other brokerage firms to execute trades on U.S. exchanges for its clients. (In Kazakhstan, Freedom Finance does, however, underwrite IPOs, according to a June 2017 Reuters article.)

Yet Freedom Holding’s clients are buying shares of companies’ initial public offerings – in large quantities. 

Routing transactions to a Turlov outfit in Belize

The way these trades are apparently being accomplished is through a complicated maneuver: Freedom Holding’s clients send money to FFIN Brokerage Services Inc., a Belize City–based broker-dealer whose website promises “direct access to the U.S. market.” Yet FFIN Brokerage Services is not a subsidiary of Freedom Holding. Instead Freedom Holding CEO Turlov owns it, as clearly laid out in Freedom Holding’s July 2018 proxy statement.

Turlov’s ownership of FFIN Brokerage Services seems to be a detail that Freedom Holding is not keen to frequently share. True, the fine print of a 2017 prospectus also alluded to this fact, as did a 2019 Cyprus regulatory disclosure. And, yes, a June 2019 S&P ratings note once described FFIN Brokerage Services as Freedom Holding’s “largest counterparty.” But other Freedom Holding documents, especially its SEC quarterly and annual filings that more investors would regularly encounter, do not mention FFIN Brokerage Services or Turlov’s ownership of it. 

And FFIN Brokerage Services is likely involved with Freedom Holding’s hefty number of related-party transactions. Numerous Freedom Holding’s brochures and contracts instruct clients to send their funds to FFIN Brokerage Services. A Freedom Holding marketing document in May 2017 apparently referred to FFIN Brokerage Services as having “conducted a series of [IPO] deals this year,” per a translation offered by Google Translate. 

Yet, apart from FFIN Brokerage Services’ holding a license to trade foreign currencies in Belize, the company lacks regulatory approvals to execute trades in any other countries. Despite this, a disclosure by Freedom Holding’s Cyprus subsidiary about its top brokers cited FFIN Brokerage Services as handling as much as 9.12 percent of its equity orders in 2019. And Freedom Holding’s 2017 prospectus referred to FFIN Brokerage Services as “a placement agent” for its share offering. 

Perhaps the strangest aspect to FFIN Brokerage Services’ involvement is that Freedom Holding’s clients must abide by an unusual 93-day lockup provision, per a FFIN Brokerage Services document. (At other U.S. brokerage companies, a client order for buying or selling public securities, even as part of an IPO, can be canceled at any point until the order is transacted — without any lockups or restrictions.) 

Nothing in Freedom Holding’s documents — in English or Russian — explains how clients might benefit from the 93-day lockup of their capital. This arrangement, however, could give FFIN Brokerage Services access to plenty of cash for three months, with the sole obligation of delivering the newly issued shares at the end of the period.

Blurring the lines

In its 2019 annual report, Freedom Holding disclosed 12 different types of related-party transactions with Turlov-owned entities. And during the six months that ended Sept. 30, the value of commissions that Freedom Holding earned from its business with Turlov entities amounted to 57 percent of its $126.12 million in sales — or almost $72 million. 

Because Turlov’s related-party dealings with Freedom Holding are so extensive, one can ask if this company has a strong future doing any business unconnected to Turlov.

And cash is going out the door to Turlov-linked affiliates as well: Through Sept. 30, more than one-third of Freedom Holding’s commission payments, or $10.38 million, went to entities owned by Turlov.

While related-party transactions are legal, savvy investors often closely scrutinize them to ensure that executives are not misusing shareholder assets for private gain. To that end, the SEC requires public companies to disclose such relationships in their annual proxy statements. And when public companies have not been forthcoming in describing their role in handling a CEO’s or a board member’s private investments, the SEC has been aggressive in filing claims against such companies and their executives.

Michelle Leder, the founder of Footnoted, described Freedom Holding’s related-party dealings as “more than a bit dizzying.” Her subscription service analyzes public company filings for evidence of potential transactions or misleading data.

“I almost felt like I needed a flowchart to figure [the related-party transactions] all out — lots of money going back and forth between different entities with Turlov being the common link,” Leder said.

One possible explanation offered by Leder for the high volume of self-dealing is that the board of directors of Freedom Holding can’t operate as a counterweight to Turlov since it is a controlled company, according to New York Stock Exchange guidelines. More than 50 percent of its shares are held by one person or entity and thus it’s exempt from SEC requirements for having independent directors.

Raking in capital in Cyprus 

Deeply buried in a regulatory filing of Freedom Holding’s Cyprus subsidiary is a curious detail: The subsidiary, Freedom Finance Cyprus Limited, does not need much capital to generate a lot of revenue. 

Put on the green eyeshade briefly: European Union regulations require that financial institutions set aside 10.5 percent of their tier 1 capital (or the sum of their retained earnings and established reserves) as insurance against unexpected losses. Freedom Holding’s European operations, which consist primarily of its Cyprus subsidiary, reported $42.6 million in tier 1 capital at the end of last year. Thus, as of the end of December, the amount of capital that the company’s European operations (known as Freedom Finance Europe) needed to hold in reserve was a little more than $4.47 million. As a result, the Cyrus subsidiary ended up with $38.13 million in ready capital in its coffers.

To be sure, holding additional cash in reserve for various contingencies is prudent for a company. And given stock markets’ volatility, extra liquidity could mean the difference between life and death for a financial services company like Freedom Holding.

The Cyprus subsidiary’s regulatory filings also reveal a rather remarkable profitability. For fiscal 2019, the subsidiary earned $33.80 million, more than fiscal 2018’s $11.9 million and a considerable improvement over its $30,000 loss in fiscal 2017. As the chart below shows, Freedom Finance Cyprus Limited’s total 2019 income was far greater than the combined incomes of Freedom Holding’s other subsidiaries.


Annual income for 6 Freedom Holding subsidiaries
Sources: audited income statements

Straining for cash in other parts of the organization

Yet while a pile of cash sits at its Cyprus subsidiary, Freedom Holding is showing signs of being desperate for cash in virtually all other corners of its organization. Freedom Finance Europe is offering money market interest rates that are four to six times higher than what U.S. institutions are promising. Banks usually attract depositors for their money market funds by paying a few extra basis points in interest — but not multiples of what a rival does. U.S. regulators often scrutinize banks whose money market interest rates are outliers within the marketplace on the view that management may want to quickly inject cash to conceal previous losses. In fact, the parent company’s main division, Freedom Finance, is paying its brokers a 15 percent commission if their clients deposit 1,000 euros in cash, according to an “agent agreement” posted on its website. 

Furthermore, the way Freedom Holding funds its operations is not congruent with the typical practices of a company that can readily access $38 million in cash. The company’s banking and brokerage subsidiaries in Russia and Kazakhstan, operating under the Freedom Finance umbrella, are funding themselves through sales of short-term bonds with high interest rates — ones even as steep as 12 percent. Unless they have no other option, most corporate management teams would try to use available resources to reduce a drag on earnings from interest expense. 

Exactly what is Freedom Holding doing in Cyprus to make that kind of money? The Cyprus subsidiary’s primary operation is offering Freedom24, an online trading platform it touts as “an online stocks store.” Until earlier this year, Freedom 24 used fraudulent credit card processor Wirecard for payments. Cyprus is also where Freedom Holding has based its nascent Freedom Finance Europe division that’s aimed at capturing business from day traders and individual investors in the Western European market.

Even though the customers targeted are individuals who are new to trading or investing, Freedom24 and Freedom Finance Europe are bare bones offerings in comparison with the mobile applications offered by, say, InteractiveBrokers or TD Ameritrade. 

Partnering with a troubled company to execute trades

Furthermore, Freedom Finance Cyprus Limited is enlisting a brokerage that recently landed in regulatory hot water to carry out its trades: New York–based brokerage firm Lek Securities. The SEC alleged in 2017 that Lek Securities had improperly traded options for Ukrainian clients.

(In October 2019, Lek Securities’ co-founder Samuel Lek agreed to pay a $420,000 penalty and admitted to the SEC that he had broken federal securities laws. Lek Securities paid $1.52 million in penalties and disgorgement and also acknowledged a series of violations. FINRA, in conjunction with other U.S. exchanges, gave Lek a lifetime ban from the securities industry and fined Lek Securities an additional $900,000 for its supervisory failures.)

And Freedom Finance’s tight relationship with Lek Securities goes back years. SEC correspondence shows that in 2015 Lek Securities sought to act as a prime broker for a planned Freedom Finance brokerage in the U.S. named FFIN Securities Inc., for which it would process and match up its trades, as well as serve as a custodian for its securities. (Freedom Finance dropped the project the following year.)

In addition, with Freedom Finance unable to execute its own trades on U.S. exchanges, London-based Lek Securities U.K. Limited last year handled 90 percent of Freedom Finance Cyprus Limited’s equity orders, after doing 99.5 percent of them in 2018. 

Betting it all

Curious as to how such a sprawling operation, with units from Belize to Cyprus and from Almaty to Vegas, emerged? In 2008, while a 20-year-old university student, the Russian-born Turlov launched Freedom Finance in Moscow, and it catered primarily to Russian day traders. Turlov bought a small money management firm in 2013. 

In November 2015, Turlov merged Freedom Finance’s assets with those of Salt Lake City–based BMB Munai Inc., a dormant oil and gas exploration company that had (unsuccessfully) sought to export oil from properties in Kazakhstan. BMB Munia had for a while listed its shares for public trading in the United States. Turlov renamed the newly merged company Freedom Holding Corporation and incorporated it in Las Vegas. In October 2019, Nasdaq listed it on the Nasdaq Capital Market tier of early-stage companies. And just this past August, the company’s Kazakh brokerage unit, Freedom Finance JSC, purchased Bank Kassa Nova JSC in Kazakhstan. This joined the Moscow-based retail bank (FFIN Bank) that Freedom Holding had bought in 2017. 

In a September profile of Turlov, Bloomberg News noted that the financial services assets he had begun cobbling together in 2008 now amount to one of Russia’s 10 largest brokerage firms. A Bloomberg article from October 2017 is more illuminating: Turlov is revealed to have a riverboat gambler’s risk management practices.

Kazakhstan-based Freedom Finance JSC borrowed money using short-term repurchase agreements, pledging its (large) positions in the stocks of a handful of local companies as collateral. The Kazakh brokerage then used that money to expand its market-making activities (such as posting the prices it offers to buy and sell stocks) on the Kazakhstan Stock Exchange. 

This was an incredibly risky strategy. Emerging market equities are frequently thinly traded and volatile. Had the price of Freedom Finance’s pledged stock declined, the firm’s repurchase-agreement counterparties could have either immediately demanded additional cash as collateral or seized (and sold) the pledged shares, threatening the company’s solvency.

Yet as a chart of the Kazakhstan Stock Exchange index shows, Turlov’s gambit worked: Freedom Finance, the exchange’s busiest trader, profited handsomely when the stocks it made markets for gradually increased in value. Freedom Holding’s fiscal 2017 10-K annual report shows a securities trading gain of $23 million, to $33.74 million, from $10.8 million in the prior fiscal year.

– – – – – – – –

In the weeks prior to publication of this article, the Foundation for Financial Journalism sought comments from Freedom Holding. After Adam Cook, the company’s corporate secretary, declined to make Turlov available for a telephone interview, email questions were sent on Nov. 12 and again on Nov. 13. On Nov. 25, Ron Poulton declined to address them, citing the availability of information in its SEC filings and the company’s website. 

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The U5 Loophole

Illustration: Edel Rodriguez
Illustration: Edel Rodriguez
Illustration: Edel Rodriguez

Achieving success on Wall Street requires a wide mixture of skills: mastering technical subjects, such as math, economics and finance; earning and keeping the respect of others (and vice versa); and displaying good judgment. Yet apart from passing the Series 7 exam, an elementary test of securities industry rules and concepts, few other credentials are needed before a person can trade government bonds or advise on a big merger.

A clean U5 form, issued by Wall Street’s banks and brokerages, cannot be obtained, however, by undergoing schooling or passing tests.

The U5, or FINRA’s Uniform Termination Notice for Security Industry Registration, is a document that any banking or brokerage firm that a member of FINRA files when an employee departs, for whatever reason. FINRA, also called the Financial Industry Regulatory Authority, is Wall Street’s self-regulatory organization.

Don’t be fooled by the dull title, though; the U5 is one of the most important documents on Wall Street. And negotiations to discuss them can easily become a battleground where employers and employees fight over whether an upcoming exit will be classified as a resignation or a firing — and if problematic behavior is revealed.

On the U5 form, the employer must provide the reason for termination as “voluntary,” “permitted to resign” or “discharged” (or “deceased or “other”). If the employee has been “discharged” or “permitted to resign,” the employer is supposed to fill in a “termination explanation” box with a reason. Banks or brokerages must also indicate if the exiting employee is currently subject to (or was when terminated) an investigation by a foreign or domestic governmental body or a self-regulating organization, or is undergoing an internal review related to issues of fraud, the wrongful taking of property or a violation of industry standards of conduct. Criminal felony charges (such as some cases of sexual harassment) and some misdemeanor infractions are also to be recorded.

Blaine Bortnick, a lawyer who specializes in Wall Street employment practices, said the U5 is a powerful lever for banks and brokerages to wield: Compliance officers at a prospective employer can stop the hiring of anyone with only a slight infraction — if the matter is ever recorded on a U5. “Compliance always can put the kibosh on a hire if they don’t like the U5 regardless of what the business does,” he said. “They’ve got that power these days.”

Thus, a “marked up” U5 can end a Wall Street career for most people, according to Bortnick, and bank executives have almost military-like power over their employees as a result. Indeed, in New York (where many financial companies are headquartered), the state’s supreme court has ruled that an employer’s filing of a U5 is privileged from court proceedings; an employee cannot sue a firm for defamation based on a U5.

Certainly if employers were more honest on U5 forms about the precise reasons for employees’ departures, others companies could much more easily determine if a prospective hire had been terminated for cause, such as violating a federal regulation or law, or if the departure had been involuntary but connected to a strategic shift or cost cutting. If FINRA enforced a more rigorous standard of disclosure, this might prompt some employers to make different hiring decisions. To be sure, any such change in U5 disclosure practices would also raise substantive questions about employee due process and privacy. Further reforms might address if firms are arranging hasty, informal verbal negotiations to let problematic executives leave with a “voluntary” departure (when no termination reason must be noted on the U5) before these employers conduct their own internal review or refer a case to law enforcement.

In the wake of the #MeToo movement’s fostering of a rapid cultural shift in attitudes and employment practices, a trader or banker whose U5 shows allegations of sexual harassment or the breaching of a code of conduct might have greatly diminished job prospects.

Wall Street’s history is full of examples of banks that repeatedly ignored the gross misconduct of certain individuals because they generated a lot of revenue. But an honest U5 disclosure regime might pose reputational and legal risk for FINRA member firms.

Even though one FINRA rule seems to forbid sexual harassment and abuse, a bad actor is not prevented from landing a new job at a different firm if his (or her) previous employer fails to be forthcoming on a U5 form. Rule 5240 states, “No member or person associated with a member shall . . . engage, directly, or indirectly, in any conduct that threatens, harasses, coerces, intimidates or otherwise attempts improperly to influence another member, a person associated with a member, or any other person.”

Regulators in the United Kingdom have taken an approach to this issue that might be instructive for their U.S. colleagues. U.K. officials observed that individuals who left one firm for another with little disclosure about prior conduct problems caused a good deal of mayhem; these regulators even coined a phrase for this practice: “rolling bad apples.”

In a review ordered by the Bank of England and Chancellor of the Exchequer following the global financial crisis of 2009 and the Libor-fixing scandal, regulators said banks and brokerages needed to have much more detailed information about potential “rolling bad apples.” Officials laid out their recommendations in a June 2015 Fair and Effective Markets Review. The Financial Conduct Authority now requires firms to provide or obtain a “regulatory reference” on all new managerial and executive hires, including a detailed account of any disciplinary actions taken within the past five years.

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#MeToo on Wall Street: An Intern’s Battle With Barclays

Illustration: Edel Rodriguez
Illustration: Edel Rodriguez
Illustration: Edel Rodriguez

In June 2018 when Todd Richter left Barclays Capital in New York City, his new employer, Guggenheim Securities, wasted little time before issuing a press release that trumpeted the hiring of a new senior managing director for its health care investment-banking group.

Richter’s hiring was worth crowing about, since he had worked at the biggest firms on Wall Street — and at the highest levels.

Before Richter’s stint at Barclays, where he served as a vice chairman of global health care investment banking, he had been a managing director at Merrill Lynch. Prior to that he held the same title at Banc of America Securities. He spent much of his career at Morgan Stanley, where he headed health care equity research. And for 14 years Institutional Investor magazine picked him for its prestigious All-America Research Team.

During his years at Barclays, from 2015 to 2018, Richter was a so-called rainmaker who worked on some of Wall Street’s biggest deals. For instance, when Mars Inc. bought VCA for $9.1 billion in 2017, Richter’s 35-year friendship with VCA’s founder Robert Antin netted Barclays a $40.9 million advisory fee.

So why did Richter, who is now 62, leave Barclays in the middle of the following year?

What Juliet Cousins described to a reporter about her summer internship at Barclays in 2017 might hold the answer. (Her name is a pseudonym used here to protect the woman from retaliation and harassment.)

Cousins first met Richter in October 2016 when he interviewed her, then a college junior, for Barclays’ investment banking internship program for the following summer.

Interviewed at length by the Foundation for Financial Journalism in March 2019 and again this past July, Cousins described inappropriate workplace behavior by Richter including his making unwanted physical contact and comments about her appearance — as well as his initiating more overt sexual overtures and touching after her internship ended.

‘Why aren’t you cheating?

Cousins shared what she thought were Richter’s odd questions – biased even – during her job interview: For example, Richter asked her, “Why aren’t you cheating?” Cousins asked what he meant (wondering if this was a trick question), and he replied, “You know there are ‘women’s programs’ [at Barclays] so why are you in the general recruiting [pool]?” Cousins said she interpreted this comment as a reference to something like the bank’s Women’s Initiative Network, which is designed to increase the bank’s percentage of women hires.

A Barclays spokeswoman did not return a call seeking comment about Richter’s views about recruiting women to the bank.

After Cousins tried to clarify Richter’s unusual question, she recalled, Richter followed up with “You seem too weak to be doing investment banking. Why do you want to do this?” She spent 20 minutes calmly trying to convince Richter of her merits.

A few weeks later Richter called her to say she had the job and that he wanted her to work in his health care banking unit. Out of relief and happiness at getting a foot in Wall Street’s door, she shelved her concerns about the interview, she recalled.

When he was asked in June 2019 about that job interview, Richter said only that he was one of six or seven people who had interviewed Cousins.

A kiss upon arrival

In her March 2019 interview, Cousins also described what she considered to be an inappropriate interaction on her first day of work, when she stopped by Richter’s office: In front of some of her new colleagues, Richter kissed her on the cheek and told her that she looked beautiful. She thought this was an odd way for an investment banking managing director to greet a college student in the presence of other staff. “I think I knew he was single,” Cousins said. “And I just thought he was gay because why else would he do that?”

Richter, through a spokesman, late last month said that this incident did not happen and that the first he had heard of it was through a reporter and not Barclays human resources department.

Their brief encounters throughout that summer were in the same vein, she remembered: “He would walk by me in the hallway and would always compliment my outfit.” Another time, in an elevator bank, Richter told her that her “hair looked good pulled back.”

Richter was also adamant last month that he had not provided these compliments, saying, “I never remarked on her looks.”

But her summer at Barclays did not go as Cousins had hoped, she told the Foundation for Financial Journalism. She was not assigned to work in the health care banking group as Richter had suggested would happen. Instead, Cousins said she believed she had been shoehorned into another banking group (with its own group of summer interns) where she felt unwanted and unwelcome, adding that as a result she grew increasingly concerned about her prospects for a full-time job offer from Barclays.

About a week before the summer internship ended, Cousins went to see Richter for advice, and while he did not bolster her hopes for receiving a full-time job offer, he told her to stay in touch, she recalled. “Well whatever happens, here’s my cellphone number,” Cousins remembered Richter telling her. “Text me. We’ll get drinks.”

Two weeks or so after her internship ended, with no job offer from Barclays in hand, Cousins felt “really desperate,” she said, about her Wall Street employment prospects “and willing to take help from anyone.” She texted Richter during a vacation in Scotland to arrange a future meeting for job advice. Richter texted back that he also was on vacation and shared two photos with his image, claiming he was swimming on the French Riviera. He was wearing a Rolex. She commented on the watch and sent him a selfie. He noted that she was wearing an expensive Moncler parka and looked “cute/sexy,” adding, “Didn’t see you dressed at work like that.”

Shortly after the two exchanged these messages, Barclays informed Cousins that the firm did not intend to extend her a full-time offer, she said.

An elaborate dinner for a former intern

Cousins also described how later that summer the two shared drinks and dinner at a fancy Manhattan restaurant where Richter’s behavior veered into a new, overtly sexually suggestive direction that she said she did not want or encourage. Rather, when Richter asked Cousins to dine with him at Danny Meyer’s tony Union Square Cafe, she hoped he would view their meeting as “a mentor dinner” and understand that she, then only 21, wanted to enlist his connections to land a full-time job after graduation, she said.

Their Aug. 30, 2017, dinner started out innocently enough, with talk about Cousins’ family and friends, but quickly turned strange as the booze began to flow, she recalled. As Richter threw back vodka highballs, he pressed waitstaff to refill her wineglass “before I was even finished,” she said.

Richter emphasized her good fortune at having the opportunity to gain his advice, Cousins remembered. “You’re so special,” he told her. “No other intern [at Barclays] would be able to have dinner with a man like me,” adding that he had wanted to get to know her better over the summer but had held off because “it would have been inappropriate.” And he mentioned that “everyone in his [health care banking unit] had noticed how much he admired her.” Moments later Richter told her he had known during her initial interview that he had wanted to date her, and then he quickly shifted the conversation to her personal life, Cousins said. He called her “beautiful,” she recalled, and wanted to know why she did not have a boyfriend. He then asked her how many people she had slept with.

Richter, however, said late last month he never asked her about the number of men she had slept with.

Cousins remembered the questions from a much older man about her personal life had made her feel “incredibly uncomfortable” and that she gave him “a vague answer.”

In a June 2019 phone interview, Richter offered a radically different account of that dinner and the dynamic between the two of them: Richter initially offered to meet Cousins in his office, but she declined because she felt awkward about encountering former Barclays colleagues after not receiving a full-time job offer. “When we had dinner,” Richter recalled, Cousins “was not employed at [Barclays], and the whole purpose of the dinner was for me to kind of help her and give her advice.”

Richter did not remember excessive drinking at the dinner, saying only that he and Cousins had “split a bottle of wine.” Asked if they had discussed her personal life, he replied that he did not remember anything like that. “At no point did I ever think that I made her feel uncomfortable,” Richter said in the 2019 interview.

Just prior to this article’s publication, Richter was pressed again on Cousins’ allegations. While during his July 2019 phone conversation he had heavily relied on “I do not recall,” his responses in July 2020 were much clearer, flatly rejecting much of her account of his behavior, both during her internship and their dinner afterward.

‘We’re hitting another bar’

But Cousins recalled that she had found it challenging to rebuff Richter’s unwanted advances as the evening progressed. At the end of the dinner, Richter ordered an Uber. “We’re hitting another bar,” he told her. She felt confused, thinking that somehow the dinner meeting was turning into a date, but decided that being in a crowded bar with him would be safe. “He kept emphasizing how powerful he was,” she said. “So I agreed to go to the bar because it seemed like such a big opportunity to be spending time with someone so high up at the bank.”

On their way out of Union Square Cafe, however, Richter “started to touch my butt,” she recalled, adding that she ignored it and entered the Uber with him. They went to a bar at the base of the Residences at 400 Fifth Avenue, where he owned a penthouse condominium. “As we walked up the stairs to the bar, he touched my butt again,” she said. “I didn’t say anything because I was uncomfortable and scared.”

At the bar, Richter ordered two glasses of vodka for them, she recalled. When they sat down, Richter started “staring into my eyes and telling me how beautiful I looked,” Cousins said.

Asked by an interviewer why she did not bolt, Cousins replied, “I don’t know,” adding in retrospect, “I think I should have.”

Cousins also described a further incident that turned into an outright sexual invitation: She was contemplating whether to leave the bar at 400 Fifth Avenue when someone at Union Square Cafe called Richter’s cellphone to say her bag was still there. Richter suggested that they first go up to his penthouse apartment to get Henry, his dog, so they could walk together back to the restaurant. It was a ruse, she said in hindsight, designed to move her upstairs to have sex with him.

In Richter’s apartment things got tense, according to Cousins’ recollection: “He’s trying to cuddle with me,” she said. “And I just keep pacing back and forth to avoid him touching me. Then he stands up and puts his arms around me.” Added Cousins: “He was looking into my eyes saying, ‘What are you thinking?’ I said, ‘I want my bag.’ He called the restaurant and said that his girlfriend forgot her bag and we are coming to get it.”

Cousins recalled an uncomfortable Uber ride back to the restaurant: Richter kept saying she was “perfect” for him. After she retrieved her bag from the café, she told the driver to head to Grand Central, where she could take a train home. According to Cousins, Richter instead said he wanted her to stay with him. “It’s too late to take the train,” he told her.I’d feel much more comfortable if you slept in my guest bedroom and I’ll make you coffee in the morning.” Following her reply of “Absolutely not, Grand Central!” he leaned in and kissed her, she said. She tried to dodge the kiss but could not. “And then I ran away to Grand Central,” she added.

During his 2019 interview, Richter said he did not recall any of the more explicit details of the evening shared by Cousins with the Foundation for Financial Journalism and insisted that he did not try to pressure her to have sex with him, as she alleged. “I don’t cross lines,” he said. “I would never do anything to cross a line. To touch someone — never! It’s just not my nature.”

Nevertheless, Richter continued to chase Cousins after that late summer evening, she recalled during her interview. He texted her at 6:31 a.m. the next morning, “Great time,” adding that he was hungover and working from home. He asked about her weekend plans and said he wanted to get together again when he returned from Las Vegas. She wrote back that she still needed to find a job, thinking he might help. “You’re pretty special,” Richter replied. “Knew that the first time we met.”

In early October, Richter texted her again. “Just checking in,” he wrote, according to an archive of their text exchange. “How’s life? How’s the job search? Henry and I are in SoCA enjoying some late summer sun,” he wrote. “Was just thinking about you.”

That was their last communication, according to Cousins. And even though Richter had once promised to give her a list of friends and acquaintances at other Wall Street firms, he never did, she noted.

(Richter said last month he did not know the names of recruiters at other firms, so he could not have provided them. But he had kept his word, he insisted, giving her the names of several banks that he felt would not be concerned with her lack of a full-time Barclays offer.)

Later in the fall of 2017, The New York Times and The New Yorker published groundbreaking stories about systemic sexual harassment of women in the workplace; both outlets detailed lengthy allegations against Hollywood mogul Harvey Weinstein. Other exposés carried allegations of sexual assaults by powerful men including Charlie Rose, Les Moonves and Matt Lauer. Although incidents of sexual harassment and assault have been prevalent on Wall Street for decades, the financial industry has yet to have a public reckoning over them: Wall Street’s ample profits, coupled with an unofficial code of silence, make it easy to cover up such unsavory incidents with cash settlements and ironclad nondisclosure agreements.

Cousins was determined to not let that happen with Richter, she recalled.

Weighing the decision to tell her story

In December 2017, after Cousins secured a job offer in a different industry, she reported what Richter had done to Barclays’ human resources department.

Why did she wait? Cousins said she feared that Barclays might retaliate against her and she wanted to first land a full-time job. For a little while she even thought that Richter’s behavior might be typical of Wall Street norms and was unsure that reporting it to Barclays representatives would make a difference, she later explained. And while she wrestled with whether to report Richter, Cousins happened upon a copy of Time magazine’s annual Person of the Year issue. The Dec. 7, 2017, cover story, titled “The Silence Breakers,” spotlighted a brave group of women who had taken great risks to come forward to report workplace sexual harassment and assault. Seeing that dramatic cover story prompted her to realize that no rules or laws can work if women fail to speak up.

An executive moves on

For his part, Richter shared in the 2019 interview his recollections of his last days at Barclays. In “late December” of 2017 representatives of Barclays human resources department asked to speak with him, he said. “They started asking me questions about [Cousins] and it was clear that something was amiss,” he recalled. “I was very upset.” A few days later, Richter asked for another meeting. “Look,” he said he told the human resources executives, “I take my reputation really seriously. I did not sleep with this woman. I didn’t touch this woman. But if I made her uncomfortable in any way, shape, or form, I’m sorry. I’m happy to meet with her to apologize.”

Richter remembered being instructed, “Do not reach out. Do not talk to her. Don’t do anything.” He noted that in his 39 years of working on Wall Street, “I’d never been accused of anything, any impropriety, either financial or personal.”

In January 2018 Richter was attending JPMorgan Chase’s health care conference in San Francisco when his boss, Richard Landgarten, asked him to accompany him on a walk, Richter said. Landgarten, the head of Barclays’ health care group, told him the “firm is very concerned about this situation,” referring to Cousins’ complaint.

Richter recalled that he told Landgarten, “I’ve done nothing wrong. If I made her uncomfortable, I’ll apologize. One hundred percent of my dialogue with her when she was working there in the summer was in my office, and I gave her really good advice, and I’ll stand by that.”

By then, Richter asserted, he had already decided to leave Barclays – not because of Cousins’ allegations — but because he had not gotten along with Landgarten since 2015. Landgarten had not paid him a sufficient bonus for the Mars-VCA deal and had made fun of Richter’s relationship with VCA in a group email, he claimed.

Richter offered to retire, he recalled. At the time he did not have a new full-time Wall Street job offer, although he had just started teaching at Columbia Business School. Landgarten used the alleged incident with Cousins to get rid of him, Richter claimed. “I just felt like [Barclays was] being vindictive to me, and I was happy to get out of there,” he said, adding that after some back-and-forth with the human resources department, Barclays let him resign rather than retire and, in exchange for not joining a competitor for three months, receive a portion of his unvested Barclays shares. He signed a separation agreement with Barclays in mid-March 2018.

Despite Barclays’ requiring Richter to take what Wall Street calls “garden leave” (a three-month noncompete period when an ex-employee stops working to let nonpublic confidential information grow stale), he worked with full pay and benefits on a pair of pending deals; this included, he said, advising Zoetis on its $2 billion acquisition of Abaxis. And nothing about his various interactions with Cousins was entered on his U5, according to Richter. (A U5 is a regulatory document filed within 30 days of an employee’s departure from a FINRA member firm, which notes whether the exit was voluntary or involuntary and if disciplinary or regulatory issues arose.)

[module align=”left” width=”half” type=”aside”] Learn more about what FINRA member firms must report about departing employees in “The U5 Loophole.”[/module]

Cousins recalled that a Barclays representative phoned her on March 21, 2018, with news about Richter, saying, “We took your case seriously and we took appropriate action.” When she asked a question about him, the representative replied, “Todd Richter is leaving the firm.” That was the whole conversation, according to Cousins: “I should’ve asked more questions but I didn’t,” she said. “I was really happy.”

On June 1, 2018, Richter left Barclays, and five days he later joined Guggenheim Securities. He noted that he has known its CEO, Alan Schwartz, for years. (Schwartz previously served as Bear Stearns’ final chief executive.) Richter said he is making the same amount of money as he earned at Barclays but his title is not as lofty. “It wasn’t about the money,” Richter continued, declining to provide specifics about his new compensation. “It really was just an opportunity to be at kind of a special place,” he said.

Cousins told the Foundation for Financial Journalism that when she heard about Richter’s move to Guggenheim Securities she became upset about a rumor that Barclays gave him a big bonus upon his exit. (Richter declined to discuss his Barclays compensation, other than to say he felt the firm shortchanged him.)

In a June 2019 statement provided to this reporter, Guggenheim confirmed Richter’s assertion that no alleged incident involving Cousins appeared on his U5 form: “When Guggenheim Partners hired Todd Richter, it did what it always does. It thoroughly conducted a background check and reviewed his past employment history, including reviewing the U-5 filed by his past employer with FINRA. This review produced no suggestion whatsoever of any aspect of the alleged behavior about which you inquire.”

Reaffirming that he did not remember any inappropriate or sordid details of his evening with Cousins, Richter expressed contrition: “If this woman feels this way, I feel awful,” he said. “I do! I mean, I don’t want to sound like a victim or whatever. But I’m not a bad actor. I’m not a bad guy.”

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Amy Walker’s War on Credit Suisse and a System of Entitled Indifference

Illustration: Edel Rodriguez
Illustration: Edel Rodriguez
Illustration: Edel Rodriguez

For more than a decade Amy Walker, a research analyst in London, has been waging a ceaseless battle for justice in connection with what she alleges was a sexual assault by her colleague at Credit Suisse.

Ever since Walker filed claims about her being drugged and groped at a barroom without her consent in 2010, she has fought police incompetence, years of indifference from her employer and Wall Street’s culture of silence about bad behavior.

Most of all, Walker has fought to hold Michael Shillaker, the man who groped her, accountable for his actions. (Walker is unsure, though, who drugged her.)

Shillaker, previously an influential managing director in Credit Suisse’s European equity research department, has said the groping incident happened but insisted that Walker was a willing, consensual participant, and prosecutors twice declined to take the matter to trial.

Walker, however, has vehemently disagreed with Shillaker’s version of events. In July 2018, Walker thought she had finally scored a victory; she pressed Credit Suisse to revisit its 2010 investigation, and the bank ultimately fired Shillaker. But later that year after Shillaker brought his case to a Spanish court, he won back pay and clearance to work at other banking firms.

What follows is their recounting of events, including their interactions at the bar, two police investigations as well as two prosecutorial reviews, with a focus on Walker’s attempt to obtain justice after undergoing what she considers was sexual assault.

The Foundation for Financial Journalism spoke with Walker extensively in a series of interviews, beginning in June 2018, and interviewed Shillaker at length in September 2018. Asked to expand on his responses from that interview, as well as to discuss subsequent events, Shillaker’s lawyers in the United States, the United Kingdom and Spain sent detailed legal letters to the Foundation for Financial Journalism that vigorously deny any suggestion that their client did anything wrong to Walker. (Shillaker did not respond to a recent email with additional questions.)

Rounding up co-workers for a good turnout at a Canary Wharf bar

Walker’s quest for justice began after an impromptu afterwork get-together with colleagues over drinks on April 16, 2010. The Friday night outing was organized by Shillaker, who was then 39 and Credit Suisse’s senior research analyst for its European steel and mining research group, for some of his colleagues in the bank’s European research department. An email Shillaker sent his colleagues to pitch the outing noted that he was putting the gathering together after his weekend flight to Madrid (so he could see his new girlfriend) was cancelled.

At 5 p.m. when Shillaker left Credit Suisse’s office at Canary Wharf in the heart of London’s financial district, he urged others to follow him to a nearby wine bar called Corney & Barrow.

Shillaker “was conscripting people all afternoon,” Walker recalled in an interview, noting that he had thrown himself into securing a good turnout, sending out emails and corralling people at their desks or in the hallway to attend.

Walker, then a 31-year-old vice president whose job was to analyze European chemical companies, is a serious, matter-of-fact South African, with a doctorate in chemical engineering. She was then relatively new to the financial industry, having joined Credit Suisse in 2007 after working for several engineering consultancies following a stint in the Netherlands at Royal Dutch Shell.

Going out for drinks after work was not ordinarily part of Walker’s routine, she said. She recalled that she half-jokingly wrote that April day to a colleague that if she decided to go, “it’s just a shameless career ‘ladder climbing’ move.”

And in case Walker had ideas about working late to avoid the gathering, at about 6 p.m. Shillaker sent a junior associate to remind her and paper industry analyst Lars Kjellberg that it was time for them to join their colleagues at the bar.

When a reporter informed Shillaker of Walker’s reservations at the time, Shillaker said only “She didn’t have to come.”

But there was another reason Walker was reluctant to go: She really disliked Michael Shillaker, she recalled. Walker, who did not report to Shillaker, said in an interview that he was a “bully,” whose frequent verbal tirades were humiliating for other analysts and support staff — and had evoked public tears from several women.

Raised in Wiltshire, a small county in the west of England, Shillaker studied accounting at the University of Southampton. He briefly worked at KPMG and Deloitte before landing a job as a junior analyst at Credit Suisse in the mid-1990s. In 2001 he joined UBS, where his career took off; by 2004 Credit Suisse had recruited him back. While Shillaker worked for UBS, he was on the 72nd floor of the World Trade Center’s South Tower on Sept.11, 2001, when the first jet hit, and five minutes after he exited the building, it collapsed. “It was horrible,” he recalled in his September 2018 interview. “I cried for years.”

Shillaker was a highly regarded steel analyst; even his detractors acknowledged his proficiency. “Michael is very good at his job,” Walker said in her statement to police. “But I am afraid of him, and avoid any conversation with him. I stay off his radar.”

Ordering rounds of drinks on a Friday evening

When Walker arrived at Corney & Barrow that April 2010 evening, Shillaker encouraged her to order a drink, she recalled. After Walker chose a small glass of white wine, she kept her coat on — the better to make a quick exit, she said — and talked to a colleague while nursing her drink. She had not even finished it before Shillaker urged her to have a second one and indicated to the waiter to bring a “large” glass by holding his hands “far apart,” she remembered. She did not object.

Walker was not a regular drinker and only occasionally has a glass of wine or a gin and tonic, she said, adding that prior to the April outing she had been drunk just once in her life.

At the bar that evening Walker took a sip of the larger, second glass. “It was a different taste,” she recalled, noting that she did not know enough about wine to be discerning. She finished only about three-quarters of the second glass.

Shillaker kept encouraging Walker to take her coat off, and at first she declined because she felt embarrassed by his requests, she remembered. She eventually complied, but when she sat on her coat, her dress rode up “and showed a lot of my legs,” she said, adding that after she tried to pull it down, Shillaker and a few other male co-workers made comments. She kept quiet because “I didn’t want to appear prissy,” she said. (Throughout that Friday at work Shillaker had repeatedly commented on her formal attire for a client meeting, with remarks like “You’re looking very glamorous today,” according to Walker’s later statement to police.)

At about 8 p.m. Walker found herself alone at the bar with Shillaker since the others in their group had left and he had gone over to sit next to her, she recalled. They talked about her work performance, and “he was saying I was doing really well,” she noted. They started gossiping.

“The conversation got quite flirty,” Shillaker recalled.

Shillaker, who had been in the process of divorcing from his wife of five years, asked Walker if her partner was the only man she had been with. She recalled that she interpreted this as a question about whether her boyfriend was the only man she had slept with. Walker found herself telling Shillaker that Tristan Jakob-Hoff was indeed the only one. The two co-workers then discussed whether Shillaker was having affairs with two other women in the office. “I don’t remember feeling alarmed,” she noted about the personal nature of this conversation. (And that discussion is the last thing Walker said she clearly remembered about her time at the bar, emphasizing to a reporter she can recall only fragments of what happened afterward.)

Asked later about his conversation with Walker that was so atypical of their office discussions, Shillaker insisted, “She could have left at any point.” Shillaker recalled that he then asked if she “fancied” him and that she replied, “yes.” He later told a reporter, “It was a very happy atmosphere.”

While they were seated on the crowded outside patio of the packed Corney & Barrow, Shillaker kissed Walker with “his tongue in my mouth” and “cupped his hand” around her right breast and “was squeezing it,” she recalled. “God,” he told her, “I’d love to take you to a hotel.” His face, she said, was really close to hers, and she could smell cigarettes on his breath. Walker remembered feeling “ashamed” about what was then happening but did not recall telling Shillaker “no” or trying to leave. “I couldn’t move,” she said. “I don’t know why. I hadn’t drunk that much.”

Walker did not remember ordering a third glass of wine that she drank from. Yet she was emphatic in telling this reporter that she did not consent to Shillaker’s public petting and certainly had not been in any condition to do so.

“I would never knowingly kiss [Shillaker] or allow him to touch my body,” she told police. “I respected him as an analyst but despised him as a human being. I have never been unfaithful to Tristan nor would I want to be.”

Shillaker said in his September 2018 interview that he remembered exactly what happened when he and Walker were alone: They were sitting next to each other and talking, and when Walker returned from the bathroom, they started kissing. “Completely consensual,” he said, acknowledging he had engaged in heavy petting: touching, over her clothing, her breasts and her vaginal area. He asked Walker if she wanted to go to a hotel, and she said yes, Shillaker claimed. He later cited his question “Would you like to go to a hotel?” as evidence he had sought her consent for sex.

“What would your boyfriend say?” Shillaker recalled asking Walker. “I can do whatever I like,” he recalled her saying. Her response surprised him, he said, noting, “It was quite striking.” Shillaker conceded that his girlfriend in Madrid would not have been happy with his actions at the bar. “Morally, it was not the best thing to do,” he said.

Both Shillaker and Walker remembered that someone who walked by said, “Get a room.” (Shillaker later said that observer’s comment suggested that others perceived the petting as consensual rather than something done against Walker’s will.)

Shortly after broaching the idea of finding a hotel room, at about 9 p.m., Shillaker noticed that Walker had become “unsteady” and had “slipped on her seat” and he decided to call it a night, he remembered.

Walker recalled being back in the lobby of the Credit Suisse building sometime later that evening with a woman standing over her, as well as Jakob-Hoff.

“I have no further memory,” she told police on April 21, 2010, “until being in the shower at home, unable to stand up.”

For his part, Jakob-Hoff recalled in a 2018 interview that at about 6:45 p.m. Walker called him from the bar and “sounded perfectly sober and happy.” When she next called, at 8:42 p.m., she told him she was “so shit-faced” that she needed him to take her home, and she was slurring her words very badly, he added. At 9:30 p.m. Jakob-Hoff decided to go to Credit Suisse, and when he arrived there, he found Walker lying in the reception area across several chairs, with a plastic bag near her mouth and a red blanket covering her. “She was drifting in and out of consciousness,” he continued.

Jakob-Hoff stayed in the lobby with Walker, hoping she would sober up, he recalled. “Amy slept for some time, only waking to vomit,” he said. When Jakob-Hoff helped her to the toilet, she fell asleep in the stall and remained there for 10 minutes, until he went in and helped her walk out, he added.

Asked about Walker’s rapid deterioration of mental status that evening from being alert (while casually drinking) to passing out, Shillaker in his 2018 interview claimed she had told him after vomiting, “I should not have been drinking with Valium and Prozac.” (A later toxicology report showed only trace amounts of Valium in Walker’s system, consistent with her statement to police that she had taken the drug more than a week prior, to help her sleep. No Prozac was detected, per the toxicology report; Walker said she has never taken Prozac.)

Staggering, stumbling and struggling to recover

Walker staggered out of the building and walked home with Jakob-Hoff as no cab would stop to take them, he recalled. Hearing that Shillaker had wanted to go to a hotel room and thinking he might had been behaving like “a chancer,” Jakob-Hoff asked Walker if she believed that Shillaker had “spiked her drink” and she replied she did not think so, Jakob-Hoff added.

After Jakob-Hoff put Walker in the shower at their home, he heard a “thud” and found her on her knees, he recounted. “I can’t stand up,” she told him. He then placed her in the bathtub but, worried she might drown, he remained in the room with her, he said. Afterward she fell into a deep sleep on the sofa. Then while Jakob-Hoff prepared a bagel for her to eat, Walker mentioned to him that Shillaker had “stuck his tongue down her throat.” Jakob-Hoff was angry that Shillaker had taken “advantage of her,” he remembered, adding that Walker eventually told him that Shillaker had “touched her boobs” and placed his hands under her skirt. “Oh yes,” she told him, “his hands were all over me.” After hearing this, Jakob-Hoff felt like “someone was defiling our relationship,” he recalled.

The morning after the bar incident Jakob-Hoff again suggested to Walker that perhaps her second glass of wine had been spiked, and they started researching “date rape” drugs online. “Her behavior and symptoms,” Jakob-Hoff recalled, “appeared to be the same as [what] GHB or Rohypnol” triggers.

Convinced that one of her glasses of wine had somehow been spiked, the day after the incident, April 17, 2010, Walker sought a test at the Royal London Hospital, where staffers told her she needed to first report to police what they called “the assault” because of chain of custody issues, according to Walker. She reported the incident at the Limehouse police station, where an officer took a urine sample and swabbed her mouth but did not take a blood sample or wish to test the vomit still on her purple coat.

Shillaker sent Walker an email the morning after their bar encounter. “Hey I hope u r ok,” he wrote that Saturday. “God was really worried about u last night. Are u alive?”

The Monday after the Corney & Barrow incident, Walker went to work early and saw Shillaker exiting the elevator, she recalled. “Hey, are you alright?” he asked her.

“Yes, I’m fine,” she remembered saying, even though this was not so. Seeing Shillaker caused her to have a “panic attack,” and she realized she would not be able to continue working around him, she later recounted.

Later that same Monday he emailed her “Are you OK?,” adding, “Haven’t said a word to anyone.” She did not reply, she said.

(In a May 2010 letter to the Crown Prosecution Service, Shillaker’s attorney said Shillaker wrote that email to Walker to “allay her concerns” that he may have been telling colleagues “about what for Walker was an embarrassing episode.”)

Reporting the incident to Credit Suisse as well as the police

Early on Monday, April 20, 2010, Walker reported her version of what had happened at the bar to human resources executive Jennifer Barker and Steven East, who supervised both Walker and Shillaker and served as Credit Suisse’s Europe, Middle East and Asia equity research chief.

“She has memories of selected episodes of Mike Shillaker sexually assaulting her, but didn’t have a full recollection of the evening,” according to East’s notes of the meeting. “She said this has left her severely bruised, but she did not elaborate further to me on the nature of the sexual assault.” (Photographs snapped four days after the incident show large bruises on Walker’s knees and arms, incurred when she fell in the tub that evening.)

And the day after Walker reported the incident to Credit Suisse executives, she gave a lengthy statement to Detective Constable Karen McGarry, who also informed Walker that police need not test the vomit stains on her coat. “Have it dry-cleaned,” Walker recalled McGarry as saying.

Credit Suisse was initially supportive of Walker, she said, citing the company’s offer to let her work from home and to ensure law enforcement access to employees who were potential witnesses. “I very much appreciate all you and CS have done to help,” Walker wrote East on April 21, 2010.

That same day, East informed Shillaker that he was being suspended immediately, with pay, based on an allegation he had “sexually assaulted” a colleague. Shillaker was dumbfounded, he told a reporter. “I couldn’t relate,” he recalled. “I didn’t even know what he was talking about, because nothing from [the bar get-together] suggested to me that this could have been possibly that allegation. What have I done that’s really, really so serious and when?”

Shillaker said Credit Suisse’s security personnel escorted him out of the building and confiscated his corporate identification card. “What the hell do I do?” he remembered thinking. “This is serious, serious, serious stuff.” His divorce attorney recommended a criminal lawyer.

On April 30, 2010, McGarry arrested Shillaker and he spent time in jail. Shillaker met with McGarry on May 4 and shared his version of what had happened on April 16.

Credit Suisse’s 2010 “Disciplinary Procedures Policy” says an employee can be dismissed “without notice” not only for “assault, attempted assault or threatening behavior” but also for a host of lesser offenses: for “behaviour under the influence of drugs or alcohol which adversely affects others at the Company,” for “insulting or indecent behaviour” or for any conduct which, in “the opinion” of Credit Suisse, could “adversely affect” its reputation.

Furthermore, the company’s “Supervisor/Subordinates Relationship Policy” notes that intimate or sexual relationships between two employees in cases when one directly or indirectly oversees the other can impair the decision-making ability of the person with more rank; a managing director must report a relationship of this nature to the human resources department for a review. Credit Suisse ended up taking no further disciplinary action against Shillaker in 2010 in connection with the incident at the bar.

On May 21, 2010, a month after Walker had reported the bar incident to Credit Suisse, Shillaker was back at the bank, working in another London office of the firm. Walker recalled asking why. “We have heard his side of the story,” East and Barker told a teary Walker at a meeting, adding, “We understand there is very little chance” her case against him would be prosecuted by law enforcement — even though police were still awaiting the results of a toxicology report to determine if Walker had been drugged.

Nonetheless, on June 3, 2010, Credit Suisse human resources staffers interviewed Walker as part of a separate inquiry to examine her allegations that Shillaker had repeatedly bullied subordinates – claims she had raised when she reported his barroom behavior to the company. In addition, her colleagues Alessandro Abate and Lars Kjellberg gave statements that supported her claims about Shillaker’s bullying conduct, with Abate, a native of Italy, alleging that Shillaker had called him “a monkey” because he occasionally made mistakes when writing in English. Nicola Tate, Shillaker’s longtime administrative assistant, said, “Mike is a very demanding boss, he is loud, he shouts his demands at me.”

When a reporter asked Shillaker about the allegations that he had bullied people at work, he said that a human resources staffer told him the investigation of that matter had produced “significant conflicting evidence” and he had received a verbal warning, the bank’s mildest possible punishment, after the inquiry’s closure sometime in 2010.

In June 2010, the toxicology report ordered by London police indicated that no Rohypnol or GHB had been detected in Walker’s system. Based on the police’s recommendation following its review of the toxicology report, prosecutors decided to not charge Shillaker.

Walker recalled that while discussing the toxicology report with her, McGarry had asked, “Do you take Nytol?” with Walker replying she had likely taken some of that over-the-counter sleep aid weeks or perhaps months earlier but did not do so regularly. According to Walker, McGarry then replied, “That’s interesting; we found it in your system, and you’ve just told me you take it.” Although Walker repeatedly asserted that Nytol could not possibly have been present in her system that April 16, 2010, evening, McGarry brushed her off.

Baffled and frustrated, Walker met with McGarry’s supervisor, who declined to elaborate on the toxicology findings, beyond noting that “there were no opioids found in your system.” Walker insisted she had never taken opioids and so such a substance could not have anything to do with the Corney & Barrow incident — to no avail, she recalled.

By mid-June of 2010, Shillaker had returned to his Credit Suisse office at Canary Wharf. Walker was stunned — not just by the police’s failure to act but also by Credit Suisse’s decision to side with Shillaker, she recalled.

Shillaker shared in a June 19, 2010, email with East how “delighted” his clients and co-workers were about his return to Credit Suisse. He also expressed outrage, railing against what he perceived as his unfair treatment. “This is a horrific situation for me to be in,” Shillaker wrote. “I wake up with a black cloud over me every single day.” He compared the trauma he experienced from the assault claim to his September 11 experience. “I have had 2 major shocking events in my life,” he continued. “I was in the twin towers on 9/11. I have had false allegations made against me that led to me being suspended, arrested and my movements controlled. Both of which show a side of human nature I would never have believe existed.”

Expressing no sympathy for Walker, Shillaker concluded, “What is happening here is pure evil and I do not deserve nor ever deserved this.”

On June 24, 2010, Walker resigned from Credit Suisse to work for Morgan Stanley. Reflecting on Credit Suisse’s handling of its investigation, Walker said, “As an employee, you think you’re protected. This happens, and the guy gets a free pass. So essentially, what they said to this guy, who already thinks he writes his own checks, was ‘This is fine.’”

Although Walker left Credit Suisse, for the next decade she refused to let the matter drop — as she pursued a second police investigation in yet another bid to have Shillaker prosecuted. She also weathered a series of failed attempts to place her complete story in the British and American press.

Throughout all these events, Shillaker tried to silence Walker. On Aug. 4, 2010, she received a letter from his attorney. “Your allegations have caused our client huge personal suffering, considerable financial loss and . . . significant legal fees,” the lawyer wrote. He warned Walker not to repeat her “groundless” allegations to any “third party” and threatened legal action for “defamation” if she failed to desist.

By October 2010 after she made a public records request, Walker received a redacted version of Shillaker’s statement to the police, contained within the Crime Reporting Information System (CRIS) record, which documented all the law enforcement activities of the investigation. She recalled her shock and tears upon reading in this report that Shillaker had told police he had touched her genital area. Until that moment she had no idea that had occurred; she had remembered that at most he had touched her inner thigh. “Reading about it made me feel yet more humiliated and sick at the thought of how close I may have come to even greater harm,” she noted.

Seeking legal redress a second time

After reading the CRIS report, Walker became convinced that the lead police investigator, Detective Constable Karen McGarry, had botched key parts of the investigation, Walker recalled. And Walker was especially troubled by how Credit Suisse often knew important, highly private details of her case weeks before she did, she said. For example, Walker recalled Barker saying on May 21, 2010, “We understand it is highly unlikely [Shillaker] is going to be charged.”

After months of Walker’s complaining about how her case was handled, London Metropolitan Police agreed at a November 2010 meeting to formally re-examine its oversight of the investigation. Fortunately for Walker, she had preserved her vomit-stained purple coat in a sealed plastic bag.

A second toxicology report, released on May 16, 2011, provided an explanation for why McGarry had asked Walker about Nytol: Her vomit contained diphenhydramine, an antihistamine that is the active ingredient in Benadryl as well as some over-the-counter sleeping aids that are popular in England. Diphenhydramine, when dissolved in alcohol or other liquids, has been linked to date rape incidents.

So though Walker took some comfort from knowing that she had indeed been drugged, that was all the test could do — it could not tell her who drugged her.

(Asked about this toxicology finding, Shillaker strongly denied that he had slipped anything into Walker’s drink. “I didn’t drug her,” he said, adding that such an allegation was “completely absurd.”)

In November 2012, the London police released its review of the case, and it confirmed all of Walker’s worst fears, she said. The review indicated that since McGarry did not take Walker’s coat as evidence, her drug screening had been improper. Despite Walker’s insistence that she had been drugged and assaulted, McGarry had approached Walker’s case as a “local crime” — not a serious sexual assault; thus the case was never presented to the London police’s special sex crimes unit, the police review concluded. Furthermore, although a sedative had been detected, McGarry told the Crown Prosecution Service the “forensic report was negative,” which led prosecutors to recommend that no charges be filed.

And as a result of what McGarry referred to as her personal friendship with Credit Suisse’s London security chief Tim Rawlins, she had repeatedly shared with the bank sensitive health details about Walker, as well as confidential information from the police investigation.

Ultimately, the Metropolitan Police’s review concluded that McGarry’s errors had been so extensive, they warranted “gross misconduct” charges be brought against her, but she resigned prior to the report’s release.

At a Dec. 1, 2012, meeting, Andrew Hadik, the Crown Prosecution Service lawyer assigned to the case, told Walker he could not recommend that his team try to prosecute the case, according to her notes of the meeting. No evidence had been found that indicated that Shillaker had drugged Walker or had the opportunity to do so, Hadik said. And since police had not administered the proper tests in 2010, prosecutors could not determine when Walker had ingested the diphenhydramine. Acknowledging the lack of sufficient evidence for a prosecution, Walker nonetheless asserted she knew what had happened to her and found it “very difficult to accept that there are no consequences” for Shillaker.

Bringing the case to the press

Still infuriated by a May 2011 letter Credit Suisse had sent her — that minimized the bar incident as “in fact, a kiss” — Walker decided to contact news outlets, she recalled. The letter’s “mocking and dismissive tone, particularly the use of quotation marks around sexual assault, as if [she had] made it up” were particularly ugly, she noted.

In the letter, Credit Suisse had pointed out that Shillaker had “admitted that he had kissed” her but said Walker “was a completely willing participant and that he did not force himself upon her.” Shillaker’s view, the bank had added, was “not inconsistent” with Walker’s “account of events.” Furthermore, “in light of the fact that no one else had witnessed the incident,” Credit Suisse had stated, “it was not thought necessary” for the bank to “further investigate the incident.”

In February 2012, The Sunday Times informed Credit Suisse it was considering publishing an article with Walker’s allegations. Yet the article never ran, and Credit Suisse and Shillaker threatened to sue Walker if she continued to share her account with others. Undeterred, Walker contacted two more newspapers, but Shillaker’s attorneys succeeded in killing both pieces, she claimed.

A lengthy story about the bar incident appeared in The Independent on Sunday in October 2012 without naming Walker, Shillaker or Credit Suisse. But the Independent removed the story from its website after Shillaker’s attorney threatened the publication, according to Shillaker. “It was a completely, completely one-sided view, full of inaccuracies,” he later recalled to a reporter.

Going straight to the CEO

On May 12, 2013, Walker received what she considered to be a crushing disappointment from the prosecutors who had examined the police review of the case. Louise Smith, a Crown Prosecution Service supervisor, wrote Walker, saying prosecutors could not take the Walker case to trial because they felt they were unable to prove that Shillaker knew his contact with her was nonconsensual. Smith added that Walker “had told . . . police that [she] did not resist or object to what he did at the time,” although she had later asserted she had not provided consent. 

Walker and Jakob-Hoff kept meeting with lawyers, the Crown Prosecution Service and even a member of Parliament in a bid to press prosecutors to re-examine their conclusions. Yet when Walker learned at a 2016 meeting with a senior Crown Prosecution Service lawyer that her case file had been destroyed (despite regulations mandating the preservation of such records for as much as 10 years), her hopes that prosecutors would re-examine incident a third time had been dashed.

By January 2018 as the #MeToo movement started to gain steam, Walker was ready to try taking a different tack: She wrote directly to then-Credit Suisse CEO Tidjane Thiam, including her statement to the police, McGarry’s report, Credit Suisse’s conduct code and two long Economist articles on workplace sexual harassment. “To my knowledge,” she wrote, “Credit Suisse has still not taken any action on this matter, and [Shillaker] remains in his position as managing director at the firm you now lead.”

For two months, she heard nothing from Thiam. On March 1, 2018, he wrote back — after Patrick Jenkins, then the Financial Times’ financial editor, told the bank he was writing about the 2010 incident. Thiam apologized to Walker for not responding sooner, saying he had launched “a thorough review” of the firm’s “historic handling” of her allegations. He assured her he was treating the case with the “utmost seriousness,” adding, “If there are lessons to be learnt, I will make sure we learn them.”

Jenkins’ March 4, 2018, article mentioned that Thiam pledged to do a “thorough review” of the bank’s handling of the incident — but not one of the incident itself. The Financial Times piece did not mention Walker or Shillaker by name.

That March a Credit Suisse human resources staffer phoned Shillaker. “I’m really sorry,” he recalled being told. “Amy Walker is back.” Reflecting on how he felt about the new Credit Suisse investigation of 2018, Shillaker said, “Here we go again,” adding, “Five or six times I’ve had to prove my innocence again and again and again; my story is always the same.”

For two weeks in March 2018, Walker went round and round with Credit Suisse staffers about the ground rules for the bank’s new investigation, debating whether she could record her meetings with them, who would be permitted to attend the sessions and if a third party should arbitrate, she recalled.

On a May 3, 2018, call, when Karen Mitchell, Credit Suisse’s global head of human resources for corporate functions, asked Walker, “What does resolution look like to you?” Walker replied that she had repeatedly documented for the bank that Shillaker in 2010 had violated its stated policies — to the point where dismissal was warranted, and if the new investigation corroborated her views, she would not comprehend how he could not face consequences.

Summoned to Zurich on July 18, 2018, Shillaker told his version of the bar incident to the bank’s global head of compliance, Lara Warner, who was leading Credit Suisse’s new investigation. Warner told Shillaker the new investigation had “a few more weeks to go,” and then Thiam would make his decision, he recalled.

On Aug. 23, 2018, the Financial Times reported that two Credit Suisse bankers (unnamed in the piece) had been fired as a result of sexual assault allegations from 2010. “I was trembling,” Shillaker recalled of the moment he learned by phone about the article: He was walking the beach with his two kids in southern Spain, where he had moved after marrying his girlfriend from Madrid. “I was like, Oh my God. Is this right? I’ve been fired?”

Later that August day a Credit Suisse human resources manager emailed Shillaker: He had indeed been fired. As his then lawyer William Garnett told this reporter, Shillaker had been fired for being “involved in a situation that has had a reputational effect on the company” and for “a breach of contractual good faith between the parties.” He received no severance and never returned to his Madrid office at Credit Suisse. Garnett, an attorney at Bates Wells & Braithwaite, called Shillaker — and Walker — “victims” that September: “What Credit Suisse has done is to put itself first. When does an investment bank ever do anything but? If you want loyalty, buy a dog.”

When asked whether he saw himself as a “victim,” Shillaker replied emotionally during his own September interview, “I don’t want to use the word victim.” He added, “All I’m telling you is that time and time again I’ve had to prove my innocence. It’s gone on and on and on, and suddenly I’ve lost my job.”

Continued Shillaker, “This is a life changer.” He was now leading a frugal lifestyle, after years of making about $1 million each year, he said. “My wife and I sit down every day with spreadsheets, working out what we have to cut, what we have to sell,” he added. “I never had enough [money] so that I can just sit down and say, ‘It doesn’t matter.’”

Invited to share the degree of sympathy he felt for what Amy Walker had experienced, Shillaker responded, “I did not do anything wrong, right? So this is very, very painful for me. I have no opinion of what she thinks about this.”

Steven East, the research chief who had supervised both Shillaker and Walker, departed Credit Suisse at the same time Shillaker did.

For a short while after the departures of Shillaker and East, Credit Suisse executives might have thought they had succeeded at delivering justice and that a certain unsavory chapter of its history was closed.

In an interview on Aug. 24, 2018, Warner said that she discovered that Credit Suisse had failed to conduct a “full investigation” in 2010, largely because the police had asked the company to not to interfere. Thus bank authorities did not interview many potential witnesses. Warner also learned that Shillaker had never told Credit Suisse something he had reported to the police — that he had not only kissed Walker but had also touched, over her clothing, her breast and vaginal area.

“There was no indication in our review that anyone at the bank had the benefit of that police statement,” Warner said, adding that Credit Suisse instead relied on a summary of Shillaker’s “recollection of events” supplied by his attorney. Through the new investigation, Warner came to believe Walker’s version of events, not Shillaker’s, she said.

“There was no doubt that the degree of touching went well beyond a kiss,” Warner asserted, adding that Shillaker’s actions represented a “violation, even though it was eight years ago, of our current expectations of behavior of our employees.”

Taking strides to recognize a wrong

After firing the two executives, Credit Suisse offered to donate $100,000 to a charity of Walker’s choosing, in her name. The company also appointed an ombudsperson to handle issues of sexual harassment and abuse.

“One of the things that has struck me,” Warner said during her August 2018 interview, “is the bravery that people have in bringing these types of issues to the fore when they are in positions of lesser power, because it is not an easy thing to do.”

After her tears of joy subsided, Walker was overwhelmed with a feeling of relief, she said in September 2018, noting she had not gone a day without thinking about the Corney & Barrow incident. She had worried if true change would ever arrive at Credit Suisse, she added.

“Deep and meaningful cultural change, even if the will at the very top of the organization is there, takes a lot of time and a lot of effort,” Walker said. She had no regrets over devoting years of her life to her fight or deciding to tell her story publicly (and thus possibly jeopardizing her career), she said. Yet the man who had inappropriately touched her had kept his Credit Suisse job for eight more years, continuing to earn millions of dollars in cumulative compensation, she asserted.

“Shillaker does not seem to have acknowledged, or indeed even understood, that he is at fault here,” Walker wrote in a September 2018 email to a reporter. “No doubt that view was reinforced by the repeated failures of anyone in authority (the police, the Crown Prosecution Service, Credit Suisse) to take any action to censure him.”

Ruling in Shillaker’s favor in a Spanish court

In late 2018 Shillaker pursued a claim against Credit Suisse in a Madrid court, according to Marty Singer, his litigation counsel. Credit Suisse “admitted” that Shillaker was a “good leaver” – and that he had been dismissed from Credit Suisse “without cause,” Singer summarized in a letter to this reporter. To settle Shillaker’s litigation, Credit Suisse appears to have paid him deferred and back compensation, and his Financial Conduct Authority record shows no disciplinary infractions. (Shillaker did not respond to a request to share legal documents from his Madrid case.)

Despite Shillaker’s legal victory in Spain, his short-term job prospects might be hindered by a new set of British regulations for financial services firms that went into full effect in December 2019. The Senior Managers and Certification Regime requires any such U.K. firm that seeks to hire a new manager or executive to obtain from the person’s previous employers a detailed regulatory reference for the prior six years, including accounts of any investigations involving the employee.

Those regulations appear to have not hindered Steven East’s career much, however. In September, East joined Redburn, a small research-focused London brokerage firm, where he oversees a team of 53 analysts. And the privately held Redburn lists East as a partner. Over the past decade East has served as a key defense witness for Credit Suisse, after two of his subordinates brought high-profile lawsuits against the bank:  A 2012 age discrimination suit was settled confidentially in 2013, but a 2019 gender discrimination claim, alleging bullying and harassment, remains unresolved.

The Foundation for Financial Journalism recently emailed East seeking comment on his departure from Credit Suisse and his new role at Redburn; he has not responded.

Credit Suisse did not respond to numerous requests from the Foundation for Financial Journalism for clarifications about Shillaker’s legal settlement. The bank’s Karen Mitchell, in a May 27, 2019, email to Walker, said it “acknowledged the position of Spanish law that Mr. [Shillaker] had a claim against Credit Suisse. His dismissal has not been reversed by the bank. As such, Credit Suisse has at all times remained committed to its decision to dismiss Mr. [Shillaker]. Mr. [Shillaker] no longer works for the bank.”

Walker told the Foundation for Financial Journalism she was outraged by what she perceived as Credit Suisse’s about-face: its sudden cooperation with Shillaker after the Madrid court proceedings, particularly its willingness to re-characterize the nature of his departure. When a senior officer of the bank contacted her in May 2019 to find out where she wanted its $100,000 charitable contribution to go, she replied she would not participate. Credit Suisse, Walker wrote, “remains a corporate sponsor and endorser of sexual misconduct and harassment. . . . I want your [executive officers] to understand that I am not prepared to allow Credit Suisse to use me for the purposes of its superficial and transparent PR exercises. Please refrain from any further such attempts in future.”

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The Pity of Wirecard, Part II: Bezzle Never Sleeps

Illustration: Edel Rodriguez
Illustration: Edel Rodriguez
Illustration: Edel Rodriguez

If questions about the integrity of Wirecard AG’s accounting in its crucial Asian operations are ever to be resolved, Singapore regulators will need to step back and take a long, hard look at James Henry O’Sullivan’s relationship to the Aschheim, Germany–based company. Prosecutors at Singapore’s Consumer Affairs Department have been investigating Wirecard’s fast-growing Asian division, claiming in a March 8 filing that employees in its Singapore office orchestrated a complex, multiyear scheme to inflate the company’s revenue.

Specifically, the regulators would want to examine O’Sullivan’s complicated role in Wirecard’s suspect October 2015 purchase of Great India Retail’s online payment businesses, which the Southern Investigative Reporting Foundation reported on in January 2018.

Forty-six-year-old O’Sullivan, a native of England but said to be currently living in Singapore, seems to keep a low profile; his name rarely shows up in legal documents or on the internet, except in filings for a series of Isle of Man–based shell companies and a Luxembourg holding company, Caireen SARL.

But sift through enough of this paperwork and a very distinctive picture of O’Sullivan emerges — that of a digital payments industry veteran with a cleverly hidden hand in nearly everything Wirecard does in Asia. And O’Sullivan is the likely owner of International Techno Solutions, one of 11transactional parties” that Singaporean prosecutors have alleged engaged in “arrestable offenses,” such as round-trip accounting and money laundering, to boost Wirecard’s revenue.

Flying under the radar may soon be a thing of the past for O’Sullivan if two Chennai, India–based brothers have anything to say about it.

Ramu and Palaniyapan Ramasamy, the founders of Hermes Tickets and Great India Technology, in March sued O’Sullivan, as well as Wirecard and its chief operating officer, Jan Marsalek, claiming they had masterminded a scheme to persuade the brothers to sell their companies under false pretenses and thus exposed them to reputational and economic harm.

(Hermes Tickets and Great India Technology are both subsidiaries of the Ramasamys’ larger company Great India Retail. And the Ramasamys used to be vocal Wirecard supporters: Ramu Ramasamy delivered the India strategy update at Wirecard’s 2016 Capital Markets Day presentation to analysts and investors.)

Anyone reading the Ramasamys’ complaint would have difficulty distinguishing between the interests of O’Sullivan and those of Wirecard since the suit has described both as pursuing an identical strategy and seeking the same assets. The Ramasamys have claimed in their suit that O’Sullivan (referred to as Defendant No. 4) approached them in early 2014 and made a bid for Hermes Tickets — through a Singapore-based company named Santego he seems to control. And though the Ramasamys declined O’Sullivan’s bid, he kept in contact with them and submitted another offer at the end of 2014, they said. The brothers turned down that one, too.

But O’Sullivan shifted gears in December 2014, according to the Ramasamys’ suit: He tried to arrange for Wirecard to invest in Great India Technology by introducing the brothers to Wirecard COO Marsalek, they said. The complaint has further alleged that O’Sullivan described Wirecard to Ramu Ramasamy as his “German partners” and told the brothers he was aware of Wirecard’s strategic deliberations as well as its management’s willingness to move rapidly to close a deal.

In October 2015 Wirecard invested 14 million euros in Great India Technology, amounting to 56 percent of its privately held shares. Separately, O’Sullivan paid 1 million euros to purchase his own 5 percent stake. Per the Ramasamy’s lawsuit, the entity that he used to purchase and hold his 5 percent investment in Great India Technology was Emerging Markets Investment Fund 1A, a Mauritius-based fund.

That same Emerging Markets Investment Fund 1A had in September 2015 paid the Ramasamys about 37 million euros to purchase Hermes Tickets. Yet six months later, the fund sold Hermes Tickets to Wirecard for 230 million euros up front, with 110 million euros in performance bonuses delivered over three years; the total price amounted to 340 million euros. In a press release and its corporate filings, Wirecard discussed its Hermes Tickets purchase at length — but without mentioning the seller, Emerging Markets Investment Fund 1A.

Wirecard has denied the Ramasamys’ allegations that it misled the brothers or collaborated with O’Sullivan. Angela Liu, an attorney at London law firm Herbert Smith Freehills who represents Wirecard, said via email, “Wirecard wholly rejects the allegations made against it by [Great India Retail.] Wirecard considers that the lawsuit has no merit and will be defending it in full.”

Liu added, “Wirecard is not aware of any role of Mr. James Henry O’Sullivan in Wirecard’s acquisition of Hermes; he did not receive any compensation from Wirecard.”

But a detail that just surfaced as result of the lawsuit’s filing might prove very damaging to Wirecard: Page 24 of Ramu Ramasamy’s affidavit submitted to the court on April 1 clearly suggested that O’Sullivan (Defendant No. 4) was either the owner or agent of Emerging Markets Investment Fund 1A (Defendant No. 3). Moreover, Ramasamy’s affidavit described O’Sullivan as having played an active role in negotiating the fund’s Hermes Tickets purchase and its two-month-later resale to Wirecard. (The fund is also a defendant in the Ramasamys’ lawsuit.)

Indeed the Ramasamys’ lawsuit has claimed that O’Sullivan used Emerging Markets Investment Fund 1A to purchase Hermes Tickets as well the 5 percent stake in Great India Technology — and to subsequently resell them to Wirecard for a substantial multiple of their original prices.

So what’s the risk to Wirecard from its Hermes Tickets deal being examined in court? Should the Ramasamys prove that O’Sullivan is an owner of Emerging Market Investment Fund 1A, a host of questions would be raised about possible improper sales practices by Wirecard. And where did that handsome sum of 340 million euros paid by Wirecard go?

While O’Sullivan might not be the sole owner of Emerging Markets Investment Fund 1A’s shares, he could not use it to buy and sell assets unless he was either a sizable stakeholder or had been given power of attorney by someone who is.

Singaporean prosecutors have stated they are investigating Hermes Tickets and Great India Technology for their possible role in Wirecard’s alleged accounting scheme. And while the prosecutors’ March 8 filing did not mention Emerging Markets Investment Fund 1A, they did name one of the fund’s key investments, Orbit Corporate & Leisure Travels, as an additional so-called transactional party potentially involved with dubious sales. (To date, the fund has invested in four companies: Great India Technology,  Hermes Tickets, Orbit Corporate & Leisure Travels, and Goomo, a consumer-focused company with a travel-booking platform that was spun off in March 2017 from Orbit.)

Though the Ramasamy brothers are seeking about 51 million euros in damages from Wirecard and the other defendants, they also greatly want information. Ramu Ramasamy’s affidavit asked the judge to compel Wirecard to disclose the particulars of its relationship with Emerging Markets Investment Fund 1A and for the fund to identify all of its equity ownership.

When queried if Wirecard knew of O’Sullivan’s efforts to buy Hermes Tickets and about his alleged stake in Emerging Markets Investment Fund 1A, Liu replied, “Wirecard was not aware of any attempt by Mr. O’Sullivan to buy Hermes in 2014 nor does Wirecard have any information that Mr. O’Sullivan is or was a shareholder of EMIF1A.” She said, “As evidenced by the share registry, Mr. O’Sullivan never was nor is the owner of 5% of the shares in GIT,” referring to Great India Technology.

Liu also acknowledged that O’Sullivan has had a longstanding relationship with Wirecard. “Mr. O’Sullivan has been in contact with a multitude of employees at Wirecard for many years; discussing a variety of subject matters, including joint customers and customer projects.”

The incredible disappearing act of O’Sullivan

O’Sullivan’s success as an operator in the digital payments sector can be attributed both to the web of connections he made in the early stages of his career as well as his aforementioned practice of keeping a low profile.

Nonetheless, O’Sullivan’s name crops up in some sparse British regulatory filings for a series of now-shuttered companies that used to be based in the tax and regulatory haven of the Isle of Man — all linked to David Vanrenen, a South Africa-born digital payment entrepreneur. One of the initial developers of what became known as the digital wallet, Vanrenen (like O’Sullivan until recently) lives in Monaco; Vanrenen’s son Daniel may have introduced O’Sullivan to him. (Visa just purchased Earthport, a cross-border payment services company that Vanrenen co-founded in the late 1990s, for $320 million.)

Starting in 2002 O’Sullivan served as chief executive of one of Vanrenen’s companies, Waltech Limited, and as a director of four of its subsidiaries. And Vanrenen’s Walpay became a leading payment processor for high-risk operators in the often shadowy but legal industries that Wirecard has long served ― ones offering pornography, internet gambling, currency exchange and binary options.

According to Bloomberg, O’Sullivan was the chief technology officer of another Isle of Man–domiciled company, Pay 2 Limited; this prepaid card issuer claimed prior to its 2009 dissolution that it processed 50 million pounds a month in transactions. One of O’Sullivan’s colleagues at Pay 2 Limited, its former financial controller Peter Stenslunde, is now executive director of Wirecard South Africa.

More recently, however, O’Sullivan has adopted a new modus operandi: He seems to have stepped away from daily corporate management duties for the most part. And in what appears to be an attempt to remove all public traces of his business ties, O’Sullivan began (especially after October 2015) using representatives to stand in for him on some corporate boards or as a company’s registered owner (so that their names not his appear in public filings).

Vanishing from Bijlipay Asia

A good example of O’Sullivan’s muted business presence can be observed with Bijlipay Asia Ltd., a holding company that began its life as a Vanrenen-controlled entity called Waltech Asia Pte. Ltd. but changed its name in 2009 after its registration in Singapore. From Jan. 12, 2009, until Oct. 28, 2015 — the day after the Great India Technology deal became final — O’Sullivan served as a director of the company. (Roy Harding, a longtime colleague of O’Sullivan from his days at Waltech Limited, departed from Bijlipay Asia’s board at the same time. Also a director of O’Sullivan’s holding company Caireen SARL, Harding resigned from its board on March 31, 2017.)

Although O’Sullivan is no longer on Bijlipay Asia’s board, his proxy is almost certainly 53-year-old Ricky Raymund Misson, who resides in Singapore. Referring to himself as audiovisual consultant and a former staff sergeant with the Singapore Armed Forces’ special operations group, Misson has an unusual résumé for someone now running several enterprises involved with multinational digital payment services.

Misson’s name appears in the database of Singapore’s Accounting and Corporate Regulatory Authority as the principal owner of four companies: Bijlipay Asia, Misson Pte. Ltd., Africa Card Services Pte. Ltd. and Santego Capital Pte. Ltd.

Bijlipay and Africa Card Services are engaged in aspects of digital payment services. Records indicate Misson Pte. Ltd. is the entity Misson relies on to manage his audiovisual consulting business. And Santego Capital is probably the holding company that the Ramasamys have alleged O’Sullivan used in early 2014 (as mentioned above) for his first Hermes Tickets bid. (The Ramasamys’ lawsuit referred to “Santego Business Corporation,” but no company with that name is listed in Singapore’s corporate registry. An individual involved in the litigation told the Southern Investigative Reporting Foundation that Ramu Ramasamy substituted “business” for “capital” when filing his affidavit.)

Misson’s Bijlipay is Wirecard’s oldest publicly disclosed customer in the Asia-Pacific region. (Its holding company Bijlipay Asia owns 95 percent of Skilworth Technologies Private Limited, a Chennai-based payments company that possesses the trademark for the Bijlipay mobile point-of-sale machine marketed in India. Another former colleague of O’Sullivan, Timothy William Johnstone, sits on Skilworth’s board.)

The Southern Investigative Reporting Foundation obtained dozens of Wirecard emails and documents referring to Bijlipay, but none mentioned Misson.

Yet, internal Wirecard documents and emails indicate that O’Sullivan is well-known to key executives in Wirecard’s Singapore office and that they clearly understand he controls Bijlipay.

For example, a Nov. 15, 2017, email thread between Wirecard Asia’s executive director, Fook Sun Ng, and Wirecard Asia financial staff (including finance director Edo Kurniawan) discussed Bijlipay’s 3.71 million euro debt to Wirecard so that Ng could then discuss the matter that evening with O’Sullivan.

A May 2018 report by law firm Rajah & Tann put Bijlipay at the center of a fraudulent accounting scheme and claimed that three years’ worth of sales and purchase agreements between Bijlipay and Wirecard’s Indonesian office were fake. (Wirecard hired Rajah & Tann in April 2018 to examine the claims of a Singapore-based whistleblower alleging that the company’s executives had committed widespread accounting fraud.)

In their March court filing, the Singaporean prosecutors named Ng, Kurniawan and four other Wirecard Asia employees as suspects in a series of potentially “arrestable offenses” in the Wirecard accounting case.

Misson did not reply to several emails from the Southern Investigative Reporting Foundation seeking comment.

Bijlipay’s CEO, Pradeep Oommen, did not respond to an email with several questions from the Southern Investigative Reporting Foundation.

And when asked about Bijlipay’s importance to Wirecard, attorney Liu said Bijilpay had contributed less than 1 million euros to Wirecard’s revenue in 2018.

Wirecard, according to its internal documents, might not realize lot of revenue from Bijlipay but it has instead contributed plenty of headaches. For example, in May 2017 Wirecard’s supervisory board wanted to see the “business case” (a standard internal assessment of probable profit and loss made by a bank before closing a commercial loan), for the $10 million loan Wirecard had granted Bijlipay in 2014. When it dawned on a group of finance executives that they had not created one, merger and acquisition manager Lars Rastede remarked in astonishment via email, “Did nobody perform a cost/income calculation before jumping into the Bijli project financed by $10 million?”

Reworking the helm at Internal Techno Solutions

Another company that succeeded (at least formally) in jettisoning the O’Sullivan name from its management and ownership structure is International Techno Solutions Pte. Ltd. Originally launched in 2003 as Walpay Asia Ltd. and based on the Isle of Man, the company in 2008 adopted the name International Techno Solutions Pte. Ltd. after registering in Singapore. O’Sullivan served on International Techno Solutions’ board from October 2008 to October 2010 and as its owner until May 2014.

This spring Singaporean prosecutors included the company as one of the cited transactional parties in their ongoing investigation of Wirecard’s accounting and sales practices.

A year before prosecutors became concerned about International Techno Solutions, Rajah & Tann had flagged as problematic a series of transactions between the company and Wirecard’s Indonesia office.

In May Singapore authorities revoked International Techno Solution’s registration in a move known as “striking off.”

The many faces of Senjo

One of the few entities O’Sullivan can still be directly connected to is Caireen SARL, a Luxembourg holding company that, in turn, owns Senjo Payments Europe SA. The latter company’s name, however, bears a remarkable similarity to that of Senjo Group Private Ltd., a Singapore-based payments company and financial technology investor described by the Financial Times in April as one of Wirecard’s three biggest customers.

Although Wirecard called this estimate inaccurate — and in May sued the paper in a German court for “making use of and misrepresenting business secrets,” according to Reuters — internal company emails from 2016 and 2017 supported the Financial Times’ reporting.

And the Ramasamys’ complaint listed O’Sullivan’s address as in “care of Senjo” at #56, One Raffles Place, the former address of Senjo Group’s Singapore headquarters.

Abigail Peters, an outside public relations adviser for Senjo Group, denied that O’Sullivan’s Senjo Payments Europe is connected to her client. In an email, Peters wrote, “No entity called ‘Senjo Europe’ or ‘Senjo Payments Europe’ has ever been part of Senjo Group.”

Peters did not directly address a question about whether O’Sullivan is a Senjo Group owner, but stated, “James Henry O’Sullivan has provided Senjo Group with consultancy services on market and investment opportunities. In that regard we have mutual confidentiality obligations with Mr. O’Sullivan. We are aware that Senjo’s relationship with Mr. O’Sullivan is not exclusive.”

But Senjo Group is closely linked to two key entities cited in either the Rajah & Tann or the Singaporean prosecutors’ reports: In a November 2017 press release, Senjo Group described as its “assets” (or investments) both Bijlipay and Mindlogicx, a Bangalore, India–based payments company.

During a January 2018 CNBC Asia interview when COO Gavin Lock was asked for details about Senjo Group, he said his company was “founded in 2016” by a “group of successful e-payment and corporate finance executives.” That skimpy overview of the organization’s labyrinthine history omitted, however, the critical role Wirecard played in funding and managing it.

What is now called Senjo Group opened its doors in March 2006 as E-Credit Plus Pte. Ltd. in Singapore. By September 2007 Wirecard executives (including COO Marsalek) were among the listed officers of E-Credit Plus’ British subsidiary E-Credence UK Limited. On Dec. 28, 2009, Wirecard purchased E-Credit Plus for 12.8 million euros, a rather steep price for a company with just 380,000 euros in revenue that year. The company was eventually renamed Wirecard Asia Pte. Ltd. and remained based in Singapore; it formed the basis for Wirecard’s rapid expansion in the Asia-Pacific region.

Discussing a move that that brings to mind the round-trip accounting charge being investigated by the Singaporean prosecutors, Wirecard disclosed in its 2014 annual report that it had “deconsolidated” Wirecard Asia Pte. Ltd. (of Singapore) so as “to optimize its organizational structure.” In other words, five years after Wirecard had initially purchased this division from E-Credit Plus, Wirecard sold it to Senjo Group’s first two listed officers: Senjo Group’s current general manager, Christopher Eddie, and its head of commerce, Yoshio Tomiie. Wirecard received a net payment of 100,000 euros for the company. (Wirecard today does maintain a division called Wirecard Asia.)

In February 2017 Tomiie sold the holding company that held his Senjo Group stake (called YO54 Holdings Pte. Ltd.) to Surajpal Singh, a real estate investor from Singapore, and Richard Willett, a 79-year-old horse breeder and wealthy retired Canadian entrepreneur who now lives on a ranch in Montana.

The Willett family’s interest in Senjo Group is managed by Willett’s son Oliver, who directs investments for Les Gantiers Limited, the Willett family’s office. Based in Monaco, Oliver Willett enjoys a close professional relationship with O’Sullivan. The two collaborated in 2014 and 2015 when O’Sullivan negotiated the Hermes Tickets and Great India Technology transactions.

Senjo Group gave the barest of replies to questions from the Southern Investigative Reporting Foundation and did not reply to a follow-up email seeking clarification on O’Sullivan’s ownership ties.

Richard and Oliver Willett did not reply to emails and phone calls seeking comment for this article.

Multiple phone calls to a contact number for James Henry O’Sullivan did not result in a response.

Ramu Ramasamy also did not reply to requests for comment.

Wirecard’s full set of responses still leaves O’Sullivan’s role a great mystery.

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The Pity of Wirecard, Part I: Oliver’s Army

SINGAPORE — Few companies can explain their meteoric growth as alluringly as Wirecard AG.

According to one of its preferred narratives, Wirecard presents itself as Europe’s leading financial technology innovator, a globe-spanning developer of white label code and applications that companies can use to help build their own online payment systems.

In Wirecard’s telling, its software removes the friction from electronic payments for both merchants and consumers. And in another narrative, it is a nimble bank, steadily generating low-risk revenue through the sale of integrated banking and credit-card processing services to businesses, and prepaid credit cards to consumers.

To date, investors have found the prospect of owning shares in a company that is simultaneously driving a technological shift in consumer behavior while growing profits irresistible. Last September, Wirecard entered the German corporate establishment when it displaced Commerzbank for inclusion alongside the likes of BMW and Bayer on the blue-chip DAX index, a closely followed roster of 30 of Germany’s biggest companies.

By late January, Wirecard’s market capitalization was almost 24.6 billion euros.

And on Jan. 30 that all changed, perhaps forever.

That’s the day the Financial Times published an exposé detailing a Singaporean law firm’s investigation of a host of alleged accounting irregularities in Wirecard’s Asian operations, and its stock price was pummeled. A German regulatory intervention that banned short selling of Wirecard’s shares through April 18 (a clear indication that the company’s tale of a short seller conspiracy had found some official support) did stabilize the stock price, but not before 10.6 billion euros of market capitalization were erased.

A close read of the May 2018 preliminary findings of the Singaporean law firm, named Rajah & Tann, suggests that a significant percentage of Wirecard’s success in the Asia-Pacific region — the most striking component of its growth story for the past three years — may be attributable to dubious transactions that inflated both the balance sheet and income statement. (On April 18, Wirecard, through London law firm Herbert Smith Freehills LP demanded that the Southern Investigative Reporting Foundation remove from this article a link to a document with the Singaporean law firm’s findings, arguing it does not represent a formally concluded investigation and that its publication represents a breach of the expectation of attorney-client privilege.)

On March 26, Wirecard released a statement on the Rajah & Tann report that concluded the suspect transactions would not have a material financial effect on the company’s 2018 results. It did acknowledge that “a few local employees” in Singapore might have unspecified “criminal liability” under that country’s law but no specifics were provided.

Documents obtained by the Southern Investigative Reporting Foundation show that Wirecard’s Asian success story is just that — a tale or myth fed to investors designed to propel the share price ever higher. The only thing that was keeping Wirecard’s regional operations from being exposed as a financial black hole was a single unit that Wirecard desperately wanted to keep concealed.


Meet CardSystems Middle East FZ LLC, a tiny, Dubai-based entity with a long name on Wirecard’s ever-expanding organizational chart. Don’t waste time looking for information on CardSystems in Wirecard filings. Apart from a few very brief mentions in annual reports, there’s no other reference by Wirecard.

CardSystems built a complex ecosystem of payment processors and banks that economically girds a series of gambling, adult entertainment and dating or companionship websites whose content is problematic enough that Wirecard decided it can’t have its name associated with them (even though it has a well-established track record of working with such content).

Moral and reputational concerns aside, any business that can succeed only when its core operation is hidden behind a daisy chain of lightly regulated banks and shell companies is probably going to cause investors a migraine one day.

Wirecard’s management has not been forthright about where its rapid earnings growth has come from. As recently as March 29 the company was telling investors that porn and gambling represented about 10 percent of its total transactions.

If Wirecard were to drop this line of business, then more than one-third of its operating profit would go out the door. This is a fact that Wirecard CEO Markus Braun does not touch upon when he makes speeches about the importance of optimism to Europe’s digital business community.

CardSystems essentially functions as a veiled middleman, linking various pornographic and gambling content providers to a network of payment processors and so called acquiring banks. Many of the payment processors operate behind a series of fake websites of the sort described in a June 2017 Reuters investigation.

(A brief aside: Deutsche Payment, one such payment processor that used a network of fake websites to mask illegal offshore gambling transactions, appears to have been controlled by Wirecard, which owned its trademark. According to the Internet Archive, for many years the Deutsche Payment website redirected visitors to Wirecard Austria’s site. Wirecard did not disclose the corporate connection but removed the Deutsche Payment link from its website shortly after the Reuters article was published.)

In return for this matchmaking, CardSystems receives an agreed-upon cut of the payment processing fee.

With this network in place, Wirecard can maintain a legal and reputational distance from what executives in its Alscheim, Germany, headquarters call “emotional content,” apparently referring to the gambling and porn operations.

(Although many institutional investors won’t relish being even indirectly exposed to porn and gambling, processing payments for this type of subject matter is perfectly legal in many countries.)

CardSystems’ internal financial projections for 2018, obtained by the Southern Investigative Reporting Foundation, reveal it was expected to generate sales of 450 million to 500 million euros, and earnings before interest, taxes, depreciation and amortization (or EBITDA) were slated to be an eye-popping 200 million euros. (EBITDA is a frequently cited and controversial yardstick for profitability that leaves out capital expansion and financing costs.)

Based on Wirecard’s 2018 preliminary results, CardSystems may have contributed about 22 percent of the company’s revenue and almost 35 percent of EBITDA. (Wirecard executives familiar with the unit’s performance of last year said they believed that it met or slightly exceeded these targets.)

Still, that’s tiddlywinks compared with what CardSystems meant to Wirecard in 2017,  since, according to the Federal Gazette publication of Germany’s Ministry of Justice and Consumer Protection, CardSystems accounted for 126.7 million euros or slightly less than 50 percent of Wirecard’s net income.

For all its impressive sales and profits, CardSystems is practically a one-person operation. It’s the brainchild of longtime Wirecard veteran Oliver Bellenhaus, who runs it out of his home office in what is currently the world’s tallest building, the 200-story Burj Khalifa in Dubai.

Nailing down a specific number of CardSystem employees proved difficult for the Southern Investigative Reporting Foundation. Probably fewer than a dozen employees are dedicated to the unit’s business, according to current and former Wirecard officials who spoke on the condition of anonymity out of fear of litigation.

CardSystems is a gold mine for Wirecard but its structure should check almost every box on a list of things guaranteed to raise an auditor’s hackles. The first issue is the size of its revenue relative to the small size of its workforce, a disparity especially pronounced given the sheer size of CardSystem’s business. In order to have its accounts pass muster with auditors, Wirecard officials classified about 60 Dubai-based company employees as assigned to CardSystems, but in reality they were on the company’s books at a different subsidiary.

Bellenhaus has complete operational control over CardSystems and has managed to keep a few banks, primarily ones located in Eastern Europe, engaged in his referral network. This is no mean feat since most established acquiring banks have stopped processing payments connected to porn websites, given the industry’s high charge-back rates. Apart from a stray press release issued in 2010, just about the only place the 45-year-old Bellenhaus is publicly quoted or referenced is on the websites of a Latvian bank and a Vilnius law firm.

(Charge-backs differ from traditional refund claims in that they involve a consumer’s essentially going over a merchant’s head and asking his or her bank to forcibly remove funds from a business’s bank account. When they are processed often enough, the time and expense involved rapidly begin to wipe out profitability for the acquiring bank.)

Bellenhaus did not reply to an email seeking comment. And in response to a question about CardSystems’ staffing levels, Wirecard spokeswoman Iris Stoeckl disputed that the unit’s head count is small, stating that 200 sales and tech staffers work at its Middle East and North Africa hub. She did not directly address a question about CardSystems’ virtual absence from company filings other than to note, “[Wirecard] cannot disclose any additional figures beside the figures disclosed in our annual audited report.”

There’s little evidence that Wirecard’s profile in the internet’s darker corners is diminishing. Consider the recent YouTube video on which Alexis D. Vyne, a transgender adult entertainer and film actor, shows how the company processes payments for, a Canadian website popular with individuals seeking escorts and sexual services. (Over the past several months, ads placed on LeoList were linked to four human trafficking arrests in the Greater Toronto area.)

Bringing CardSystems into the daylight ought to prompt some pointed questions from investors, and one of the first orders of business should be establishing how much business is really being done by that company for Wirecard.

Some basic extrapolation suggests that without the profits from CardSystems, Wirecard’s regional income statement would be awash in red ink.

In 2017 Wirecard’s annual report stated Asia-Pacific sales and EBITDA were, respectively, 619.2 million euros and 153.4 million euros. Recall that CardSystems’ results are included within Asia-Pacific results, however. Thus, when CardSystems’ sales of 450 million euros and EBITDA of 175 million euros are deducted, Wirecard’s Asia-Pacific sales clearly lost money in 2017.

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Wirecard AG: Something Is Terribly Wrong Here

After the Financial Times published a pair of whistleblower-driven exposés that suggested some of Wirecard’s parabolic growth in the Asia-Pacific region resulted from a purported multiyear revenue inflation scheme, anyone wanting to understand the kettle the German payments company finds itself boiling in would do well to adopt the timeless journalistic maxim “follow the money.”

But where to start?

India would be a good initial place.

According to a March 11 court filing by Singaporean prosecutors, three “transactional parties” involved in questionable deals (including two Wirecard subsidiaries) are located in India. (Singapore is both the headquarters for Wirecard’s Asia-Pacific region and where the FT reported the alleged scheme had been launched.)

The prosecutors’ filing is a response to Wirecard’s motion in the high court that sought to limit the scope of the Singapore police’s commercial affairs department investigation and secure the return of computers and files taken in raids on Feb. 8, Feb. 20 and March 5. (The high court rejected Wirecard’s motion for “a lack of legal basis” but noted that the company may still appeal the decision, according to The Straits Times.)

The companies that Singaporean prosecutors are interested in — Hermes Tickets I, Great Indian Technology and Orbit Corporate & Leisure Travels — were first flagged as suspicious by the Southern Investigative Reporting Foundation’s investigation last year of Wirecard’s October 2015 purchase (for 230 million euros) of a hodgepodge of small, privately held payments and e-commerce companies called Great Indian Retail, based in India. Wirecard paid an additional 110 million euros in earnout payments through 2017.

Additional documents recently filed in India by Star Destination Management — the parent of Star Global Currency Exchange, a kiosk-based currency exchange company purchased by Wirecard — strongly suggest that the prosecutors need not go beyond India to establish that the Great Indian Retail deal stinks to high heaven.

Nothing about the deal is close to adding up.

Consider Star Destination Management’s 2016 annual report, which gives no indication that it sold its core revenue-generating asset in February 2016. Whatever else happened that year, kiosk ticket sales clearly were not too robust, and as of March 31, 2016, the company reported a loss of a little under 25,200 euros. Although Star Global Currency’s purchase price was not disclosed, the modest scale of its operations is seen in the Department of Industrial Policy and Promotion‘s foreign direct investment circular where Wirecard’s 1.45 million euro capital injection is disclosed.

Star Destination’s filings offer documentary proof that the Indian sellers of these companies have received only a fraction of the 340 million euros that Wirecard spent. In any quest to follow the money, it’s important to know where the money is not.

(Wirecard, through its outside spokesman Charles Palmer of FTI Consulting, said in an emailed comment that the company had no business relationship with Star Destination Management.)

Recall that using both corporate and governmental filings, the Southern Investigative Reporting Foundation’s reporting showed that what Wirecard purchased, Hermes Tickets I and the 60 percent stake in Great Indian Technology, cost a total of 52.36 million euros — 37.36 million and 15 million, respectively.

The gap between the 230 million euros Wirecard spent buying these companies and the 52.36 million that is observable in corporate or regulatory filings is a handsome 177.6 million euros — all before another 110 million euros was paid out to the sellers for meeting agreed-upon performance targets.

And to be sure, Wirecard’s disclosures of its cash outflows from investment activity — the section of the annual report listing what the company has paid to acquire companies or assets — in the years 2015 to 2017 indicate 340 million left its coffers.

So where did the 287.6 million euros go?

All signs point to Mauritius-based Emerging Markets Investment Fund 1A, an entity with no discernible beneficial owner that’s acted as an intermediary between the sellers of Star Global Currency and Great Indian Retail, and Wirecard. Its distinguishing characteristic is its ability to get Wirecard to buy assets for multiples of what it paid just weeks prior.

(Asked whether the prices it paid for these assets were in the best interests of shareholders, Wirecard replied via email, “The acquired asset’s valuation ultimately reflects the growth potential of the Indian payments industry and the company’s unique position in the Indian market.”)

What few details there are about Emerging Markets Investment Fund 1A’s existence serve to raise further questions.

For example, it shares the identical physical address of Emerging India Fund Management, a Trident Trust administered fund in Mauritius, a jurisdiction with minimal disclosure requirements. Additionally, an email address for Emerging Markets Investment Fund 1A found on Great Indian Technology’s private-placement document tracked back to Emerging India Fund Management. Numerous calls to Trident Trust were not returned.

Furthermore, a circular series of connections link Emerging India, Emerging Markets Investment Fund 1A and Wirecard.

(Asked about Wirecard’s relationship to Emerging Markets Investment Fund 1A, FTI’s Palmer said that the company has no “economic interest” in the fund and declined to comment additionally, given the rules limited partnerships impose on disclosure.)

Emerging India, according to press accounts, has invested $180 million in two private equity transactions: Orbit Corporate & Leisure Travels, an agency specializing in trade shows and professional conferences, and Goomo, a consumer-focused company with a travel-booking platform that emerged last March from Orbit.

Orbit’s March 31, 2016, shareholder list indicated that Emerging Markets Investment Fund 1A owned 93 percent of its shares. Goomo’s Nov. 11, 2016, Memorandum & Articles of Association listed the Emerging Markets Investment Fund 1A as its primary shareholder; a credit report for Goomo’s Singapore subsidiary recorded the fund as its owner.

One of Orbit’s two listed directors, Ramesh Balasundaram, founded and sold Star Global Currency to Wirecard. Additionally, Orbit’s shareholder list describes the company as “a joint venture with Star Group of Companies,” a reference to Star Global Currency and Star Destination. Just before Wirecard bought Hermes Tickets, according to the notes of a Sept. 12, 2015 shareholder meeting, the company was negotiating to sell its travel related business to Orbit. Just five days later however, Great Indian Retail’s owners began to sell shares of Hermes Tickets to Emerging Markets Investment Fund 1A.

A January 2018 lawsuit filed in England by Hermes Tickets’ minority shareholders claims that IIFL Wealth Management UK, a unit of Indian financial services conglomerate IIFL Holdings, advised Emerging Markets Investment Fund 1A in its purchase of their shares. The suit alleges that Amit Shah, a banker for IIFL Wealth Management UK, told the plaintiffs in a phone call that IIFL established Emerging Markets Investment Fund 1A and had raised money for it.

IIFL, for its part, argued in an April 2018 response that IIFL Wealth UK had nothing to do with the transaction and Shah’s only role was as “a go between who was a mutual acquaintance of both the claimants’ representatives and Emerging Markets Investment Fund 1A.” It said that Shah had no recollection of making statements about Emerging Markets Investment Fund 1A.

Amit Shah was unable to be reached for comment. According to a press release on Feb. 6, IIFL Wealth UK said that Shah had resigned for “personal reasons.”

(Wirecard is not named in this litigation.)

A recent claim filed in the Indian state of Tamil Nadu, apparently made on behalf of an unidentified Great India Retail minority investor, does name Wirecard and its chief operating officer Jan Marsalek, as well as the Emerging Markets Investment Fund 1A and  Goomo/Orbit as defendants. It appears to be one of several similar claims and while the document was not available online, the court’s web portal says that a hearing to discuss a settlement is already scheduled.

Notably, a “James Henry O’Sullivan, c/o Senjo Group” is also listed as a defendant.

O’Sullivan has several connections to Wirecard, including a stint as a director at WalPay UK Ltd., a payments company that at some point in 2012 appears to have moved to Singapore and become WalPay Asia Ltd., and is now known as International Techno Solutions PTE.

In the March 11 filing discussed above, Singaporean prosecutors named International Techno Solutions as one of the “transactional parties” doing business with Wirecard and a subject of their investigation.

Another link between James Henry O’Sullivan and Wirecard comes via Senjo Payments Europe, which he owns through Caireen SARL, a Luxembourg-based holding company. In June 2017, Wirecard’s Bank registered a lien in Singapore for the 25 million euro loan it made to Senjo Group, and that it used in financing its $30.3 million purchase of Kalixa Group, a rival payment processor.

See the full text of Wirecard’s answers to questions from the Southern Investigative Reporting Foundation.

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Newton Glassman and Other People’s Money

Things are not going well for Newton Glassman.

Southern Investigative Reporting Foundation readers will recall Glassman was the subject of a lengthy exposé in April that detailed the many ways his direction of Catalyst Capital Group Inc., a Toronto-based private equity fund with $4.3 billion in capital commitments, and its sister company Callidus Capital Corp. should alarm both investors and regulators.

Specifically, the reporting illuminated the risk Catalyst’s limited partners face because of the fund’s continually growing exposure to Callidus — a lender to distressed companies the fund bought in 2007 and took public in 2014 — whose performance has been disastrous. If that wasn’t bad enough, Glassman directed the fund’s plunge into a series of costly and reputation-threatening lawsuits against a host of purported enemies.

On both fronts, things have gotten worse.

Callidus is kept alive only because Glassman has repeatedly violated one of the cardinal tenets of investing: Don’t throw good money after bad.

But the bigger questions for the limited partners who invested in Catalyst’s funds is how are they going to get all of their money back — especially if Catalyst can’t sell its holdings?


Catalyst’s specialty is what’s known as distressed investing. In a nutshell this is how it’s supposed to work: Glassman raises money from pension funds or endowments and then seeks to buy either the stock or debt of a company that’s hit some kind of rough patch and thus available cheaply, on the view that with some capital, better strategy or new leadership, the business turns around. (The “turnaround” part is key because private equity funds, unlike hedge funds, don’t offer regular redemptions to their limited partners, and so are set up with an eight- to 10-year lifespan.)

So when an opportunity presents itself, the fund looks to monetize their investment and sell it via an initial public offering — or to another company — for a windfall with most of the profits flowing to its LPs. But of the billions of dollars Glassman has raised in Catalyst’s five funds, only the first has since cashed out, back in 2013. The second fund was supposed to have cashed out more than four years ago in the spring of 2014. But Catalyst has repeatedly extended the deadline, and it’s now due to conclude in the fall of next year, just before its third fund is slated to cash out.

So why is Glassman not paying back LPs, some of whom are among the most prominent institutional investors in the US and Canada?

The answer appears simple: He doesn’t have the money because — at least in the case of Funds II and III — it’s been sunk into a series of investments whose performance has often been nothing short of brutal.

The mess starts with Catalyst’s 72.2 percent ownership stake in Callidus, a block amounting to almost 41.25 million shares, primarily concentrated in Funds III and IV, with 24.8 and 10.8 million shares, respectively; Fund II has 4.7 million.

Callidus’ loan book is geared towards mid-sized companies and at the end of September was valued at CA$1.1 billion. But as last April’s Southern Investigative Reporting Foundation investigation revealed, many of these loans have turned sour.

Indeed, through the first three quarters of the year Callidus has racked up CA$68.2 million in losses, while its stock tumbled to new lows, to CA$1.36 from CA$10.30 at the beginning of the year. Marked to market, this one position has cost Catalyst just under CA$369 million on paper, or about 8.6 percent.

And it’s a safe bet that Callidus’ losses will continue, helped along mightily by the mysterious CA$201 million loan extended to Horizontal Well Drillers, an Oklahoma-based oil drilling contractor that made news in September 2016 when Venezuela’s state oil company announced Horizontal was awarded a license to drill up to 191 wells – a contract purportedly worth nearly $1.3 billion. Inexplicably, this loan was made despite Horizontal’s lack of experience in working on projects of that size and scope.

Moreover, as noted in April, Venezuela’s ongoing economic collapse and political collapse has forced even the largest multinational oil exploration companies to cease operations there.

Against this backdrop, it’s not clear what, if anything, the loan was used for. It appears Horizontal has not begun drilling any wells. Nor, given its new high profile, has the company obtained any other big contracts. More simply, it’s an open question why, if the Venezuela project isn’t currently feasible, any unused funds haven’t been returned.

(Oddly, the news tab on Horizontal’s website lists only two items: a 3-year-old announcement about a new “information management” system and a press release from four years ago about the new website. There is no mention of Venezuela.)

Accordingly, Callidus wrote down the loan’s value to CA$78.6 million in the fourth quarter of last year. A call to Horizontal’s headquarters was not returned.

While loans like that to Horizontal Well Drillers stand apart, the sheer density of bad loans on Callidus’ books — the company has been forced to assume control of at least 13 borrowers — often requires Catalyst to ride to the rescue.

Through Sept. 30 CA$112 million of Catalyst LP cash had been either loaned or guaranteed in the hopes of stabilizing Callidus and, according to a trio of disclosures posted April 30, a lot more of their money will be headed that way.

For example, this filing suggests Sun Life Assurance Company of Canada (Callidus’ senior lender since 2014) was unhappy about Callidus’ request to again defer the repayment of a CA$50 million loan. In return for perhaps not calling its loan – thereby triggering a “going concern” warning from Callidus’ auditors – Catalyst guaranteed the loan while also agreeing to pay $15.5-million of it by early next year. As of Sept. 30, just under CA$8.5 million had been paid.

Additionally, the filings note how Catalyst is funding up to $150 million to cover a Callidus loan, which is likely the Horizontal Drill loan. Catalyst also agreed to extend up to $30 million to pay Callidus’ operating expenses.

Afterward, look at Callidus’ third-quarter interim financial report, where the mounting loan losses have left its shareholders with no tangible book value — or what’s left after the physical and marketable assets are sold and the liabilities paid off — the most common measurement of a company’s worth. As of Sept. 30, Callidus has a CA$40.9 million deficit.

Why does this paper deficit matter? In a bankruptcy, if a company’s current liabilities exceed its tangible assets, the subordinated lenders have to make up the difference by taking a so-called haircut, or accepting less than the amount they are owed.

Since Catalyst’s cash is Callidus’ sole lifeline, it’s a valid risk for the limited partners of Catalyst Fund’s III and IV, whose capital is behind the CA$377.2 million subordinated bridge lending facility. Moreover, the situation is bafflingly circular: Catalyst’s “advances” are how Callidus is paying the principal and interest on the subordinated loans owed to the fund. In the most recent interim management discussion and analysis Callidus reported that Catalyst has pledged to extend the maturity date of the loan for as long as necessary.

Meanwhile, language in that interim filing suggests that the Ontario Securities Commission is beginning to put a foot (lightly) down over the quality of Callidus’ financial reporting, and has placed the company on its refilings and errors list for the next three years. This list warns the public of companies that have either failed to disclose all material information or whose filings contained an inaccuracy. Additionally, the OSC made Callidus discontinue its references to yield enhancements, a term dreamed up to make impaired loan write downs more palatable by claiming that they would be offset by the increases in borrower principal and interest payments.


All this bad news about Callidus couldn’t come at a worse time for Catalyst’s limited partners in Funds II and III, who are justifiably anxious about getting their money back. Catalyst Fund II, as shown in this New Jersey Division of Investment disclosure, has returned 45.1 percent of its initial CA$635 million of capital.

In a typical private-equity fund, the diversity of investments would likely provide enough cushion to help absorb the losses from a bet gone wrong like Callidus.

Catalyst is not the typical private-equity fund manager, however. In prior years Catalyst’s initial fund with CA$185 million in assets returned an average of 32 percent a year and he could note to the Wall Street Journal that he was the “[No. 1] distressed-debt manager in the world.” But it’s fair to say that the days of Glassman and his colleagues wielding a hot hand are long gone.

Catalyst Fund II is a case in point: Of its five remaining investments – in Therapure BioPharma, Callidus, Gateway Casinos & Entertainment, Sonar Entertainment and Natural Markets Food Group – two are deeply troubled (Callidus and, as Glassman noted in an August Globe and Mail article, Natural Markets), leaving only Therapure and Gateway with the potential to be sold in the near term.

Except the fund’s limited partners are learning that there’s a big difference between “potential” and “likely” when it comes to selling an investment, and an even bigger gulf between selling an investment and doing it profitably.

Consider Therapure BioPharma Inc., a core Fund II holding since 2006, and well on its way to being sold earlier this year to a joint-venture between 3SBio Inc., a China-based pharmaceutical company, and CPE Funds, a Chinese private equity fund, for $290 million.

But on May 1 the deal collapsed for unspecified reasons, and despite Catalyst’s assertions that its pursuing an IPO of Evolve Biologics, Therapure’s drug development arm, it’s anyone’s guess if the sale even occurs, let alone brings in the $100 million Glassman said he’s shooting for, according to the Globe and Mail article referenced above.

(It was the second time in three years that an attempt to sell Therapure failed. A February 2016 IPO was shelved after investors, wary of a then-choppy market and the income statement’s sea of red ink, apparently balked at the roughly CA$900 million valuation placed on the company.)

Gateway, held in Catalyst Funds II and III, is equally as speculative as Therapure and has a recent history that includes numerous failed efforts to sell it both publicly — in this case in 2012 — and to other casino companies. On Nov. 20, Catalyst filed the initial prospectus for its IPO.

All any diligent investor can conclude about Catalyst’s stewardship of the company since taking control in 2011 is that it’s a larger company, yet remains just as hamstrung from both its leverage and its longstanding inability to turn a profit — a problem its larger rival, Great Canadian Gaming, appears to have solved. Similarly, it’s unlikely they will be fooled by the CA$156 million profit Gateway has reported through Sept. 30, the result of a CA$192.3 million paper (noncash) profit booked from a one-time sale-leaseback transaction. Without it, Gateway would be well on its way to a loss of over CA$40 million this year.

Obtaining the right to operate casinos and slot machines in three Ontario region gaming “bundles” won’t be a magic bullet for Gateway either: a pro forma income statement incorporating the properties into its 2017 results shows an CA$18.7 million loss. To develop and improve them, according to the prospectus, will require Gateway to spend between CA$490 million and CA$530 million in capital expenditures over the next three years. This won’t be a light task for a balance sheet with a CA$908 million debt burden.

One thing to note is the humdinger of a related party transaction between Catalyst and Gateway involving the company’s purchase of CA$217 million in net operating losses from a bankrupt unit of Natural Markets Restaurant Corp., permitting Gateway to avoid the avoid making a cash tax payment this year on its paper profits.

Catalyst Fund III, scheduled to wind up next December, also has a portfolio that tries a limited partner’s soul. In addition to the aforementioned 24.8 million Callidus shares, and its half of the subordinated bridge facility (currently worth CA$188.6,) it owns at least three other struggling companies – Natural Markets Restaurant Corp., Advantage Rent-A-Car and Mobilicity.

The Advantage Rent-A-Car investment looks particularly painful. With roughly $310.5 million pumped into the company after buying it out of bankruptcy in April 2014, Catalyst’s sizable investment hasn’t helped Advantage strengthen its competitive position: Ranked by 2017 fleet size and revenues, the company is a distant fourth place behind Enterprise, Hertz and Avis, according to trade publication Auto Rental News.

A Reuters investigation published in March detailed how Catalyst’s Advantage valuation is extravagantly out of line with its publicly traded peers Avis and Hertz, whose market capitalizations are less than half of their revenues.

Assuming this yardstick remains valid, and using Auto Rental News’ estimate of 2017 revenues of $330 million, would imply an initial market value of less than $200 million for Advantage, making it another investment Catalyst won’t easily sell.


One of the most damaging revelations about Glassman’s activities didn’t actually involve investments, but rather the Aug. 15 Ontario Superior Court filing in which Black Cube — the notorious Israeli corporate intelligence outfit whose assignments have included working for film producer Harvey Weinstein to discredit women who alleged he had sexually assaulted them — admitted they were retained to work on Catalyst’s behalf on September 11, 2017.

(Black Cube was used by Catalyst to help improve its odds in its ongoing war with a Toronto hedge fund, West Face Capital, a fight that has launched four lawsuits and enriched lawyers on both sides of the border.)

Shortly after being retained, Black Cube launched a star-crossed sting operation against Justice Frank Newbould, a then-recently retired Ontario Superior Court judge who’d ruled against Catalyst in an important decision regarding the sale of WIND, a wireless carrier Glassman coveted but that West Face eventually landed. The sting was designed to tar him as biased and anti-Semitic prior to filing an appeal.

Ultimately, this backfired in a big way in November, 2017 when a National Post reporter — herself the target of a Black Cube-controlled operation — exposed the whole affair.

But who hired Black Cube? The answer is a bit complicated.

Catalyst, in its reply to West Face’s counterclaim, stated that in August 2017 its counsel hired Tamara Global Holdings Ltd., to provide personal and professional security to the fund’s employees, as well as litigation support. Tamara, in turn, hired Black Cube the following month (referred to in the counterclaim by its formal name: B.C. Strategy UK Ltd.) And who’s behind Tamara? Yosef “Yossi” Tanuri, a former Israeli special forces soldier better known in the Toronto area as the director general, Israel of the Jewish Federations of Canada. An email to Tanuri was not replied to.

All of which suggests a version of the late Sen. Howard Baker’s famous question during the Watergate hearings: “What did Glassman know and when did he know it?”

Catalyst attempts to thread a rather slim needle with its answer to that question.

The reply to West Face’s counterclaim said Catalyst’s principals had nothing to do with what West Face described as allegedly unlawful activity in its counterclaim. To further distance themselves from Black Cube’s widely condemned tactics, Catalyst argued that Black Cube was directed to use “[its] best professional judgement” in executing its litigation support duties. (Catalyst doesn’t describe what these duties were.)

What Catalyst’s filing doesn’t say is that Glassman and colleagues had no idea of Black Cube’s plans, both with respect to the attempted Newbould sting as well as the parallel effort to mislead the National Post’s Blatchford prior to the filing of its “Wolfpack” suit in November 8, 2017.

A strange footnote to the Black Cube drama is the collapse of PSY Group, a Cyprus-based, Israeli-directed intelligence services company that West Face’s court filings have claimed started defaming both the fund and Greg Boland through social media and blog posts last September, a charge that Catalyst has flatly denied.

West Face lawyers have requested that an Israeli court order that PSY Group’s hard drives be preserved, a motion Ontario Superior Court Justice Glenn Hainey endorsed. Both INVOP, the corporate shell that owned PSY Group, and Emmanuel Rosen, a controversial former Israeli TV journalist who West Face has alleged worked with PSY Group, have not responded to any claims and have had motions of default filed against them. On the other hand, Virginia Jamieson, a New York City-based former public relations executive who West Face alleged sought to get the National Post to write critically about Judge Newbould, has denied having anything to do with PSY Group or the purported Internet defamation campaign. She was unable to be reached by phone and her lawyer didn’t return a call seeking comment.

The animating spirit of Glassman’s furor towards West Face Capital is his 2014 defeat at the hands of West Face and a consortium of investors in a bid to buy WIND — a loss he alleges was brought about at least in part because Brandon Moyse, a former Catalyst junior analyst who worked briefly for West Face after his departure, provided proprietary information.

Unfortunately for Glassman, Judge Newbould bluntly rejected these claims in 2016. Earlier this year an appellate court took the unusual move of dismissing Catalyst’s appeal without even hearing from West Face’s lawyers. Since then, Catalyst has applied for leave to have the Supreme Court of Canada consider their appeal. If the Supreme Court declines or if it loses, Catalyst will forfeit a CA$1.3 million letter of credit, and may be assigned other costs.

A second Catalyst lawsuit against West Face and others, known as the Vimpelcom case after the Dutch telecommunications company that sold WIND to West Face, sought a whopping CA$1.5 billion in damages.

Like the Moyse litigation, it proved unsuccessful, with a judge dismissing it on April 18 after concluding Catalyst brought the case for a “second bite at the cherry,” meaning the fund was merely re-litigating the already unsuccessful Wind claim above. In fact, the judge said that at least as far as Catalyst’s lawsuit pertained to West Face, it was an “abuse of process.” Catalyst has filed an appeal.

This aggressive litigation strategy, while bringing no end to headaches for Glassman’s opponents, is poised to make a considerable dent to Catalyst’s bank account. In the Canadian legal tradition, the losing party in a civil trial is liable to bear at least some of the victor’s legal costs. On November 19, Justice Hainey ordered Catalyst to pay CA$1.6 million in costs to the defendants, describing its efforts as “an abusive attempt to re-litigate the same allegations.” (Catalyst sought to pay about CA$906,000 according to this cost submission; their payment is suspended pending a Feb. 19 appeal hearing.)

The most high-profile contest is the CA$455 million lawsuit Catalyst brought last year against West Face and a bevy of other critics, including hedge funds, former Callidus borrowers, analysts and two journalists from the Wall Street Journal that alleged a complex “Wolfpack” conspiracy designed to benefit short sellers by driving down Callidus’ stock price.

On Oct. 29, an Ontario court heard pleadings from many of the defendants, seeking the suit’s dismissal on several grounds: That Catalyst’s defamation and conspiracy claims lacked sufficient detail and made it difficult to respond to the claim, and that the Fund had missed multiple deadlines to provide those details.

For its part, Catalyst filed a motion to strike on Oct. 25 that reiterated its claim of conspiracy and said they had provided sufficient details for the defendants to respond to.

Arguably the biggest risk to Glassman’s wealth from this legal combat might be the CA$500-million counterclaim West Face launched in 2017 against Catalyst, Callidus, Glassman and colleagues James Riley and Gabriel de Alba, as well as Black Cube and their alleged sub-contractors. Catalyst tried to have the counterclaim thrown out this year but on June 15 Ontario Superior Court Justice Sean Dunphy, in a handwritten endorsement, denied the fund’s bid. This case is moving towards the discovery process.

One of the more overlooked claims against Catalyst is from Bruce Langstaff, a former managing director of equity sales desk for Canaccord Genuity Corp., a Toronto-based broker-dealer.

A 24-year equity sales veteran, Langstaff claims Glassman and Gabriel de Alba threatened Cannacord with withholding investment banking assignments unless he was fired. He is seeking CA$3.35 million from Catalyst and Callidus for breach of contract and interference with economic relations. (He is also suing Cannacord.)

Langstaff, in his statement of defense and counterclaim, acknowledged that he provided trading strategies to West Face and the Anson Fund (another Toronto-based asset management company that Glassman sued) but denied advising them to short Callidus’ shares at any point around Aug. 9, 2017 – a day the stock price dropped to as low as CA$10.57 after opening at CA$15.36, according to Yahoo! Finance. His filing also asserted that neither he nor his clients were involved with Cannacord’s trading in the stock in the time between August 9 and August 14.

A more likely — albeit much less dramatic — explanation for the abrupt decline in Callidus’ stock price: Aug. 9 was the day a Wall Street Journal article appeared that said Callidus was the subject of four different whistleblower complaints with the OSC that alleged fraud, and that the Toronto police had opened an inquiry into the firm. Moreover, the stock continued to fall because earnings, released the following day, showed net losses.

According to Langstaff’s filing, throughout that August and early September Cannacord’s management had repeated discussions with Glassman and other Catalyst executives about how his role at the firm hurt its ability to get investment-banking business from the fund. On Sept. 26 he was fired. The claim says both Langstaff’s immediate supervisor — the bank’s institutional equity chief — and an internal investigation cleared him of any wrongdoing, but says senior managers at Canaccord told him he was being terminated to insulate the company from possible litigation from Glassman.

More specifically, the filing asserts that Langstaff — who earned up to CA$750,000 annually at Canaccord — was let go after Glassman telephoned Dan Daviau, the bank’s CEO, and told him Langstaff had engaged in improper conduct in relation to Callidus. It also says Canaccord was told by Catalyst if they were not careful, “it would get caught in the crossfire.”

Catalyst has not replied to Langstaff’s motions, prompting his lawyers to file a notice of default on Sept. 18.

In a statement of defense and counterclaim, Canaccord denied that Langstaff was dismissed due to pressure from Catalyst, but was let go because of an unspecified misconduct, as well as an internal restructuring.

Reached by phone, Langstaff declined to discuss the lawsuit. A representative for Canaccord did not respond to three phone messages seeking comment on the Langstaff lawsuit.

One transaction that may merit extra scrutiny is a deal Catalyst had absolutely nothing to do with — which is the problem.

For once Glassman is in the background; at the center of this drama is Gabriel de Alba, Glassman’s longtime deputy and a Catalyst partner since 2002.

As a core member of Catalyst’s portfolio team, de Alba has a legal obligation to devote his professional efforts solely to Catalyst and little else, according to the corporate opportunity doctrine. It’s not a complicated principle: Corporate directors and officers are not allowed to make side deals for themselves at the expense of their employer. Additionally it states company officers have a duty of loyalty, stipulating they must try and act to the benefit of the company and investors.

Catalyst’s marketing documents embrace these concepts, emphasizing that Catalyst team members will devote 100 percent of their professional time to the fund’s investment activities, and “no Catalyst professional may sit on a non-portfolio ‘for-profit’ board of directors.”

But in 2011, de Alba had a role in a restructuring of Satélites Mexicanos (or Satmex), a struggling Mexican satellite communications company that his family had a significant ownership interest in and for which he and his sister served on the board.

There’s nothing surprising about de Alba getting involved with a struggling telecom company; he’s acknowledged by many to be an expert in the field. Moreover, in Catalyst’s early years, de Alba’s role in a series of telecom investments was a key source of the fund’s profits.

Without a doubt, de Alba’s efforts paid off in a very big way when Eutelsat Communications, a French satellite operator, acquired Satmex in 2014 for a total price of over $1.4 billion (including the assumption of $311 million of debt.) It’s unclear how much de Alba, his family and other equity holders earned from the sale, but it might have been in excess of $200 million.

Yet this deal did not benefit Catalyst’s investors. Half a dozen other investment funds, including Centerbridge Partners LP and Monarch Partners LP, provided loans for the 2011 transaction. Catalyst is not recorded as one of them.

A Catalyst’s spokesman declined to respond to questions on de Alba’s role in the transaction.


The Southern Investigative Reporting Foundation posed questions via email to Catalyst spokesman Dan Gagnier.

His reply in full is as follows: “Catalyst declines to comment. Please be aware that virtually all of your questions and statements are factually inaccurate or fanciful creations that are readily reconciled by actually doing some research of the public record and/or court filings.  Instead of parroting a pack of lies fed to you to advance the agenda of others, it would behoove you and SIRF to adhere to even the most basic of journalistic principles, integrity and decency. Failure to do so exposes you and SIRF to legal liability.”

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Newton Glassman’s Legacy of Ashes

It was corporate skulduggery at its most audacious. Last September Frank Newbould dined at Scaramouche, a swanky downtown Toronto restaurant, with a businessman who said he would like to hire Newbould as an arbitrator. In reality, this was a ruse to engineer an attempted sting on Newbould, a retired Ontario judge, as the National Post reported.

Newbould’s would-be client worked for Black Cube, a Tel Aviv-based business intelligence firm, staffed with former Israeli intelligence agents, that has attracted notoriety for its work for disgraced Hollywood producer Harvey Weinstein, among others.

As Newbould and the man conversed, another Black Cube operative was secretly photographing them. Newbould’s dinner companion also surreptitiously taped the conversation. During the dinner, and at a prior meeting as well, the private eye seemed to try to elicit a reaction from the former judge by making rather loaded references to the “Jewish lobby” and “the Jewish way of doing things . . . all the time trying to take more than they should and more than agreed.” The Black Cube operative’s apparent goal? To provoke the former judge into saying something anti-Semitic, as the National Post reporter who was offered information about this meeting later reported.

But after reporter Christie Blatchford was approached by Black Cube with the recording of the meeting, she found that the 74-year-old retired judge hadn’t agreed with the statements and didn’t say anything offensive about Jewish people. She ended up reporting that Black Cube had tried to entrap Newbould on behalf of Catalyst Capital Group Inc., a $4.3 billion private equity firm in Toronto that was founded by Newton Glassman, who is Jewish. Catalyst has since denied that it hired Black Cube to do a sting on Newbould.

In August 2016 when Newbould was still on the bench, he had ruled against Catalyst in a lawsuit it had brought against Toronto-based hedge fund West Face Capital, claiming that it had used insider information when it purchased Wind Mobile Corp. In that ruling, the judge had disparaged Glassman, saying, “I viewed him more as a salesman than an objective witness.”

Catalyst, which runs five primary investment funds and whose clients include some of the largest institutional investors in the United States and Canada, appealed that decision. Had Black Cube caught Newbould making an anti-Semitic remark, an appellate court might have considered reversing the judge’s decision, reasoning that it had been motivated by prejudice against Glassman.

In February the appeal was dismissed. While Judge Newbould had initially ordered Catalyst to reimburse West Face CA$1.23 million for its legal expenses, that sum will likely increase since Catalyst’s appeal was denied.

Newbould’s ruling is likely to influence another judge’s opinion in another Catalyst suit, charging West Face with misuse of confidential information, conspiracy and breach of contract. Glassman informed some of Catalyst’s limited partners last year that he saw a “reasonable likelihood” of garnering a huge payout from this suit: In an investor presentation, Glassman said the litigation was “extremely material” and he listed its expected outcome as an unrealized gain of more than $448 million. But by losing the appeal in the first case, Catalyst’s chances of a big payout are slim.

Yet Catalyst has brought two other lawsuits against West Face that are still playing out in court. In the most recent suit brought last November, Catalyst made its most outrageous claims against West Face as well as others — with CA$455 million in damages sought. The suit has argued that the defendants were part of a “Wolfpack” that had conspired to orchestrate a “short and distort” campaign against Catalyst’s publicly traded subsidiary, Callidus Capital Corp. This “Wolfpack” is said to include a wide array of participants: a Wall Street Journal reporter, former Callidus borrowers, hedge funds and stock research and investment firms. The suggestion is that by working together and coordinating their efforts, these individuals and entities were acting like a “wolf pack” in trying to undermine Catalyst.

And Catalyst’s potential retention of Black Cube’s services has again been raised in filings for this suit. West Face alleged last year in a court filing that Catalyst had employed Black Cube to orchestrate an elaborate deception — and that Black Cube had flown several current and former West Face employees to London for “interviews” with fictional companies, apparently with the aim of extracting information. (Other Callidus borrowers involved in litigation against Glassman have claimed that they have also been approached by private eyes.)

Black Cube allegedly had some interesting help: In West Face’s statement of defense and counterclaim, it accused Catalyst of hiring PSY Group Inc., a Cyprus-based, Israeli-directed intelligence services company. West Face, which currently has an estimated CA$2 billion under management, has claimed in a legal filing that PSY Group is little more than an internet-based trolling operation that has planted and spread fake news and video stories about Greg Boland, West Face’s CEO. West Face has also claimed that PSY Group directed the creation of a webpage that alleged the existence of a “Wolfpack corruption” conspiracy targeting Catalyst.

Why has Newton Glassman been spending so much time and money on these scorched-earth tactics?

In a December court filing, West Face left little to the imagination about its view of Glassman’s motives: It claimed he was trying to “distract attention from the deteriorating financial performance, overvalued assets, material non-disclosures and misrepresentations to investors of Catalyst, Callidus and their principals” and attempting to “intimidate West Face, Boland, other capital market participants, regulators and members of the media, in an effort to dissuade or discourage them from scrutinizing, discussing or commenting publicly on the deteriorating financial performance” of Catalyst and Callidus.

How did the conflict start? Callidus is an asset-based lender, also run by Glassman, that specializes in making loans to companies that the banks won’t touch. After Callidus’ share price mounted steadily in the wake of its 2014 IPO, West Face’s managers began examining Callidus’ financial prospects. They found that roughly 20 percent of Callidus’ loan portfolio might have to be written down because the commercial borrowers involved were in bankruptcy, restructuring or otherwise impaired. West Face elaborated in a court brief how in November 2014 its portfolio managers shorted Callidus stock when it was trading higher than CA$20.

Another rationale for West Faces skepticism was its view, as shown in a court filing, that in late 2014 Callidus disclosures to investors were often highly misleading, particularly upon revealing its balance sheet. Yet Callidus analysts said when the company sought bids for the collateral that was taken from borrowers who were unable to repay their loans, Callidus could rarely find buyers willing to pay close to the loans value.

Rather than acknowledge deteriorating loans and writing them off, West Face said Callidus simply recategorized such debts as equity and called them “assets acquired from loans” on its balance sheet and gave few updates.

West Faces legal filings say it exited its Callidus short in April 2015, and the fund’s analysis was prescient. For 2017 Callidus racked up a net loss of CA$171.59 million as a series of its loans took a turn for the worse, and its book value dropped to $3.44 a share. (Callidus’ current tangible book value — a measurement of its physical assets that subtracts intangible, or nonphysical, assets in calculating book value — is negative CA$55 million. Thus, in a potential liquidation scenario, the companys shareholders wouldn’t see a dime.)

Catalyst even advanced CA$31 million to Callidus this past February and March, shortly before the release of Callidus’ annual report. Though no reason was given, the most likely explanation is the cash helped Callidus avoid violating its debt covenants.

Court documents as well as interviews conducted over the past year and a half suggest that Glassman and Catalyst have regularly engaged in business practices that, at best, are well outside Wall Street’s norms.

The avalanche of expensive litigation that Glassman has brought to bear against his critics is less a tactic than a tool, one that helps keep at bay many skeptical investors and reporters, who are wary of lawsuits and the likes of Black Cube and PSY Group. (Catalyst and Callidus also filed a defamation suit against two Wall Street Journal reporters; Dow Jones, the paper’s parent company; and a Callidus borrower.) In turn, the litigation allows Callidus and Catalyst to operate without the headaches and awkward questions that public scrutiny can bring.


Newton Glassman might be spending millions to make his enemies miserable but even his most implacable foes would say the 53-year-old Toronto native is fiercely smart and relentless. He’s also very private. On the rare occasions that he gives an interview to the press, he refuses to allow photographs or even illustrations of his face to accompany the story. (A recent photograph captured him in a suit and tie.)

The son of a surgeon, Glassman is an alumnus of the University of Toronto’s law school and the University of Pennsylvania’s Wharton School. He eventually headed to Wall Street, joined the staff of Cerberus Capital Management LP in 1997 and rose to the rank of a managing director. He oversaw the fund’s telecommunications portfolio and its Canadian investments.

While working for Cerberus, Glassman developed a distinctive attitude about lending to companies in fiscal dire straits: “If you want to be in a blood sport — and distressed [lending] is a blood sport — you got to be able to take a punch,” he told Bloomberg in 2016. He also learned to land a punch or two. A 2011 profile of Glassman in Canada’s Financial Post Magazine noted, “He earned a reputation for being a tenacious, heavy-handed financier who doesn’t suffer fools lightly.”

In 2002 Glassman left Cerberus and returned to Toronto, where he set up Catalyst. He partnered with a banker, Gabriel de Alba, and later a Toronto lawyer, James Riley.

Over the past 16 years Catalyst, under Glassman’s leadership, has raised in its five primary funds a sum that is now $4.3 billion, generating a healthy stream of management fees. Catalyst has also provided a stage for Glassman to deploy the distressed-debt investing chops he developed at Cerberus; he has played a role in management shake-ups at wireless provider Mobilicity, Advantage Rent-A-Car and many other firms. One of the Catalyst’s highest-profile investments has been in Gateway Casinos & Entertainment Ltd., a casino company that is now the second largest gaming operator in Canada. In 2015 The Wall Street Journal noted, “Catalyst boasts the second-most consistent performance record among distressed-debt funds globally, according to data provider Preqin Ltd., after Cerberus.”

Most fund managers would give their front teeth for results like that, but Glassman appears to want more — much more — and that’s where Callidus Capital Corp. has come in.

Toronto businessman Sam Fleiser founded Callidus in 2004 and Glassman directed Catalyst to buy a controlling interest in the company three years later. Catalyst provides the capital for Callidus’ loans.

Considering the risk involved in making such loans, Fleiser ran the company conservatively. During the five years prior to 2011, just CA$4 million in losses were written down on three loans, out of an estimated CA$600 million in lending — even though Callidus charged interest rates as high as 18 percent.

But in 2011 Fleiser departed from Callidus. Upon taking the helm of Callidus, Glassman had two very specific goals: to take Callidus public and grow its loan book considerably. While this might have seemed like a good idea given the success of Callidus under its previous management team, things turned out very differently.


Growing Callidus’ loan book has meant lending more money to troubled companies, and the universe of financially stressed companies that are able to repay significant sums at high interest rates is limited. But in order for Catalyst’s heavyweight investors to be protected, Callidus’ borrowers must have sufficient collateral to cover their loans in case they run into financial difficulty — or the losses will flow right to the lender’s bottom line. (About 71 percent of Callidus’ shares is held in three Catalyst funds and with the stock trading at about CA$5.15, the value of this stake has dropped to just less than CA$185 million. Callidus has also borrowed CA$315.3 million from Catalyst via a short-term line of credit.)

Sam Fleiser was discerning in selecting borrowers; Newton Glassman appears to have been anything but. Nonetheless, Callidus’ growth was truly extraordinary in the initial years of Glassman’s leadership: In 2012 the company had CA$132 million in gross loan receivables. Two years later this metric had mushroomed to CA$823 million, with the size of loans climbing as well.

And by the end of 2015, Callidus had 39 loans for an amount totaling CA$1.2 billion on its books. But were all the new loans sound?

Underwriters tasked with marketing Callidus to investors were likely asking that very question in April 2014 as they examined its IPO. To allay these concerns, Catalyst promised it would guarantee all the loans Callidus made before the IPO.

Callidus was relentless in selling investors on the idea that its management team was expert at handling loan risk. Since 2014 Callidus’ filings have been peppered with point-blank assurances that it has made almost no dud loans and its borrowers’ collateral has been more than sufficient to cover any risks. In the IPO prospectus, Callidus claimed to have “no realized losses on principal on Callidus-originated loans after consideration of liquidated collateral costs to settle from 2011 until 2013.” During a November 2014 conference call with brokerage analysts, Glassman boasted, “we don’t have a single loan in the portfolio that’s not performing” and “performing means [paying] current interest and all obligations.” A year later Glassman, on another call, repeated this claim.

These assurances have proved very hollow.

Callidus’ portfolio, as shown in its 2017 annual report, is a wasteland of troubled loans.

Start with Callidus’ loan receivables, which tumbled to CA$247.3 million (a drop of 76 percent from CA$1.02 billion at the end of 2016), as well as its set loan loss provision of CA$217.4 million, which rose 39 percent from CA$134.3 million.

Then consider the loan portfolio’s leverage: More than 68 percent of Callidus’ net loans receivable are to just two very troubled companies.

C&C Wood Products Ltd., a British Columbia-based timber products company, owes the fund CA$104 million. And because of C&C Wood’s inability to repay its loans, Callidus assumed control of the company in November 2017. In a press release, Glassman was glowing in describing C&C Wood’s turnaround. But its financial results — a loss of CA$1.2 million on CA$16.3 million in sales — point to a different reality.

The other company is Horizontal Well Drillers, an Oklahoma-based oil-drilling outfit that has received $216.9 million in loans from Callidus. If Horizontal’s name rings a bell, this is probably because of the attention it received in September 2016 when Venezuela’s state-owned oil company, Petróleos de Venezuela SA, announced that Horizontal (in conjunction with Halliburton) had been awarded a contract worth $3.2 billion to drill 480 wells.

The announcement immediately raised investor eyebrows given Horizon’s small size and the fact that, per a CNBC report, Venezuela isn’t paying its immense debts to even the largest of the oil services companies. This situation has forced the likes of Baker Hughes, Schlumberger and Halliburton to set aside hundreds of millions of dollars to cover prospective losses from their uncollectible debts.

Callidus has taken a dim view of Horizontal’s prospects and now values its loan at CA$69.1 million, a write down of CA$131.9 million.

And the financial pain for Callidus and its investors from this loan probably isn’t over yet: Buried at the foot of a lengthy disclosure in the 2017 management discussion and analysis statement is the acknowledgement that if the Venezuelan contract doesn’t materialize, as much as $64 million more could be written down.

As if the Callidus-Horizontal relationship wasn’t already strange enough, matters became surreal when Callidus’ former chief underwriter Craig Boyer sued Callidus, alleging it had failed to grant him his stock options and health and other benefits. In a counterclaim, Callidus accused Boyer of allowing Horizontal to draft a letter with a forged Callidus letterhead to assure Venezuelan officials that Horizontal had adequate financing in place. Boyer has denied this allegation. (See “Mr. Boyer’s War” for more on this saga.)


So what happened to Glassman’s assurances to investors about performing loans and a robust cushion of collateral? Under his leadership, Callidus’ lending practices have seemingly defied logic at times. Many borrowers, in interviews and legal filings, have complained that Callidus changes its loan terms just as negotiations are ending, then seeks personal guarantees from the borrower’s management.

Moreover, some of the borrowers have claimed that once a loan is signed, Callidus then fails to provide them sufficient financing. As a result, at least six commercial borrowers (and likely more) have seen their operations nearly collapse, only for the companies to then be rescued by Callidus.

Alken Basin Drilling Ltd.’s history offers an example of this scenario. In 2013 Kevin Baumann bought the Canadian water-well drilling firm in Bentley, Alberta. A year later, when he needed credit after his business fortunes sharply declined, Baumann turned to Callidus, which agreed to lend him as much as CA$28.5 million. Baumann is now being sued by Callidus for refusing to deliver his personal guarantee to cover the losses accrued.

Baumann said Callidus initially told him he didn’t have to put up a personal guarantee, as the company charged interest rates of 18 percent to 20 percent. But then at the “eleventh hour,” according to a counterclaim he filed, Callidus changed its mind, forcing Baumann and other Alken shareholders to provide personal guarantees. In Baumann’s case, the guarantee was to be his Alken shares and a farm he owned, with the total value of both at CA$6 million. (In an interview with the Southern Investigative Reporting Foundation, Baumann accused Callidus of embracing a “loaning to own” strategy.)

And Baumann has also claimed that Callidus reneged on giving him the money that Alken needed to keep functioning. Instead, Callidus “drip fed” funds to the business, according to his counterclaim. When Alken made multiple funding requests to draw on its credit, most were rejected, Baumann said. “You might ask for $5 million,” he said, “but they say, Take $100,000 or how about $200,000.’. . . So they drip you until they kill ya and then they take the business over.” (Callidus, however, has denied it withheld funds.)

In March 2015 Callidus demanded repayment of its loan, even though Alken was not in breach of its loan agreement, Baumann said. Baumann tried to file for creditor protection for Alken. The following month, he said, he was pressured to resign and Callidus then inserted its own management team. The new president, Scott Sinclair, is an interesting choice to replace Baumann, given the 2009 sanction he received from the Ontario Securities Commission, which included a CA$15,000 fine and a 10-year ban on serving as a director of publicly traded company.

Alken was put into receivership in March 2016; Callidus claimed Alken owed it CA$27.4 million. But its assets were worth only CA$10.6 million, according to an April 2016 report from the receiver. Soon after this, another Callidus-owned company, Altair Water and Drilling Services, took over Alken’s remaining assets through a credit bid of CA$24.2 million that added up to an estimated CA$17 million loss on the loan. Whatever drove Altair’s bid, it wasn’t value.

Yet, according to Baumann’s March 2017 legal brief, just before the receivership went into effect, Altair and Alken received two memorandums of agreement for a well-drilling contract in Egypt that Sinclair allegedly described to Callidus as potentially worth CA$200 million. This begs the question: Why place a company in receivership just as it was gaining such large contracts?

Baumann has an answer for that. He claimed in a court filing that these Egyptian memorandums were withheld from other potential Alken suitors because the contract “would have significantly increased the value of Alken’s assets available for sale in the receivership process” and would have decreased the amount that Callidus demanded from him personally in the loan guarantee.

Another borrower accused Callidus of lending money under false pretenses. In 2014 Callidus agreed to lend $34 million to Esco Marine Inc., a ship recycling company in Brownsville, Texas. Esco’s managers put up personal guarantees. And Esco’s team has also said Callidus changed the terms of the loan at the last minute and then balked at providing the company sufficient funds to continue its operations. (Callidus denies this allegation.) In 2015 Esco filed for bankruptcy, with Callidus pursuing Esco’s management for some of the money promised under the personal guarantees.

Last year a U.S. district court judge in Texas wrote in an opinion that there was sufficient evidence to indicate that Callidus had engaged in “fraudulent inducement” in failing to fulfill all of the loan’s original terms. Andrew Levy, Esco’s CEO, settled his suit against Callidus in return for cooperating with its litigation against the “Wolfpack.” In a brief interview with the Southern Investigative Reporting Foundation, Levy said that while “we dislike Newton Glassman,” the agreement with Callidus prevented him from discussing the terms of the settlement.

“[I] had to make a very hard business decision about [Esco Marine’s] interests,” Levy said, “despite having strong feelings about our case.”

In another case, Callidus agreed in 2012 to lend Morrisville, North Carolina-based information technology provider Xchange Technology Group $36.9 million but wound up pushing out its CEO in June 2013. Soon afterward Callidus put the company into receivership. (In 2013 the receiver disclosed that Xchange had lost $27.5 million over the previous two years. But Callidus’ 2014 IPO filing made no mention of the fact that Xchange was insolvent, had suffered such losses or was being kept afloat only with Callidus financing.)

Unable to find a buyer as Xchange bled cash and customers, Callidus turned Xchange into a subsidiary and brought it out of bankruptcy in 2015, but not before listing its value in Callidus’ 2014 annual report at $60.18 million (a steep increase from the $35 million it paid through a credit bid in 2013). Through a loan guarantee with Callidus in March 2016, Catalyst spent $101.3 million to purchase the Xchange loan from Callidus’ books, thereby presenting one of its most troubled positions as a windfall and forestalling a share price decline that could weigh heavily on Catalyst’s performance. (Previous payments to Callidus under the guarantee had covered only the loan’s principal, as investors had learned in February 2015; this payment included accrued and unpaid interest.)

But that’s not the half of it: At the annual meeting for the limited partners of Catalyst Fund III and Catalyst Fund IV held in April 2017, Catalyst reported having paid $54.82 million for Xchange, with no discussion of the $46.48 million discrepancy. Just as potentially troubling for investors, however, is the fact that in the same presentation Xchange’s total value was listed as $9.39 million, a $91.9 million loss in value in just over a year.

Callidus’ investment in Bluberi Group, a Drummondville, Quebec-based developer of games for slot machines, has been even more problematic. In November 2012 Callidus provided Bluberi a CA$24 million loan on the basis of a business plan that projected selling 3,300 slot machines and generating by the end of 2013 CA$25.5 million in earnings before interest, taxes, depreciation and amortization, or EBITDA. The projections proved to be more like daydreams, however, as Bluberi installed just 324 slot machines and burned through CA$2.6 million in cash.

Despite the missed projections, Callidus continued to extend credit to Bluberi. By November 2015 Bluberi owed Callidus CA$84.1 million. Early in that month, employees of Cole Kepro International, which makes the slot machines that house Bluberi’s software, entered a Bluberi storage facility and repossessed all the gaming units Cole Kepro had recently sold Bluberi. This brought Bluberi’s business to a virtual halt. Bluberi’s CEO then dismissed most of the staff of the company and filed for creditor protection. A report by Ernst & Young, the court-appointed bankruptcy monitor, portrayed Bluberi as being in financial and operational chaos, with a negative equity of CA$52.8 million after incurring losses of CA$14.1 million in 2013 and CA$22.8 million in 2014.

By the middle of November 2015, according to the receiver, Bluberi had just CA$54,000 left in its bank account.

In March 2017 when Callidus released its results for fiscal 2016, it disclosed that it had taken over Bluberi and appraised the company at CA$110.7 million, a value with little discernible economic basis whatsoever. Callidus’ reasoning? A “large, diversified gaming company” had signed “an agreement to deploy 7,000 slot machines” that Bluberi would be building.

That assertion was problematic.

The “large, diversified gaming company” said to be buying all those machines was Gateway Casinos & Entertainment Ltd., a company controlled by Catalyst that’s not in any shape financially to pay for an order that large. In 2012, Gateway disclosed in a prospectus that all its gaming equipment was purchased and owned by the British Columbia Lottery Corporation; Gateway didn’t have the authority to purchase a single machine.

In March of this year Gateway won a concession in another part of Canada: The Ontario Lottery and Gaming Commission awarded Gateway the right to operate as many as 11 casinos in central Ontario.

Nonetheless Bluberi can’t capitalize on a relationship with Gateway because Bluberi doesn’t have the requisite Class III license to manufacture and market traditional slot machines. It develops and markets Class II games, which are a variation of bingo installed in slot machines in Native American casinos throughout the United States. It’s unclear if Bluberi is seeking a Class III license.

Since March 2017 Callidus’ filings have subtly changed the language used to discuss the agreement for the 7,000 slot machines. A June 30, 2017, filing refers to it numerous times: There’s a reference to a “mutual understanding” between Catalyst, Bluberi and Gateway that 7,000 slot machines would be sold to Gateway, along with a letter from Gateway’s CEO confirming the company’s “potential to purchase up to 7,000 slot machines from Bluberi” over a three-year period.

But in the filing for the quarter that ended Sept. 30, 2017, however, the discussion of Bluberi’s Gateway contract is limited to Callidus’ being “hopeful that [Bluberi] will be able to firm up an order for 7,000 machines.”

And Callidus’ management discussion and analysis for 2017 contained no reference to a Bluberi order from Gateway.

Still more Bluberi headaches may arrive for Catalyst, however. In a little-noticed court decision on March 16 of this year, Montreal Justice Jean-François Michaud approved a petition by Gérald Duhamel, Bluberi’s founder and former CEO, for obtaining litigation funding so as pursue a claim against Callidus.


Glassman’s promises to Callidus’ investors about the strength of the collateral that backs its loans are also problematic.

Callidus’ investor filings regularly feature a discussion of the amount and quality of the collateral behind its loans, nearly every time noting that its borrowers’ collateral is equal to or greater than the value of their loan.

The implied message conveyed to investors is simple, along lines such as this: “No matter what happens, these loans are protected and so is your investment.” Notwithstanding Callidus’ and Catalyst’s ample disclosures about the loans’ risks to investor capital, the Southern Investigative Reporting Foundation has uncovered instances when a Callidus borrower’s collateral was nowhere close to the loan’s value. Moreover, Callidus’ filings have repeatedly failed to disclose borrowers’ sharply deteriorating finances.

Consider Harvey Industries LLC, a Livonia, Michigan-based auto parts company that in 2012 borrowed $41.5 million from Callidus; Harvey’s collateral was its plant, land and a personal guarantee from the founder. Things went badly, with Harvey closing a plant and laying off staff. By early 2015 the company owed Callidus $39 million. At that point, Harvey filed for bankruptcy protection.

Those reading Callidus’ March 2015 quarterly management discussion and analysis would likely conclude the loan portfolio’s collateral was more than adequate. The document stated, “the estimated collateral value coverage on net loans receivable was approximately 161 percent with a range between 100 percent and 250 percent on an individual loan basis.”

A few months later investors would learn how much Harvey had collapsed. A July 2015 court filing valued Harvey’s assets at just $4.5 million to $9.1 million — more than 75 percent less than the figure Callidus had given investors the previous March.

The collateral’s loss in value didn’t represent the only threat that the Harvey loan posed to Catalyst’s limited partners: In June 2015 Callidus took control of Harvey through a $25 million credit bid. Per the bankruptcy receiver’s reports from March through October 2015, Harvey was awash in a sea of red ink, losing an average of $1 million a month. Business hasn’t improved, though, since Callidus acquired the company, with Harvey reporting a gross margin loss of $3.2 million, according to Callidus’ 2017 annual report.

Going broke takes a lot of money: Harvey’s monthly debt service, paid primarily to Callidus, was $758,200 over the eight months of bankruptcy, and “professional fees,” primarily paid to lawyers and accountants, were $98,445. It’s not all grim news for Callidus investors, though. From a few brief lines in the Sept. 30, 2017, quarterly filing, they learned that Catalyst bailed out Callidus’ loan to Harvey, which is now called Wabash Castings Inc.

Then there is the case when the collateral for one of Callidus’ borrowers went belly-up. In 2013 Callidus acquired millions of dollars of debt owed to HSBC by Gray Aqua Group, a fish-farming business located on Canada’s Atlantic Coast. At the same time, Gray Aqua entered into a CA$43.5 million credit agreement with Callidus. The terms of the loan called for its repayment in the fall of 2014, but the deadline was later extended to early 2016.

In the summer of 2015 sea lice infested some of Gray Aqua’s fish farms, wiping out most of its harvest. A few months later, 380,000 smolt in a hatchery facility had to be destroyed due to disease.

As a result, Gray Aqua did not repay the loan by the 2016 deadline. Soon after, the company filed for bankruptcy protection and still owed Callidus CA$55 million. Although the bankruptcy receiver stated Callidus knew about the sea lice infestation in August 2015, it did not disclose this loss in its third-quarter earnings report, as many analysts might have expected. Callidus later reported in its 2015 annual report a pretax loan loss provision of CA$22.7 million.

The loss provision was inadequate, and in Callidus’ second-quarter 2016 filing it set aside CA$12 million more for loan losses related to Gray Aqua, bringing the amount reserved to CA$34.7 million. The company was sold that year for a mere CA$15 million.

Similar to what happened in Harvey’s case, the losses from Gray Aqua’s and other troubled loans have rarely seemed to meaningfully affect Callidus’ disclosures. In its 2015 annual management discussion and analysis, Callidus reported that its loans in aggregate were backed by collateral representing 172 percent of the loans’ value — and the loans on its internal watch list had collateral representing on average 104 percent of the loans’ value.


Catalyst’s holding large portions of Callidus’ stock and serving as the guarantor for many of its troubled loans are not the only looming headaches for Catalyst’s limited partners.

Start with Catalyst’s estimated CA$900 million investment in Gateway Casinos & Entertainment; in 2016 stakes in Gateway represented more than 38 percent of the Catalyst Fund II and 29 percent of the Catalyst Fund III. How Catalyst could arrive at its valuation of this huge position is baffling.

While the Catalyst Fund III marked up its Gateway positions by almost 50 percent from 2011 to 2016, another private equity firm with a stake in the company, Los Angeles-based Tennenbaum Capital Partners, however, marked down its position 16.4 percent.

Though Gateway is clearly in better financial shape than the likes of Xchange and Bluberi, Gateway has a debt load of CA$690 million and, per Moody’s Investor Services, a subprime B2 credit rating. The rating agency’s most recent note expected Gateway to have negative CA$110 million in free cash flow given its schedule of improvements and renovations. To free up cash, Gateway has completed a series of sale-leaseback transactions, with its most recently announced transaction in late February netting CA$483 million.

A deal like this to sell and then lease back property is a standard corporate finance tool, typically offering a company a mixed bag of pros and cons: It is a quick way to raise capital, especially for an entity like Gateway that’s used a lot of debt to grow rapidly. Yet, given the sale of its core real estate assets, Gateway’s future borrowing will likely carry a higher interest rate since the company will have fewer assets to pledge as collateral. Unless a sale-leaseback deal helps a corporation acquire a trophy asset or is used to retire a block of debt, many investors look at this as the financial equivalent of chopping up the deck to keep the fireplace going — a clear signal that financing options are becoming limited.

Gateway’s debt holders recently sent a message to Catalyst’s management that their patience is wearing thin. After Gateway negotiated new lines of credit with its lenders, Catalyst sought to use $250 million of the proceeds to pay a dividend (or return capital) to its limited partners — a standard practice for private equity funds of all stripes. But in recent weeks, several investors who own a large chunk of Gateway’s 8.25 percent notes protested, arguing that Gateway’s operations needed the cash more than Catalyst and its limited partners. After some tense negotiations with the noteholders, Catalyst was allowed to take $100 million as a dividend, with a mighty big catch: The bondholders made the fund pay them a consent fee of 2 points (one-half a percentage point more than what was initially agreed upon) or $5.1 million, to receive the money.

By cutting its prospective dividend in half and then making Catalyst pay what is effectively a 10 percent fee to obtain the money, investors were sending a clear message about what Catalyst’s priorities should be.

Therapure Biopharma Inc., a Canadian pharmaceutical contract manufacturer, is another company that Catalyst has invested in; Catalyst has long touted its prospects only to find the marketplace offering a decisively different value. According to the prospectus for Therapure’s aborted 2016 IPO, it lost CA$10.8 million on just CA$29.5 million in revenue for the nine months that ended on Sept. 30, 2015; during 2012 to 2014, it lost CA$37.16 million on CA$69.87 million in revenue.

In January 2016 before the erstwhile IPO, Therapure’s management had made some rosy assertions that the company had a roster of drugs and treatments in development. But it’s unclear what the status of these products is today. (The IPO had sought to raise CA$130 million and valued Therapure at more than CA$900 million.)

Therapure also carried CA$32.4 million in debt prior to its September sale for $290 million to a partnership between a Hong Kong-based biotech company and a private equity fund advised by China Citic Bank International. As part of that deal, Catalyst retains the right to Therapure’s plasma product line. Currently this line seems to be centered on one product that’s undergoing a Food and Drug Administration Phase 3 trial. For this product, the protein in plasma is purified. The good news for Therapure is that there’s a real demand for the product; the bad news is that large, established competitors dominate the crowded and mature marketplace.


Newton Glassman’s carefully constructed world is starting to give way.

Although the bevy of lawsuits initiated by Glassman is evidence that he’s not quietly accepting his professional setbacks or public criticism, investment managers and journalists should not be his biggest concern. In August The Wall Street Journal reported that at least four individuals had filed whistleblower complaints with Canadian securities regulators, including the Ontario Securities Commission, alleging fraud at Catalyst and Callidus. One of the whistleblowers told the Southern Investigative Reporting Foundation of the U.S. Securities and Exchange Commission interview on these matters.

While those who criticize Catalyst may do so at their own financial peril, signs of changing times for Catalyst and Callidus are all around. Last fall Lax O’Sullivan Lisus Gottlieb, Catalyst’s longtime law firm, stopped representing Catalyst and Callidus, perhaps in response to their involvement with Black Cube. Meanwhile, West Face is seeking $550 million in damages against Catalyst through a Dec. 29 counterclaim, alleging that Catalyst “utilized unlawful means in carrying out their agreed upon campaign of vilification, defamation and harassment.”

Callidus’ stock price flirts daily with all-time lows despite the company’s having spent an estimated CA$110 million for a series of share repurchases. And a pair of no-frills websites, Litigating With Catalyst Capital and Callidus Capital Litigation (owned and maintained by West Face and Kevin Baumann, respectively), offer an unflattering picture of Newton Glassman’s future: constant litigation, massive expenses and increasingly bruising defeats.

The Southern Investigative Reporting Foundation submitted detailed questions via email to Callidus and Catalyst spokesman Daniel Gagnier, but he didn’t reply.

David Moore, a lawyer representing Callidus and Catalyst, responded with a letter saying many of the questions dealt with ongoing litigation and thus the companies would decline comment. Nonetheless, he claimed the questions were “riddled with inaccuracies, misunderstandings and purposeful fabrications.”

Editor’s note: In its CA$455 million “Wolfpack” conspiracy lawsuit, Catalyst alleged that journalist Bruce Livesey was a member of a short selling conspiracy against Callidus. It specifically claimed that West Face had “retained” Livesey to write a negative story about Callidus.

The allegations are entirely false: Livesey is an investigative reporter with 30 years of experience; he has never worked for West Face in any capacity. And West Face has completely denied Catalyst’s claim in court filings.

The claim about Livesey first surfaced in 2017 when Callidus lawyers deposed Esco Marine co-founder Andrew Levy. In a recent interview with the Southern Investigative Reporting Foundation, however, Levy strongly denied ever having said that West Face had employed Livesey. Levy refused to discuss his deposition but noted the following: “All I said was that a reporter named Bruce from Canada called me and told me he was reporting on Callidus for a publication up there. I asked him who else he’d spoken to and he told me, Greg Boland’ and some other people. It’s just false to connect him to any hedge fund.”

Catalyst attorney David Moore’s letter to the Southern Investigative Reporting Foundation also repeated the lawsuit claim that Livesey was part of a “Wolfpack” conspiracy. Moore sharply criticized Livesey, decrying “his use of expletives” and “an animus and agenda” against Glassman.

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Mr. Boyer’s War

For eight years, Craig Boyer was a senior executive at Callidus Capital, and by the time he quit in 2016 he was its chief underwriter and vice president. But last year Boyer sued Callidus for CA$100,000 in damages, claiming the company had denied him health and other benefits and seeking the return of his stock options.

It’s safe to say that when Boyer left Callidus, he was clearly an unhappy man. In his claim, he said he had been subjected to “abusive management conduct” in the form of “abusive email and verbal treatment” from Callidus CEO Newton Glassman, including “on occasion, physical abuse.” Boyer even mentioned how in 2016 he was “participating in a meeting where a senior officer of the defendant’s parent [company] physically attacked the plaintiff’s immediate superior.”

Boyer’s portrait of Callidus as a “poisoned” workplace, whose management style focuses on the “berating and belittling” of employees, is not an isolated one: Two former employees of Callidus’ parent company, Catalyst, have alleged in court filings that they had witnessed numerous instances of Glassman being emotionally or verbally abusive to his colleagues.

Yet Callidus, in a statement of defense and counterclaim, has denied Boyer’s allegations of a poisoned work environment, saying he never raised such issues while working at the company. The statement also said, “all of Callidus’ employees are treated fairly and with dignity.” In fact, Callidus claimed that Boyer had developed a reputation of being difficult with employees who reported to him.

Moreover, Callidus struck back with a CA$150 million counterclaim, accusing Boyer of being incompetent in “failing to properly monitor loans in his portfolio.” Specifically, the counterclaim alleged that Boyer had failed to conduct proper due diligence on Gray Aqua, a fish farming company in eastern Canada, by ignoring the fact its fish stock could not be used as collateral.

Plus, Callidus accused Boyer of encouraging another borrower, Xchange Technology Group, to “artificially inflate the results shown on their . . . financial statements.” And Boyer did not inform Callidus’ credit committee that Xchange’s financial statements were “based on an artificially inflated before interest, taxes, depreciation and amortization, or EBIDTA,” according to Callidus.

When these and other problems were brought to his attention, Callidus alleged, Boyer abruptly quit.

In a reply and defense to the counterclaim, Boyer’s lawyers hit right back, saying he had no authority over others within the company. The lawyers asserted that Boyer had properly monitored the loans in his portfolio and it was his (unnamed) colleagues, after assuming oversight of his loan book, who had made mistakes, especially in Gray Aqua’s case. Boyer’s lawyers denied that he had pressured Xchange to artificially inflate the EBITDA figures.

“The complaints respecting the work environment were open and notorious and well known to those who perpetrated them” Boyer’s lawyers wrote, adding that Callidus’ counterclaim was “raised for ulterior purposes.” They asserted, “Callidus is subject to multiple complaints and regulatory investigations with respect to its material non-disclosure to fund members and the public as to the status, and transfer, of its various investments” and the counterclaim was therefore designed to “deflect these complaints and investigations.”

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Wirecard AG: The Great Indian Shareholder Robbery

Wirecard AG is the luckiest company you have never heard of.

It has the good luck of a boxer who is a master of bobbing and weaving in the ring, making it difficult for an opponent to land a punch. Prizefights, though, typically go for all of 10 or 12 three-minute rounds. Yet for 10 years a combination of short sellers, journalists and forensic research consultancies (whose clients often include short sellers) have publicized a long list of concerns about Wirecard’s operations, to little avail.

Why so much drama?

For one, Wirecard has a business model that is pure catnip to critics of every stripe.

Having emerged from a reverse merger of a struggling dot-com era call-center operation, Wirecard shifted to payment processing. But it also owns a bank, has a low-tech prepaid payment card segment and still retains an even lower-tech call-center unit, all headquartered in a small suburb 10 miles from Munich.

Wirecard is a “rollup,” primarily built through the acquisition of smaller companies at a breakneck pace: Since late 2014 it has made 11 acquisitions. Critics argue that rollups use acquired revenue to mask broader troubles with organic growth.

Moreover, Wirecard’s approach to many of these purchases could be charitably called “highly unusual,” such when it has made large prepayments prior to announcing a deal. The Financial Times reported in April 2015 that Wirecard provided different levels of regulatory disclosure about transactions, according to the jurisdiction involved. As the FT noted, a corporate filing in Singapore (where a company purchased by Wirecard was based) revealed that its assumption of 12 million euros in liabilities was really an opaque loan it made to an unspecified recipient after the deal’s completion “for the acquisition of intangible assets from a third party.” (Wirecard CEO Markus Braun told the FT, “At such owner led companies . . . sometimes you have to buy out third party shareholders, or you have to take over assets of sister companies. This is then part of the purchase price.”)

And Wirecard’s management often discloses its financial results using custom, or “adjusted,” metrics rather than following applicable International Financial Reporting Standards. While this practice is completely legal, it can inflate the appearance of earnings and cash flow figures.

Despite all this, investors are still placing their faith — and money — behind Wirecard because of its prospects for reporting the kind of growth shown in its most recent  earnings report, for the quarter that ended Sept. 30.

The slope of the stock chart below would suggest that Wirecard’s critics are against the ropes and taking so many blows that the referee might need to step in.

Source: Nasdaq
Source: Nasdaq


But lucky doesn’t equal smart for Wirecard’s investors.

After a seven-month investigation, the Southern Investigative Reporting Foundation has obtained thousands of pages of documents that suggest a minimum of 175 million euros — and perhaps as much as 285 million euros — from Wirecard’s 340 million euro purchase of an India-based payment processor in October 2015 did not go to the seller.

Making matters odder still, Wirecard’s own filings show the money left its coffers.

So where did a large chunk of Wirecard’s capital go in one of its fastest growing markets?


In the fall of 2014 corporate finance officials from JM Financial Services, a prominent Mumbai-based investment bank, received a mandate to locate a buyer for Chennai, India-based Hermes I Tickets Private Ltd., a modestly sized e-commerce company that derived 63 percent of its business from selling travel tickets.

The Southern Investigative Reporting Foundation obtained a copy of the pitch book that bankers used to market Hermes Tickets to prospective buyers. For fiscal 2015, Hermes Tickets aimed to generate 22 million euros in sales and about 3.8 million euros in earnings before interest, taxes, depreciation and amortization, or EBITDA (a standard, though imperfect, gauge of a company’s potential profitability).

The asking price was 46.2 million euros, but no buyers emerged for Hermes Tickets that fall or through much of 2015.

On Oct. 27, 2015, a deal was announced and, well, patience paid off: Wirecard purchased Hermes Tickets when it bought the payment businesses of its parent, Great Indian Retail Group, and a 60 percent stake in another subsidiary, Great Indian Technology. The transaction’s price tag was 230 million euros in cash, plus 110 million euros in prospective earnout payments over three years.

If it seems baffling that Wirecard’s deal to pick up Great Indian Retail’s payment businesses ended up totaling 340 million euros when only 13 months earlier Hermes, its primary component, had been shopped around for 80 percent less, that’s because it is. While India is a rapidly expanding economy, Hermes Tickets might have appreciated in value somewhat — but not that much. (Wirecard, for its part, argued that Great Indian Retail’s payment assets grew substantially in value in that 13-month period because of Indian GDP growth and the rapid growth of the digital payment market.)

Even with Wirecard’s history of oddly structured acquisitions, the Great Indian Retail deal sticks out, the more so since a source with Indian venture capital experience looked at Hermes Tickets’ financials in 2014 and described its payments business as being “very small.” So the Southern Investigative Reporting Foundation started to look for documents that might explain just what Wirecard had bought, and more important, where the cash went (a task greatly aided by India’s paperwork-heavy regulatory system.)

While for an American, interpreting India’s reporting format, currency and phrases can be a challenge, the sale of Hermes Tickets in Great Indian Retail’s 2016 annual report is clearly described as the “proceeds from sale of investment in subsidiary” of 2,749,940,988 rupees, or 37,365,539 euros. This is broadly congruent with the September 2014 asking price.

India’s Department of Industrial Policy and Promotion requires a company that receives a direct investment from foreigners (or FDI) to disclose the names of those involved in the transaction as well as the value. As such, the FDI circular offers a way to confirm the sale of Hermes Tickets: From October 2015 to March 2016, a buyer paid about $39 million, roughly 35 million euros, for Hermes Tickets shares.

(Wirecard denied purchasing Hermes Tickets for 37.36 million euros and said that DIPP data only shows investments from foreign entities into India, and as such, does not reflect what it paid in Mauritius.)

Someone examining this transaction might suppose that since Hermes Tickets cost 37.36 million euros, the balance of 192.64 million euros went for the 60 percent stake in Great Indian Technology.

Unfortunately for Wirecard’s shareholders, determining what happened is not that easy.

Great Indian Technology’s primary asset appears to be its ownership of licenses to operate two prepaid payment cards, iCashCard and SmartShop. (Customers pay fees so they can deposit cash at Great Indian Retail-branded kiosks and then use the cards in debit transactions.)

According to the Sept. 25, 2015, notes of Great Indian Technology’s extraordinary general meeting, Wirecard spent a total of 15 million euros on the company — through a 1 million euro cash payment up front and a 14 million euro private placement. Great Indian Technology’s annual report indicates that the company was not very active or profitable; it generated a pretax profit of 21,952 euros for the fiscal year that ended March 31, 2015.

A close read of Wirecard’s discussion of its merger activity in the 2015 annual report reveals that in addition to Great Indian Retail’s payment businesses deal, the company had also acquired Star Global Currency Exchange Private Ltd., an operator of currency-exchange kiosks and shops. (The deal’s press release referred to “StarGlobal” as “a brand,” not a standalone company.)

It’s a curious transaction.

No linkages are apparent between Great Indian Retail and Star Global Currency in public documents. Star Global Currency’s founders, the Balasundaram brothers, do not appear to own shares of Great Indian Retail, and likewise, Great Indian Retail’s founders, the Ramasamy brothers, do not appear to hold stock in Star Global Currency. There are not any listings of related party transactions between the two companies, and Star Global Currency is not referenced in the Hermes Tickets pitch book. Star Global Currency’s website does not even mention Great Indian Retail’s money transfer and currency cards.

What is not in doubt is the math: If Wirecard spent 230 million euros up front, and the combined transaction price for Great Indian Technology (15 million euros) and Hermes Tickets (37.36 million euros) was 52.36 million euros, Star Global Currency should have been worth at least 177.6 million euros.

It was not, however.

Wirecard made a 1.3 million euro investment in Star Global Currency at an implied 2 million euro valuation, according to a March 2016 share transfer form and the FDI circular. Although it was more productive than Great Indian Technology, Star Global Currency booked a small loss on its roughly 32 million euros in gross revenue for the fiscal year that ended March 31, 2016, per its annual report. Nor was the company very big — with just 20 employees, 2.95 million euros in total assets and a book value of 1.71 million euros.

All told, the Southern Investigative Reporting Foundation was able to track 54.36 million euros of the 230 million euros that Wirecard spent on the purchase of Great Indian Retail’s payment businesses, leaving 175.64 million euros unaccounted for.

Stranger still, Wirecard’s cash outflows from investment activity, as disclosed in its filings, clearly indicate that the money for the acquisitions and the 110 million euro incentive payment left its coffers.

So where did the money go? And why isn’t Wirecard alarmed about the missing funds? The answers aren’t immediately apparent.

There is one company, however, that should bear some extra scrutiny: the Emerging Markets Investment Fund 1A, a Mauritius-based fund that has served as an intermediary between the buyers and sellers in all of Wirecard’s India-related transactions.

Star Global Currency’s share transfer filing shows Emerging Markets Investment Fund 1A acting as a conduit, transferring to Wirecard a block of 504,499 shares of Star Destination Management Co. Private Ltd. (Star Global Currency’s parent company). The fund held the shares for 27 days and sold them to Wirecard at cost.

The fund performed the same role — buying stock and then selling the shares to Wirecard shortly afterward — for Hermes Tickets (the FDI circular cites three separate transactions) and Great Indian Technology.

None of Wirecard’s filings discussed Emerging Markets Investment Fund 1A’s role in its India strategy.

Foreign direct investors in Indian companies have used Mauritius-domiciled holding companies to shield their profits from capital gains taxes, but that loophole was largely closed in 2016. Regardless, Emerging Market Investment Fund 1A’s ownership of Great Indian Retail’s subsidiaries’ shares was for a few months at most; to qualify for India’s lower tax rate on long-term capital investments, an investor has to own an asset for a minimum of 36 months.

An email address and a street location listed in the contact information for Emerging Market Investment Fund 1A in Great Indian Technology’s September 2015 private placement letter provide some clues: The email address is associated with another Mauritius-based entity, Emerging India Fund Management, as is the street address.

The website of Emerging India is splashy, and it claims to manage an impressive $1.5 billion through diverse investment strategies, but good luck figuring out who works for the fund or who owns it. The fund is based in Mauritius and uses the address of Trident Trust, an administrator for hundreds of funds that adopt its address for registration purposes. Repeated calls and email messages to Emerging India and Trident Trust were not returned.

Despite Emerging India Fund Management’s claim to have $1.5 billion in assets under management, the Southern Investigative Reporting Foundation could not find any managers of India-based institutional or endowment capital with knowledge of it. There are, however, two private equity transactions that the fund has made — for Orbit Corporate + Leisure Travels, an agency specializing in trade shows and professional conferences, and Goomo, a consumer-focused company with a travel-booking platform that emerged last March from Orbit. The fund, according to the Hindu Business Line report, has invested a total of $180 million in the two ventures.

Wirecard said that other than the Oct. 27, 2015, transaction, it has never had a connection to Emerging India Fund Management and that the fund did not act as a conduit for Great Indian Retail. The company did not address a question about the fund’s ownership.

Several connections exist between the two travel companies and Wirecard.

To start with, one of Orbit’s two listed directors, Ramesh Balasundaram, was Star Global Currency’s co-founder and co-owner. Additionally, the company is described on its shareholder list as “a joint venture with Star Group of Companies,” a reference to Star Global Currency and Star Destination.

Emerging Markets Investment Fund 1A has played a key role, in founding and controlling both Orbit and Goomo, according to Indian corporate filings.

Orbit’s March 31, 2016, shareholder list indicated that Emerging Markets Investment Fund 1A owned 93 percent of its shares. Goomo’s Nov. 11, 2016, Memorandum & Articles of Association listed the Emerging Markets Investment Fund 1A as its primary shareholder and Trident Trust’s Mauritius address as its headquarters; a credit report for Goomo’s Singapore subsidiary recorded the fund as its owner.

A connection between Wirecard and Orbit was spelled out in the Sept. 12, 2015, notes of the extraordinary general meeting for Hermes Tickets’ shareholders, concerning negotiations with Orbit to sell Hermes Tickets’ travel-ticketing business. (Travel ticketing represented 63 percent of the Hermes Tickets’ sales, according to its pitch book.) No further details about that potential sale seem to have cropped up in filings.

Notably, those negotiations occurred at the same time (Sept. 17, 2015) that Great Indian Retail’s owners began to sell shares of Hermes Tickets to Emerging Markets Investment Fund 1A. Just eight days after that, on Sept. 25, Great Indian Technology’s shareholders held their own extraordinary general meeting, where the fund’s 1 million euro share purchase and Wirecard’s 14 million euro private placement were announced.

And there’s an unusual footnote to Wirecard’s purchases of Great Indian Retail’s businesses: Their auditors resign, often.

Hermes Tickets, for example, lost two auditing firms in the space of one week in August 2015, just two months prior to its sale to Wirecard: On Aug. 24 the Kuriachan & Nova firm cited its “preoccupation with other assignments,” and on Aug. 31 the V. Krishnan & Co. firm claimed it was “not being in a position to continue” as the company’s auditor.

At some undisclosed point in the ensuing months V. Krishnan & Co. was rehired, only to resign on June 15, 2016, due to a “preoccupation with other assignments.” All told, three different accounting firms resigned from Hermes between Aug. 24, 2015, and Oct. 17, 2017; V. Krishnan & Co. and Kuriachan & Nova were appointed and resigned twice, a third firm, CNGSN & Associates LLP, was appointed and resigned three times. (Ernst & Young, Wirecard’s auditor, is now the company’s accountant.)

Great Indian Technologies and Star Global Currency also had auditors resign.

Why does this matter? Auditor resignations — especially of the unexpected variety — are closely scrutinized by investors, who often worry that a company’s accountants have discovered something problematic and are giving up the traditionally lucrative audit fees to shield themselves from litigation risk.

The accounting firms did not respond to emailed questions.


Wirecard’s public relations chief Jana Tilz did not respond to questions posed in a series of email message sent before this article’s initial publication.

But on Jan. 24 the company’s investor relations manager Iris Stoeckl and outside public relations adviser Elliot Sloane of FTI Consulting sent responses and Wirecard also made additional comments.

Update: This article has been updated throughout to include Wirecard’s replies to questions posed several weeks ago. The answers are hyperlinked as well at the bottom of the story.

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BofI Federal Bank: Annals of the Bank of Misery

If you put together all the chief executive officers from the financial services industry in one room and asked them, “Who looks back on the years 2007 to 2009 with fondness?” it’s a very safe bet that only one hand would be raised.

That hand would be on the arm of a man named Gregory Garrabrants.

Don’t feel badly if the name doesn’t ring a bell. The enterprise Garrabrants has run since October 2007, BofI Federal Bank — a bank in La Jolla, California — is about as unlikely an institution to have prospered in those years as can be imagined.

As banks, thrifts and mortgage-finance companies were busy collapsing or receiving multiple federal bailouts, especially in Southern California (the epicenter of the global financial crisis), BofI was just beginning an earnings streak that’s seen its bottom line grow at a compounded annual rate of 44 percent since Garrabrants was hired.

Those are not bad returns for a CEO to deliver, especially for someone like Garrabrants, considering his previous job: chief of business development for IndyMac Bancorp, the fourth-largest U.S. bank to ever be seized.

Also not bad: On Oct. 23, 2007, the day Garrabrants’ hiring was announced, BofI’s closing share price was $1.76 and for fiscal 2008 its net income was just less than $4.2 million. By 2010 it was $21.1 million, with its fiscal year concluding on June 30. Today its share price is almost $24, and for the first nine months of the year the bank has reported income of almost $102.2 million.

None of the CEOs at our imaginary gathering can point to results like the stock price performance below of BofI’s for the last nine years.

Prices reflect a November 2015 4-for-1 stock split. Source:
Prices reflect a November 2015 4-for-1 stock split. Source:


Though Garrabrants is only 45 years old, his many achievements as an executive would seem to position him at the center of important conversations about assuming a higher profile in his community or within the banking industry and eventually a spot on the short list for CEO roles at money-center banks.

But those conversations don’t appear to be occurring, for reasons that are becoming increasingly clear.

That’s because Garrabrants is this market cycle’s self-appointed crusader against short  sellers. Put bluntly, he really hates them.

He hates them so much that he spends both shareholder and personal capital discussing his prediction that BofI’s critics will be sent to prison (undoubtedly one with “tiny bars“) for allegedly coercing former employees to make false statements that could drive down his bank’s share price. According to Garrabrants, when evidence emerges from BofI’s lawsuit against former BofI internal auditor Charles Matthew Erhart — whose October 2015 whistleblower complaint prompted Garrabrants’ recent outburst — it will reveal a “coordinated effort” between the media, short sellers and employees like Erhart.

Just as evil as coerced employees in Garrabrants’ Dante-esque “rings of hell” formulation are short sellers posting under pseudonyms on the popular investor website Seeking Alpha. Though several different authors have written critically about BofI, two of them, “The Friendly Bear” and “Aurelius,” have proved nettlesome enough that the bank subpoenaed them as part of the Erhart litigation. (BofI’s quest to get a leg up on short sellers has led it to do some odd things, like try to hire a well-known short seller for tens of thousands of dollars to identify other short sellers.)

Such allegations recall former CEO Patrick Byrne’s 2005 claims that a patchwork of conspiratorial relationships had created a “Miscreant’s Ball.” While Byrne’s allegations received a great deal of (mostly unflattering) attention for and Byrne in the U.S., when his theory was serialized by his colleague, former reporter Mark Mitchell, it proved libelous in Canada.

The current political climate has only inspired Garrabrants’ lexicon: During BofI’s second-quarter analyst conference call in February, he accused short sellers of publishing “fake news” and being “trolls.” In April using a favorite phrase of’s Byrne, Garrabrants referred to “captured media.”

Here’s the thing, though: BofI is winning handily if its income statement is any barometer. Nor should it go unnoticed that the last Seeking Alpha article critical of BofI was more than six months ago.

But if some BofI short sellers aren’t publishing many posts anymore, they don’t appear to have been driven off by Garrabrants’ relentlessly confrontational approach either, judging by the gradually increasing amount of shares that have been sold short.

(Given the amount of personal wealth that many CEOs have tied up in their companies’ stock, and the pressure that institutional investors place on them for short-term gains, expecting CEOs to be indifferent to short sellers is silly. But other approaches exist for a CEO to manage the challenge of having the company’s business model or prospects publicly criticized: Reed Hastings, the high-profile CEO of Netflix, responded to a December 2010 short thesis from prominent hedge-fund manager Whitney Tilson in a courteous, relentlessly logical fashion that not only led to more attention for the company’s rebuttal than Tilson’s initial claim but also proved remarkably effective at restoring the stock’s value.)

Intrigued by BofI’s drama, the Southern Investigative Reporting Foundation spent more than a year investigating the bank and concluded that Garrabrants’ obsession with short sellers is entirely justified: Their skeptical articles on BofI have put the crux of his modern banking miracle at grave risk. From where he sits, anything he and his lawyers can do to distract investors from what’s in the company’s filings is money well spent.

What those filings suggest is that BofI’s business model is quite different from what its management publicly discusses.

Moreover, BofI’s ability to generate the revenue and profits that’s made shorting its shares so painful has less to do with its proclaimed ability to structure mortgages suitable for unconventional but creditworthy borrowers or its deft touch in managing risk than something much more pedestrian: its push into consumer specialty-finance lending.

This is a nice way to describe lending to people or businesses whose circumstances make them wholly undesirable as possible clients for even traditional subprime lenders.

But as a lot of the CEOs from that erstwhile gathering above would attest to, the first wounds from this type of lending show up on the income statement; the fatal ones are on the balance sheet.


To understand where BofI is going, let’s start with where it’s been.

Founded in 1999 as the Bank of the Internet (with an official name change to BofI in 2011), it is a completely online bank without branches. At the time of its 2005 initial public offering, the bank was profitable, generating a little more than $15.7 million in revenue, primarily via lending to multifamily home builders. Let’s call this the era of BofI 1.0.

Fast-forward two years: Given BofI’s modest exposure to single-family home lending, the bank was in good shape just as the global financial crisis spread in the autumn of 2007. The newly appointed Garrabrants quickly took advantage of the widespread price collapse of mortgage-backed securities, particularly in the so-called private label market (securities whose principal and interest payments weren’t guaranteed by either Freddie Mac or Fannie Mae) and scooped up hundreds of millions of dollars of these bonds at rock-bottom prices.

The timing for this trade couldn’t have been better.

As the Federal Reserve and the Department of Treasury pumped many hundreds of billions of dollars into banks and financial institutions, the prices of the bonds rebounded sharply, generating a remarkable windfall for BofI’s shareholders, with virtually no risk. What’s more, the Southern California real estate market stabilized and loan demand climbed. Call this the dawn of BofI 2.0.

As effective as the mortgage-backed securities purchases proved to be, these bonds have been maturing at a rapid clip over the past three years. This has prompted BofI’s management to redeploy capital into a market where risk-adjusted returns are now much lower, while shareholders expectations have never been higher.

The challenge is real enough for Garrabrants and his competitors: Providing construction loans for multifamily properties isn’t terribly lucrative and currently yields about 4.5 percent. Making mostly 30-year fixed-rate loans for single family homes and apartments is even less lucrative, generating around 3 percent to 3.5 percent returns for BofI’s established rivals.

So what will be BofI 3.0?

The answer is that there are two versions: BofI’s and what’s in its filings.

The bank wants investors to believe that its outsized profits are the result of the willingness of primarily wealthy borrowers (with esoteric financing needs) to pay a good deal more for purportedly fast, expert mortgage service on jumbo loans.

Moreover, because BofI, unlike most of its competitors, doesn’t break out the yields on its various loan offerings, investors have to take management’s word for it.

This is how its astounding loan yield (5.72 percent last quarter) becomes the functional equivalent of a grandmother’s apple pie recipe: It’s the best there is but she won’t tell you how she does it, so you’ll have to be content with her explanation of “it’s a pinch of this and a dash of that.”

To be fair, BofI hasn’t given investors much reason to be skeptical.

Consider BofI’s performance in a Bloomberg-generated ranking of banks in the Russell 1000 and 2000 indexes using three criteria: return on equity, return on assets and net interest margin. Out of 272 results, BofI had the second highest return on equity and the eighth best return on assets. And despite its being an internet bank and having to attract depositors by offering higher interest rates than its traditional brick-and-mortar rivals,  BofI had a net interest margin within the top 20 percent of the banks surveyed.

Incredibly, BofI can do this all with loss reserves of just less than $46 million, or 65 basis points, on $7.02 billion of loans. Using the same universe of banks in the Russell 1000 and 2000 indexes from above, BofI placed within the top 10 percent of banks with the lowest ratio of reserves to total loans.

But how a bank arrives at great results matters. And with almost 76 percent of BofI’s third-quarter lending income being derived from single- and multifamily real estate, its arriving at a 5.72 percent yield is no light task.

A more accurate picture of BofI 3.o starts with understanding that the Federal Reserve’s policy of gradually increasing short-term interest rates is not great news for the bank since loans for one and five years are about $3.7 billion of its $8.7 billion in balance sheet assets. While the bank has steadfastly refused to confirm to the Southern Investigative Reporting Foundation whether these loans are adjustable-rate mortgages, it’s a reasonable bet that they are.

Why should that matter to the fast-growing BofI’s investors? During a period of rising interest rates borrowers usually want to cap their interest-rate expense and tend to pick a fixed-rate, 15- or 30-year mortgage. With lending now constituting 90 percent of BofI’s revenue, the looming slowdown in adjustable-rate mortgage-origination fees doesn’t help.

An examination of BofI’s loan portfolio reveals that its growth is now coming from commercial and industrial loans, whose value has spurted 80.5 percent from 2016’s third quarter to March 31 of this year.

Getting to the bottom of what drove BofI’s commercial and industrial unit’s nearly $400 million loan growth is a different matter though. BofI, to put it mildly, doesn’t give much guidance to investors, but evidence suggests that the company has been aggressively carving out a niche, serving as a lender of choice for lenders of last resort. The banks that BofI has financed are nonbank consumer-finance operations like Quick Bridge Funding and BFS Capital; they lend — at rates often north of 50 percent — to small businesses and individual borrowers not able to qualify for loans elsewhere.

How the Southern Investigative Reporting Foundation zeroed in on subprime lending as BofI’s new growth engine went like this: In early 2016, a quick search of the electronic court record system PACER and state court records yielded nearly 50 results for BofI Federal Bank, many for personal or business bankruptcy cases, as well as claims of default.

Why would a relatively small bank outside San Diego be listed as a creditor in bankruptcy claims for a New Bedford, Massachusetts, garbage disposal company, a Dumont, Iowa, truck driver and a Farmers Branch, Texas, imported car showroom?

The loans weren’t small, either: New Bedford Waste and a sister company took out $1.95 million in loans, for example, and Texas Import Sales borrowed $600,000. So when these businesses collapsed, real money was lost. (Odder still was the fact that in most cases these BofI-backed loans were personally guaranteed, bearing none of the asset claims or capital structure seniority that other lenders had in their loans to these companies. In other words: the only real security behind these loans were the personal guarantee from heavily indebted or recently bankrupt borrowers.)

So despite most bankruptcy filings being about 60 pages of deadly boring, bare bones reading, after the Southern Investigative Reporting Foundation studied the initial 50 BofI-related cases, and having interviewed 18 of the individual filers, it appeared that BofI is a central cog in a growing lending business that few have known about, let alone understood.

What is this new lending business?

From the outside, it’s supposed to look like factoring of accounts receivable, a legitimate and longstanding method of using short-term secured loans to improve a company’s cash flow. (A factor purchases a business’ invoices or accounts receivable at a discount to their face value. The difference between what’s paid and what comes in is the factor’s profit.)

A legitimate receivables factoring transaction involves a factor carefully scrutinizing the quality of the receivables and the borrower’s cash flow cycles; the word “careful” is not reflective of how these BofI-backed “working capital loan” and “business funding” operate.

With the ability to fund loans in a week or less, these lenders can quickly structure a $10,000 cash advance in exchange for the purchase of $13,500 in future receipts. Crucially, the lenders require access to a borrower’s primary business checking account, using the automated clearing house system to draft weekly — and sometimes daily — withdrawals of a fixed amount of principal and interest. If the weekly withdrawal doesn’t go through, a series of steep fees and interest rate penalties are assessed.

Most borrowers with whom the Southern Investigative Reporting Foundation spoke to described the process of repaying this type of transaction as incredibly difficult, considering the typical 40 percent interest rate. And when penalty fees and the like are assessed, the rates can be 50 percent or more, forcing many borrowers to seek relief through bankruptcy.

It’s fair to ask hard questions about these borrowers and what decisions led to their inability to repay loans that they entered into willingly, despite the steep terms. An equally valid consideration is why BofI-backed companies willingly competed to lend these troubled borrowers large sums of money, despite many dozens of documented prior bankruptcies, collapsed businesses and mountains of prior debt.

One thing is clear: This kind of lending, however distasteful, is perfectly legal. More important, it’s very lucrative.

This is the world of BofI 3.0, the Bank of the Internet’s lightly disclosed transformation into the Bank of Misery.


BofI’s foray into this type of lending is centered on something often described as “rent a charter.” It’s exactly what it sounds like: making loans to a borrower for an institution that doesn’t have a federal banking charter. While this is an idea that has been around for several decades and is often frowned upon, it’s a completely legal win-win for all involved.

The consumer lender gains a way to charge astronomical interest rates since usury laws don’t apply to federally chartered banks, and BofI can charge origination and processing fees, perhaps even capture some interest, before transferring the loan to the likes of BFS Capital and Quick Bridge Funding within 24 or 48 hours. (There are dozens of these operations but documents suggest that BofI works most closely with these two.)

This would appear to be a nearly risk-free transaction for the bank that generates perhaps a few thousand dollars of revenue per loan; at the very least, it’s nothing that would upset a curious investor.

It’s not a surprise that BofI painted just that picture in one of the very rare occasions the bank even acknowledged operating in this marketplace. On the third-quarter’s conference call in April 2016, Garrabrants said the “credit quality in our C&I book remains pristine” and the loans are “contributed to a bankruptcy-remote, special-purpose entity owned by the nonbank financial services company.” (That last sentence is a mouthful but what he meant is that all these loans are now someone else’s problem, legally and financially.)

But there’s a hook, and as these things go it’s a damned big one. What BofI does is not at all like the easy, two-step process described above; it appears that in many instances BofI lends the money to BFS Capital and Quick Bridge so they can purchase BofI’s loans to a borrower at par value. Whatever BofI’s precise role in this marketplace is, and it appears to be a gnarly mash-up of secured borrowing as well as both lender and vendor finance, it’s not as passive a process as it’s made out to be.

Nor is the business line that BofI now calls “lender finance” as risk free as claimed.

One of the clearest illustrations of this is detailed in an adversary proceeding filed in March by a trustee in federal bankruptcy court against BofI, Quick Bridge and others in the Chapter 7 proceedings of Lam Cloud Management LLC. A Cranbury, New Jersey-based data center, Lam Cloud Management filed for bankruptcy in May 2015. (BofI did not file a response to the claim.)

The trustee alleged that BofI and Quick Bridge conspired in a “blatant and transparent attempt to evade [New Jersey] usury laws, [Quick Bridge] engaged in a ‘rent a charter scheme’ by retaining BofI, a federally chartered bank, to originate the [Quick Bridge] loan.” More broadly, the claim alleges that the repayment terms proved so onerous that much in the business plans that the loans were supposed to pay for had to be scrapped, and a vicious spiral developed, with the company taking out second and third loans to remain current on its prior loans.

The six-month term loan was for $132,000 and, per the trustee’s complaint, it carried an effective annual interest interest rate of 76 percent, including $9,135.26 in origination and processing fees. (Apart from fees, the loan’s interest rate was 31 percent for six months, or 62 percent annualized.)

Repayment was via an automated clearinghouse withdrawal of $1,372.38 for 126 consecutive business days. At the time of Lam Cloud’s bankruptcy filing, $51,658 in principal and interest payments were unpaid.

The trustee’s claim spared little in its assessment of the “introducing broker” Synergy Capital as having “deceptive and unethical tactics” that “fraudulently induced” the debtor to take out three loans. (The introducing broker matches the borrower and the lender for a commission and is not connected to BofI directly.)

Most non-bank consumer finance companies rely heavily on unaffiliated so-called independent sales organizations to provide a flow of prospective borrowers and, to be polite, their sales tactics are often very high-pressure. That’s because many independent sales organizations were founded by men who worked at 1990s boiler rooms. Synergy’s co-founder, Glen DeLuca, for example, has a résumé that’s heart attack inducing, including the fact that he lost his securities brokerage license in August 1998 for failing to pay restitution to clients on another matter.

Not having a license didn’t stop him from selling stocks for several more years; what did, however, was his 2001 indictment for manipulating stock prices while working at Euro-Atlantic Securities, a brokerage that federal prosecutors alleged had members of the Colombo family, then one of New York City’s leading organized crime outfits, as secret owners. (DeLuca was sentenced to four years of probation, fined $10,000 and ordered to do 200 hours of community service. He didn’t return several messages left for him.)

On May 19, the trustee filed a notice of settlement with the court; BofI and Quick Bridge agreed to pay $30,000 and drop any claim related to the loan.

For its part, BofI’s spokesman Stuart Pfeiffer disagreed mightily when asked if the Lam Cloud settlement could serve as a precedent for borrowers or trustees to potentially sue BofI in other bankruptcy cases. In a follow-up statement, the bank said that negotiating a settlement before a response was due saved a great deal of money in legal fees, while drawing attention to the language of the consent order, which said both BofI and Quick Bridge Funding “informally” denied “any liability” against the trustee’s allegations.


Time spent studying the ecosystem of these loans, the lenders who make them and the borrowers who affix their electronic signature is an immersion in the rich broth of contemporary American failure.

After the Southern Investigative Reporting Foundation interviewed the 18 people who had listed BofI-backed consumer lenders as major creditors in bankruptcy, a question that became impossible to avoid was “Didn’t anyone vet you before you borrowed money?”

The answer is it depends on whom you ask.

As noted above, Garrabrants assured investors in April 2016 that the bank’s credit team “carefully monitors the borrowing base and underlying collateral value of loans.”

The recent career of one Mehrasa “Tony” Khodaverdi, a businessman in the Houston suburb of The Woodlands and the owner of Verdi Enterprises, a clothing, shoes and handbag wholesaler, who borrowed $35,600 from BofI on Feb. 17, 2016, could lend validity to the theory that there are different interpretations of “collateral” and “credit review” in circulation.

On Feb. 24, 2016, BofI assigned the loan to BFS Capital. (In many filings BFS Capital is listed under its trade name, Small Business Term Loans.) Despite his having made payments for 11 months, Khodaverdi defaulted in January with $25,341 left on the loan, according to a claim the lender filed in Montgomery County court on March 30.

The loan was unsecured, which was an unusual approach for BofI to take, given the fact that Khodaverdi had filed for bankruptcy in 2008, listing more than $1,060,000 in debts against $70,325 in assets. Moreover, in June 2013 he had been arrested and charged with felony aggravated assault.

Whatever the merits of second chances and Khodaverdi’s new business (he had owned a pair of restaurants in the Hattiesburg, Mississippi, area when he filed for bankruptcy protection in 2008), it’s unclear how granting him a loan using only his personal guarantee was a good credit decision. (A call to Verdi Enterprises was not returned and BFS’ attorney in the matter, Mark Bagnall of Jameson & Dunagan in Dallas, declined to comment.)

Every lender expects some delinquencies and losses. According to, the national credit card charge-off rate last year was 3.17 percent of all balances, down from 9.40 percent in 2009. But Khodaverdi’s bankruptcy claim is no outlier.

Getting to the bottom of how many bad loans have a connection to BofI isn’t easy, especially with the bank’s use of registered agents to cloak its clients’ identity on some UCC filings, like Khodaverdi’s. But using a combination of Bloomberg Law’s database and PACER, the Southern Investigative Reporting Foundation found 562 claims of default or bankruptcy creditor listings for Quick Bridge Funding and 82 of the same for BFS Capital. (As of now, it’s unclear how many have a connection to BofI.)

To date, about 70 of these are connected to BofI but the figure is growing as filers and defendants confirm (through documents) the bank’s role as a loan facilitator through a warehouse facility or so-called rent-a-charter activity.

According to BofI, the Lender Finance business is akin to financial alchemy: a growing hill of troubled loans doesn’t ever touch BofI — not a single penny of loss — while simultaneously being a dynamic profit engine whose prospects are bright.

If all this were not baffling enough, things got kicked up a notch when the Southern Investigative Reporting Foundation came across a motion filed in California Superior Court that Momentum Business Capital, an independent sales organization, brought against Quick Bridge Funding as part of a broader contract dispute.

In the motion filed on June 5, one of the exhibits contained a declaration from Ben Gold, Quick Bridge Funding’s co-founder and president, who, when asked to describe his company’s business model, said his company “acts as an agent and underwriter for BofI Federal Bank.” This would appear to suggest BofI is his company’s sole source of loans.

Similarly, at the end of the document is a very brief excerpt from a deposition of Quick Bridge’s chief executive officer, David Gilbert, who said that BofI prohibits his company from selling loans to third parties.

“As far as I know within BofI, we’re allowed to work on the revenue side, not the asset,” said Gilbert, using industry jargon for the loans. “We cannot sell the asset.”

Additionally, Gilbert said Quick Bridge was allowed to participate in the “revenue side” of the loan’s ownership, presumably meaning the cash from its interest income. (This begs the question, If his company owns the loan, what would prevent Quick Bridge from full revenue participation? Or with which other company must Quick Bridge share the income?)

So while these are only snippets submitted by one side in a legal argument, the Gold and Gilbert interviews have profound effects for BofI, if either regulators or their auditors read these documents.

Let’s boil a brutally complex issue down to its essence: BofI has promised, at length, that its balance sheet shows none of the credit risk associated with these often troubled loans because they have been sold to a business partner.

Gilbert’s deposition throws a big wrench into this argument.

He did this when he disclosed that Quick Bridge is forbidden from selling (or pledging) the “asset,” despite having paid the full value of the loan. Nor does his company appear to have full profit participation. (Gilbert didn’t return several calls and an email seeking comment.)

What lies at the bottom of the Pandora’s box of accounting “what ifs” that Gilbert’s remarks opened up?

Gilbert’s testimony about restrictions on selling and profiting from the loans implies they shouldn’t be accounted for using what PriceWaterhouseCoopers calls “sale accounting,” meaning that in some measure, they would have to be accounted for on BofI’s balance sheet. Very few investors want a bank that has a balance sheet with millions of dollars worth of loans to Mehrasa Khodaverdi.

The Southern Investigative Reporting Foundation asked BofI about Gilbert’s testimony in the deposition and the possible risk to its business.

While BofI did not address the remarks, a spokeswoman strongly defended its approach to lender finance: “The accounting treatment on our balance sheet and income statement is consistent with all applicable accounting rules and regulations and thoroughly reviewed and vetted by BDO, our external auditor.”

(After publication, the bank sent a follow-up statement noting it couldn’t comment on the Gilbert deposition but that the borrower — Quick Bridge — is free to do what they wish, provided criteria like “the loan balance is paid in full” or “excess collateral is available.”)

That may be true, but the accounting rules, as laid out by the Financial Accounting Standards Board’s Accounting Standards Codification 860, don’t appear to support the argument that loans in a “bankruptcy remote, special purpose entity” are completely free of BofI’s influence.

Let’s put on the green eyeshades, briefly. Last August Ernst & Young publicly released a lengthy document, Transfers and Servicing of Assets, that while a soul-crushingly dull read, does have an enlightening section about a “decision tree” that can guide accountants when addressing such issues.

In the middle bubble, the hypothetical question that could be posed to the auditor goes to the heart of this matter: “Does each transferee have the right to pledge or exchange the assets it received, and no constraint on the transferee provides more than a trivial benefit to the transferor?”

Based on Gilbert’s responses, it appears the answer for BofI is “no.”


BofI investors should settle down and get comfortable with the BFSes and Quick Bridges of the world, since the bank is making a big commitment to what’s called “the lending marketplace,” a series of lending platforms that seek to connect pooled lenders and borrowers.

To that end, in April the bank extended a $400 million loan to Victory Park Capital, a private equity firm whose portfolio includes numerous investments across the subprime spectrum, including AvantCredit, Borro, Kabbage and FastTrak Legal Funding.

The Victory Park Capital loan appears to have been secured by holdings in several Victory Park funds, according to Uniform Commercial Code liens that BofI filed (see pages 55 and 56). Richard Levy, Victory Park’s general partner, didn’t respond to several emails seeking comment.

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BofI Federal Bank: Disclosing Little, Saying Less

BofI Federal Bank’s disclosure practices seem baffling at best if the standard it’s judged by is how well it informs investors about developments that could potentially change the risk profile of their capital.

In fairness to BofI, the key word here is “baffling” since the laws governing U.S. corporate disclosures have few bright lines and a great deal of murkiness.

As Steven Davidoff Solomon noted in a New York Times column, the Supreme Court upheld in 2011 a previous ruling that if “disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available,” a public company’s failure to reveal certain information is considered “material” and could potentially subject it to civil and criminal investigation.

Left unsaid is the fact that companies may have their own opinions on who’s a “reasonable investor” and what he or she might consider “significant.” Hint: Companies often find ways to claim news that would prompt probing phone calls from investors and reporters isn’t significant enough to merit disclosure.

So, for example, Valeant Pharmaceuticals International went out of its way to tout its January 2013 hiring for its executive management team a former Medco Health executive Laizer Kornwasser. Valeant listed him on the company’s proxy statement and gave him a wide-ranging mandate, including oversight of its new relationship with a company called Philidor Fulfillment Services. When Kornwasser left in July 2015, however, the company didn’t say a word.

Accountants have long used a rule of thumb that if not the law is widely accepted as a fair guideline for materiality: If a company misreports a metric by more than 5 percent, that’s material and should be disclosed.

These already muddy waters turn pitch black when it comes to a company’s obligation to disclose regulatory investigations, said Tom Sporkin, a former Securities and Exchange Commission supervisory official now in private practice at Buckley Sandler LLP.

“There’s no hard and fast rule about disclosing an SEC investigation,” he said, noting that companies often retain a separate attorney to advise their general counsel on what should be disclosed. “Where materiality comes into play is if the investigation is centered on a key [officer] like the chief executive or the prospective financial liability threatens its operations, but presumably the subject would consider that.”

Sporkin, whose father Stanley Sporkin was a former SEC chief, added that the SEC tends to avoid weighing in on this issue apart from when “the public interest is clearly served,” such as in the case of a breach of a credit card company’s sensitive consumer information databases.

So BofI has a great deal of latitude about what it can tell investors. Some of the issues the bank’s management seems to think investors needn’t be bothered with are at least two regulatory probes.

Multiple former BofI employees told the Southern Investigative Reporting Foundation that within the past six months they had spoken at length to the Department of the Treasury’s Office of the Inspector General about BofI’s loan document preparation and how information about some of this had been presented to regulators. (These individuals refused to speak on the record, citing ongoing contact with the Treasury Department’s inspector general office as well as fear of legal reprisal. They said they had not had any contact with short sellers or lawyers suing BofI.)

An investigation does not suggest that the Treasury’s inspector general’s staff — which often works with the Department of Justice — would conclude any wrongdoing occurred. As of publication, BofI had not responded to a request for comment.

In March the New York Post reported that the Office of the Comptroller of the Currency, BofI’s primary regulator, is investigating whether foreign nationals had the proper tax identification prior to obtaining loans from BofI. The bank’s chief legal officer, Eshel Bar-Adon, referred to the Post report as “silliness” and said the company’s CEO Gregory Garrabrants had previously addressed these allegations. The bank hasn’t been charged with any wrongdoing.

To John Gavin, who runs the Probes Reporter, a Plymouth, Minnesota–based research service that uses Freedom of Information Act requests to detect ongoing SEC investigations, the question of whether BofI is being investigated was settled on May 25. That day Gavin received a notice from the SEC’s Freedom of Information Act officer denying his request “for certain investigative records” involving BofI because “releasing the withheld information might reasonably be expected to interfere with ongoing enforcement proceedings.”

Ordinarily, Gavin said in an interview, he would have been content to leave it at that. But he saw, via another FOIA request, how BofI executives were using FOIA to learn the identities of other individuals seeking information on the bank.

On Aug. 30 Gavin posted an article on Seeking Alpha correcting assertions by BofI CEO Garrabrants and Brad Berning, an analyst with Minneapolis-based brokerage Craig-Hallum, that market chatter about a possible SEC investigation of the bank was groundless. A few months ago, on Feb. 28, Gavin released a report asserting his findings of an ongoing investigation.

(In July 25 Craig-Hallum’s Berning had published a report, citing his Freedom of Information Act work as the basis for dismissing claims of an SEC investigation. Two days later, however, Gavin pointed out that Berning had received a notice from the SEC’s FOIA officer identical to what Gavin had received on May 25. This didn’t prompt Berning to re-evaluate his thesis, though. In a Aug. 31 note, he listed a series of reasons for considering the SEC’s FOIA result a “false positive.” Berning didn’t reply to an email and voice mail seeking comment.)

To be sure, as both Gavin and Berning observed, most SEC enforcement probes are closed without any action being taken.

Asked about Gavin’s work, BofI’s outside public relations counsel, Sitrick & Co’s Stuart Pfeiffer replied, “Due to false allegations made in short seller hit pieces and pending litigation, agencies routinely ask questions to assure themselves that such allegations are without basis. However, there are no material investigations that would require public disclosure and BofI remains in good regulatory standing.”


BofI’s disclosures about the nuts and bolts of its operations aren’t much more substantial than its sharing of regulatory probes, although the hush is stranger because the bank appears to have excellent financial results.

Consider FICO scores, the ratings system of credit strength for borrowers that’s a standard feature in the discussion and analysis of every bank’s lending operations. If a bank has a sizable amount of loans with lower FICO scores on its balance sheet, smart investors need to closely watch reported delinquencies and loss reserves.

BofI has an unusual FICO disclosure policy. The borrower information available for its small but rapidly growing portfolio of automobile and recreational vehicle loans is a model of clarity, telling investors the average FICO score and how much has been set aside to cover possible losses. As of March 31, BofI had a little more than $131 million of these loans on its balance sheet.

On the other hand, BofI doesn’t break out borrowers’ FICO scores for its $3.8 billion worth of single-family home loans. What the bank does disclose, in a veritable river of impressive-sounding mortgage industry jargon, is only marginally helpful in assessing the risk these loans pose to its balance sheet.

Here is an excerpt of what Garrabrants said on a third-quarter conference call in April: “The details of our third-quarter 2017 originations are as follows; the average FICO for single-family agency eligible production was 753 with an average loan-to-value ratio of 66.5 percent. The average FICO of the single-family jumbo production was 708 with an average loan-to-value ratio of 61.6 percent.”

Make no mistake: The single-family home loans Garrabrants referenced carry fine FICO scores, but the vast majority of them were probably sold off to the giant mortgage guarantors, Fannie Mae and Freddie Mac, generating profit for BofI. It would not be surprising if some of the jumbo loans had been sold off to Freddie and Fannie or another banks. In other words, the FICO scores the bank tells investors about tell them the least about balance sheet risks.

Many of BofI’s direct competitors, EverBank and HomeStreet Bank, for instance, disclose the FICO scores of loans kept on their balance sheet. Even Wells Fargo, a vastly larger competitor that’s recently gotten in truly hot water for other things, spent a whole page of its annual report breaking out its borrowers’ FICO scores.

Tamara Taylor, a BofI spokeswoman from Sitrick & Co., said the bank doesn’t disclose FICO scores on its portfolio of retained loans because its officials “aren’t required to.” She said that BofI’s filings break out loan-to-value bands on its single-family loans.

One of the ironic consequences of BofI’s weak disclosure practices is that this has breathed life into its own worst enemy: a small group of anonymous short sellers who plague the bank on Seeking Alpha and on Twitter. If BofI had been more forthcoming, they wouldn’t have been as likely to spend prodigious amounts of time and money to surface what they argue is material information that the bank didn’t want released.

One of these short sellers, whose pseudonym is “Spotlight Research,” posted a December 2014 Seeking Alpha article claiming that the bank was relaxing its documentation standards in making loans to foreign nationals in red-hot markets like Miami and Southern California. As proof, the author posted a BofI account executive’s presentation to mortgage brokers touting the bank’s lending to foreigners as a specialty. (The “Spotlight” author argued that foreign borrowers, who often lack many forms of documentation that are standard for U.S. borrowers, posed an enhanced risk for money laundering violations.)

Garrabrants briefly alluded to this controversy in an August 2015 New York Times article, arguing the foreign lending business line was “nowhere near the majority” of the company’s loans.

A formal disclosure about these type of loans came only two and a half years later during an April conference call, when Garrabrants said that this program now amounted to “15 percent of its jumbo mortgage production.” BofI didn’t provide a dollar value for this business on the call and refused to answer the Southern Investigative Reporting Foundation’s questions about it.

In August 2015 another short seller “The Friendly Bear” posted an article claiming that BofI was doing business with at least one broker who was pitching loans to residents of U.S. Treasury-sanctioned nations like Ukraine and Russia; the author suggested he had reviewed several loans made to residents of these countries in state filings.

Garrabrants, in the 2015 Times article, said that no regulators had raised concerns despite multiple reviews of his bank’s operations. This past April, he told investors and analysts that the foreign loans were of excellent credit quality and that the bank hadn’t sustained any credit losses from them. BofI declined to answer more specific questions about this business.

The Southern Investigative Reporting Foundation located 40 mortgages from BofI to Russian and Ukrainian nationals for New York City and Miami properties. Another 36 Chinese nationals were identified as BofI borrowers, primarily for properties in Southern California.

One of the more interesting borrowers was Vadim Shulman, a Ukrainian national and alleged billionaire who took out a $12.5 million five-year adjustable rate loan in September 2014 from BofI at a 5.25 percent interest rate to purchase a stunning house in Malibu for $25 million.

For a man who’s that rich, the loan is an odd move, costing Shulman about $237, 324.80 a month, and the rate will rise to 8 percent in September 2019.

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BofI Federal Bank: Sleeping With the Enemy Can Cost a Bank a Lot of Money

In the evening of Aug. 8, 2016, a retired hedge fund manager named Marc Cohodes was puttering around the house on his Cotati, California, farmstead when he received a most unusual phone call.

The caller was Polly Towill, a partner with Los Angeles’ Sheppard Mullin and, according to Cohodes, she got right to the point: She was calling on behalf of her client, La Jolla, California-based BofI Federal Bank and she was authorized to explore retaining him as a consultant. What the bank needed him for, said Towill, was to help the bank’s legal team and its CEO, Greg Garrabrants, better understand how short sellers developed their opinions and how they shared their views.

Of particular interest to BofI, said Towill, was anything Cohodes knew about short sellers who published their research on Seeking Alpha, especially the one who used the pseudonym “Aurelius.”

Given who Cohodes is, a more improbable request is difficult to imagine.

A short seller for 30 years as a partner — and then general partner — of a prominent short-biased hedge fund, Cohodes undoubtedly knows most members of the small community of dedicated short sellers either professionally or socially.

(His approach to short selling is simplicity itself. Those few hardy souls who are willing to wager considerable sums against popular or beloved companies, regardless of market or economic conditions have what he describes as nothing less than “a genetic defect.” Most people are predisposed to be curious about how things work; Cohodes and his friends wonder how things break.)

Moreover, unlike most short sellers who keep a low profile for fear of attracting legal headaches and inducing costly short squeezes, Cohodes is unafraid to vocally defend the right of short sellers to publicly express critical opinions without being sued.

And these days now that he is free of the concerns of running a hedge fund, Cohodes is practicing what he preaches, big time. He regularly takes to Twitter — where he has a following of 14,400 — to riff on whatever enters his mind, such as delivering eggs from his free-range chicken flock to a San Francisco store, companies he’s shorted with his personal account, his fondness for the rock band Collective Soul and rum punch. On occasion he’ll put on a collared shirt and expand his Twitter schtick into a presentation, as he did when he appeared at the Grant’s Interest Rate Observer conference in April.

It’s best to not let Cohodes’ amiably profane informality mislead you, however. His commitment to short-selling companies that are, in his view, both mismanaged and operationally unsound is every bit as robust as it was when he was a hedge fund manager.

A glance at the one-year stock price chart of two of the companies he recently shorted, Canadian mortgage lenders Home Capital Group and Equitable Bank, suggests that he’s generating a nice return for himself, rum punch and free-range chickens aside.

So as Cohodes saw it, a call from a lawyer asking him to help BofI draw a figurative map to manage its response to a multiyear drumbeat of short-seller criticism, while possibly exposing other short sellers to litigation, was mighty damned strange.

Cohodes, whose public discussion of his short positions over the decades have made him intimately aware of the litigation process, told the Southern Investigative Reporting Foundation that he initially decided to respond “straight — no emotion, nothing.”

“I told [Towill] that since I’d never said or written a word about BofI, I’d be useless,” Cohodes said. Trying to be polite, he suggested only that Towill and Garrabrants need not worry about short sellers, he recalled.

“Buckle down, execute on your plan and try to be as open as possible. The stock [price] will take care of itself,” Cohodes remembered telling Towill. (In an email reply to Towill after the conversation ended, he reiterated this suggestion.)

Towill acknowledged this was “decent advice” but wouldn’t take Cohodes’ broader hint to drop the matter. He said she told him, “Greg is really upset with all the criticism being leveled at [BofI] and they needed advice on how to counter it.”

She asked if Cohodes would be willing to sign a contract and become a consultant. When he replied that he’d only done this once, charging $1,100 per hour, she wanted to know if that was still his going rate. Cohodes then tried being outrageous and countered, “$15,000 an hour, three-hour minimum, all expenses paid.”

Towill didn’t blink and asked, “Is that your final offer?”

Trying the direct approach, Cohodes plainly said there was no way he’d work for BofI.

Finally seeming to understand that he wasn’t going to consult for BofI, Towill floated  the possibility of using a subpoena.

“I told her this would be a terrible idea,” said Cohodes, who noted that she hasn’t subpoenaed him.

(Cohodes’ view about possibly receiving a subpoena? He is rich, has time on his hands and he “would never shut the fuck up about BofI,” potentially turning any legal proceeding into a three-ring social-media circus. As things stand, he has aggressively started criticizing the bank on Twitter.)

Towill did not return a phone call seeking comment.

BofI’s external public relations counsel, Sitrick & Company’s Stuart Pfeiffer, in response to questions from the Southern Investigative Reporting Foundation, provided a statement: “While we can confirm that Ms. Towill spoke to Mr. Cohodes, we are unable to discuss why the call was made or provide other answers that may constitute a waiver of privilege.”

Editor’s note: Marc Cohodes, through a charitable trust he controls and in conjunction with a conference appearance, in October 2017 made a $15,000 donation to the Southern Investigative Reporting Foundation. The interview with him for this particular article was conducted prior to his making the donation.

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Prospect Capital: The Enemy Within

John F. Barry III, the founder, chairman and chief executive of business development company Prospect Capital in Manhattan, can’t seem to get any respect.

In June 2015 Prospect took out an advertisement in Barron’s that sought to attract more investors by touting its then 12.4 percent dividend yield and the share price promptly dropped.  A shareholder wrote a tongue-in-cheek essay calling Prospect “the most hated stock on Wall Street.” Over the past six months both the Wall Street Journal and New York Times have written critically — to varying degrees — about the company’s portfolio valuation and dividend payment practices. Not to be outdone, short sellers, who have had the company in their sights for nearly five years, are broadcasting their own list of grievances about Prospect’s operational and accounting disclosures. Posts about the company or its prospects go up on Seeking Alpha nearly weekly and attract dozens of commenters who weigh in with full-throat for days at a time.

Incredibly, a Well Fargo research analyst has even gone so far as to issue a “Sell” recommendation on its shares.

Why does a company with under a $3 billion market capitalization arouse the passion usually reserved for disputes over so-called battleground stocks like Herbalife or Tesla Motors?

One reason for the intense feelings is attributable to Prospect’s corporate structure as a business development company, an unusual hybrid of commercial lender and investment fund. At bottom, it’s a federally chartered closed-end fund required to invest at least 70 percent of its assets in the debt or equity of small- and medium-sized companies and distribute 90 percent or more of its income to investors. Because of this, a large percentage of BDC investors are attracted by the dividends; in Prospect’s case, the $1 monthly dividend gives its shares just over a 12 percent current yield.

But BDCs also have limits on their ability to pay dividends if the debt-to-equity ratio goes above 100 percent. At quarter’s end on March 31, Prospect’s ratio was 73.8 percent. A BDC not paying dividends would be hard pressed to retain many investors.

There’s a precedent for this kind of fight and it’s the stuff of Wall Street legend: Greenlight Capital’s David Einhorn waged a bitter multiyear struggle against Allied Capital, a BDC that he sold short in 2002 because of what he said were numerous financial irregularities. While Allied eventually was sold to a competitor in 2010 at a fraction of its peak market capitalization, the many millions of dollars of expense Greenlight incurred made it a Pyrrhic victory. (In an ironic twist, shortly before its sale, Allied caustically rejected an unsolicited merger bid from Prospect.)

Based on a Southern Investigative Reporting Foundation investigation into Prospect’s $1.1 billion book of collateralized loan obligation investments, it appears that investor concerns over valuations are well-placed. Then again, the risks to shareholders from incorporating market prices into their CLO portfolio are much less than management’s dexterity with esoteric accounting maneuvers.


Recall that CLOs are special purpose vehicles whose various sections, known as tranches in Wall Street parlance, are fixed-income securities made up of corporate loans. The CLO’s principal and interest is paid from its highest-rated, or most senior, tranches on down; credit losses are absorbed from the bottom up, with the unrated piece — the “equity”– bearing both the CLO’s highest interest rate and absorbing all of its initial credit write-downs. (The CLO’s higher-rated tranches can change hands with frequency but the liquidity of an equity deal is often spotty.)

BDCs like Prospect find CLOs attractive because from a risk perspective, they offer a diversified pool of loans that is higher in the capital structure than corporate debt, enabling them to get paid back first if a default were to happen. Prospect and several rival BDCs have built extensive CLO equity portfolios because given the nature of their structure, the equity tranches can target 12 percent to 15 percent annual returns.

Prospect’s approach to valuing its CLO book has been a source of sustained controversy for the company.

Critics like Wells Fargo research analyst Jonathan Bock, who issued the “Sell” rating in April discussed above, argue Prospect’s peers have shown little hesitation in reducing the value of similarly constructed CLO equity portfolios. He compared Prospect to Eagle Point Credit and highlighted the then 21-point spread between the two: at the end of last year, Eagle Point’s CLO book was valued at 55.6 percent of its estimated fair value while Prospect marked it at 76.3 percent.

While an imperfect comparison, that 20.7 percentage point differential between the two portfolios illustrated the point that the stakes are very real, representing a notional $230 million hit to Prospect’s equity value and the loss of millions of dollars in fee income for its management.

For its part, Prospect has said that it has no control over the actual portfolio valuation process since it’s done under contract by Gifford Fong Associates, a California fixed-income analytics consultancy. It’s an unusual choice: Gifford Fong certainly has an established practice in financial theory and mortgage-backed securities pricing, but based on numerous calls to CLO trading desks and investment managers, no one had heard of it being used to provide pricing. (With no centralized exchange, price discovery in the $881 billion CLO market is usually done using broker-dealer pricing services.)

Fong did not respond to a pair of phone messages and an email.

Nor has Prospect’s management done itself many favors in communicating how it arrives at its valuations, often seeking to redirect questions into discussions about the importance of being the CLO equity market’s biggest investor or the top-ranked collateral managers who structure and issue the deals they buy.

A question during Prospect’s second-quarter conference call last year is illustrative of Prospect’s roundabout way of addressing CLO valuation questions.

On Feb. 5, 2015, Raymond James Financial analyst Robert Dodd asked President and Chief Operating Officer Michael (Grier) Eliasek why four CLOs were sold for losses after being carried on the books at a premium to their acquisition price: “So I mean was there something particularly problematic about these that changed from the end of September to the period when you sold? . . . And I mean is there something we should read into that as to the overall book being marked above par when we’ve got the four most recent cases . . . all marked above par?”

In response, Eliasek said, “I would not read too much into that, Robert, there [are a] few other dynamics at play here,” before discussing how Prospect was in a position to “throw its weight around” and obtain original issue discounts and rebates, which were something that didn’t “travel with the deal” if they sold the paper in the market.

(To be sure, a company’s having a lower cost basis than competitors often makes it an investment incrementally more profitable but such an analysis is not taking into account portfolio valuations.)

Prospect’s management also argues that having what they term a “call right,” where their status as the majority investor in an equity tranche gives them the ability to compel the distribution of the underlying loans to investors, should justify a premium valuation.

But it’s not apparent this is currently applicable given what’s known as “negative net asset value,” where the cost of the equity tranches exceeds fair value, or the estimated price they’d get if they were sold into the market. Based on a survey of the conference-call transcripts of other BDCs that buy CLO equity, only Prospect is making this argument.

Put another way, it doesn’t make economic sense to break apart something that cost $25 when the sum of its parts is worth $23.50. As of the end of the March quarter, according to Wells Fargo’s Bock, 23 of Prospect’s 38 CLOs had negative NAVs.

To see whether Prospect’s CLO equity valuations have reflected prevailing market values, the Southern Investigative Reporting Foundation used trade level indications and bid-list data provided by investment-banks active in the CLO market. In two instances the public filings of Prospect’s rival BDCs were used. To make the process as fair as possible, only trades made within 30 days before or after a quarter’s end were included.

The chart below represents the Southern Investigative Reporting Foundation’s estimate of this valuation differential.

Screen Shot 2016-08-03 at 2.07.45 PM

The Southern Investigative Reporting Foundation found 13 instances where Prospect’s marks differed sharply from the prices other investors were paying for them. This differential started at the end of 2014 and in aggregate suggest that management was able to avoid at least $83 million in portfolio value reductions. (In imposing a 30-day cutoff before or after a quarter’s end, the foundation removed 10 instances of trades done at appreciably different pricing levels but as much as three months after a reporting period.)

For example, in an April 13 email given the Southern Investigative Reporting Foundation, a CLO trader told clients that a customer was offering a block of between $5- and $10 million of a Prospect owned CLO tranche, Symphony CLO IX Ltd., at 54 percent of par value. Prospect, per its 10-Q, valued this CLO at 66 percent as of March 31.

In another instance, on March 22, a broker emailed his clients that the cover bid — the second-place bid in a “Bid Wanted in Competition” auction, usually within 1 or 2 percentage points of the winner — for $2.45 million of the CIFC Funding 2013-III CLO was 43.5 percent; Prospect valued the same CLO at 67 percent on March 31.

Last December a brokerage made a two-way market in the Octagon Investment Partners XV Ltd. equity tranche, offering via email to buy $5 million at 62 percent or to sell the same amount at 65 percent. On Dec. 31, Prospect marked this at 80.4 percent.

It’s a Wall Street truism that an asset is worth only what someone will pay for it, so with a well-established CLO secondary market — even conceding that CLO equity is the least liquid in its asset class — it would appear logical to use market inputs when pricing.

It’s not so clear cut, counseled Mark Adelson, editor of the Journal of Structured Finance and a 20-year veteran of securitized product analysis. Speaking generally, Adelson said that while trade prices are ordinarily a valuation’s primary component, CLO equity’s spotty liquidity means that at least some tranches won’t trade enough and that the theoretical inputs of models are required.

“We’re talking about Level II and III assets here. Trades are very meaningful but there is a risk that the buyer was an idiot, so you can’t turn your back on the model.”

“Then again,” Adelson said, “If you have the ability to discern whether the buyer was [sophisticated] and the markets were orderly, your model needs to reflect those trades.”


Prospect’s shareholders might not have seen the “nasty, brutish and short” fate described in Thomas Hobbes’ Leviathan, but some do have a fair measure of resentment that’s perfectly understandable.

That’s due to Prospect management’s compensation framework, which virtually guarantees that fees grow if total assets under management expands. Based on a management fee of 2 percent of gross assets and an incentive fee of 20 percent, last year Prospect Capital paid Prospect Capital Management — the John Barry-controlled advisory managing its investments — over $225.3 million and the year prior it was almost $198.3 million. An additional $21.9 million was paid to Prospect Administration, the entity set up to manage the BDC’s non-portfolio operations, for a total of just under $247.2 million.

(Privately held, Prospect Capital Management isn’t obliged to disclose what Prospect Capital’s key executives earn.)

On the other hand, Prospect’s shareholders, who have experienced two dividend cuts since 2010 and over 75.8 million of share sold below net asset value, are stuck with this chart.

According to a shareholder lawsuit filed in April in U.S. District Court that is alleging a breach of fiduciary duty against Prospect Capital Management and Prospect Administration, shareholders were inappropriately charged between $54 million and $102 million, depriving shareholders of increased dividends. (In June, Prospect filed a memorandum of law in support of a motion to dismiss.)

To be sure, there’s nothing wrong with a CEO wanting his or her company to grow, and handsomely compensating those who generate increased profits is exactly how the system should work. To that end, Prospect has indeed grown its profits, reporting $346.3 million in net income from 2011’s $94.2 million.

Yet Prospect’s filings suggest that these figures are less a function of shrewd lending choices than they are of a great deal of dilution and burgeoning debt. Consider that in June of 2011 Prospect had 107.6 million shares outstanding and $406.7 million in long-term debt; five years later those totals now stand at 356.1 million and more than $2.95 billion.

When Prospect’s investors tire of mercurial portfolio growth and want higher dividends, they might take a hard look at how they compensate management. Because management is rewarded for growing interest income, rather than on how well the borrower performs, over $1 billion of loans have a payment-in-kind component, where a proportion of an interest payment is made in securities. This increases the net interest income figure, but the benefit is on paper since it brings in no cash. Management, to be sure, gets paid in cash based off a formulation that includes noncash inputs, preventing the company from investing that cash elsewhere.

Last year 8.4 percent of interest income, or more than $29.2 million, was attributable to PIK.


Prospect hasn’t taken the criticism lying down.

CEO John Barry referred to criticisms of Prospect’s business model and accounting as “a smear campaign” this February during a conference call. In December, general counsel Joseph Ferraro wrote a series of letters to Seeking Alpha angrily denouncing Probes Reporter, an institutional research provider whose specialty is using freedom of information act requests to determine if companies are fully disclosing Securities and Exchange Commission investigations, for having written that the company was not being forthcoming about a purported investigation.

Probes Reporter chief executive John Gavin in a brief interview said, “I’ve been doing this for a long time. I stand by our reporting on what [we] obtained from the SEC under the Freedom of Information Act.”

In a March release discussing the dispute with Prospect, Gavin argued that the company had more success with three critical articles published in the Motley Fool last August and September by contributor Jordan Wathen, which no longer appear on its website. Asked to confirm whether the company was behind their removal, Wathen declined comment. The Motley Fool did not respond to an email seeking comment.

The only comment given to the Southern Investigative Reporting Foundation about Prospect and its affairs was John Barry’s curt “Are you really calling me at home” when contacted at his home, followed by “Put [your questions] in an email.” Several follow-up calls and emails were ignored.

Editor’s note: A family member of the author owns Prospect shares in an investment account but did not trade the security before the release of this report.

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Bear Stearns and the Bodyguard of Lies

More than seven years after Bear Stearns’ collapse, its former senior leadership has pushed a narrative centering on the once-proud firm’s collapse having been unforeseeable.

In the telling, the metastasizing subprime crisis suddenly slipped free from fixed-income portfolios, and the only response the globe’s biggest financial institutions could muster was to cease lending, birthing a maelstrom wholly apart from any other market cycle. Cut off from vital short-term credit markets, and buffeted on all sides by self-serving rumor and the raw panic of their counterparties and clients, Bear Stearns was forced into a fire sale.

It was “a run on the bank,” a five-word phrase stopping just short of “act of God” in explaining the inexplicable and diffusing blame.

Two weeks ago the Southern Investigative Reporting Foundation obtained a just-unsealed lawsuit arguing the contrary: Bear’s financial health was in full-bore decline months before the June 2007 multibillion dollar implosion of its asset management unit’s two massively levered hedge funds.

The lawsuit and related exhibits were unsealed as a result of a Feb. 5 motion to unseal the case which was granted on March 17. (Lawyers working on behalf of Teri Buhl filed the motions; Buhl is a New York City-based independent journalist whose work appears on and Market Nexus Media’s Growth Capitalist Investor.)

In September 2009 Bruce Sherman, the founder and chief executive officer of Naples, Florida-based Private Capital Management — it once owned 5.9 percent of Bear Stearns’ shares — sued its auditor Deloitte & Touche LLP and a pair of its former senior executives, chief executive officer James Cayne and president Warren Spector. Sherman’s lawyers at Boies, Schiller & Flexner LLP allege Spector and Cayne repeatedly lied to him about the firm’s financial health, especially its valuation and risk management practices. (Sherman is a once revered value investor who sold Private Capital Management to Legg Mason in 2001 for $1.38 billion; he is suing over approximately $13 million of losses in his personal, charitable foundation and escrow accounts.)

Specifically, Sherman’s lawyers allege that because of the numerous assurances Cayne and Spector gave him throughout 2007 and 2008 that the firm was appropriately valuing its mortgage portfolio — and thus would be unlikely to have an asset write-down large enough to affect book value — he bought additional stock. As of publication, lawyers for the two executives had not returned emails seeking comment.

From the start of January to mid-March 2008, the value of Private Capital Management’s investment in Bear Stearns declined by $478.5 million.

Bear’s lawyers have insisted since January 2009 that the firm’s operational risks were fully disclosed in numerous public filings and that its management did nothing wrong. Two weeks ago they filed a motion that seeks summary judgement on all of Sherman’s claims. (See here for a defense team comment on the Sherman case; Joe Evangelisti, a J.P. Morgan spokesman, declined comment. )

Sherman’s claim cites previously unreleased emails between key Bear executives bluntly discussing its troubled balance sheet and fretting about its declining short-term funding options. (Here is a sample.)

For example, Bear’s mortgage-backed securities chief Tom Marano wrote to Paul Friedman, the repo desk head, on May 9 and May 11, 2007, discussing the firm’s balance sheet which in his view already had serious challenges. “You guys need to get a hit team on blowing the retained interest bonds out asap. This is the biggest source of balance sheet problems.”

When two Bear Stearns Asset Management hedge funds filed for bankruptcy on July 31, 2007 — incinerating $3.2 billion of Bear Stearns’ own capital — mortgage security prices collapsed, especially those that had been carved out of subprime mortgages. Trading volumes dropped across the entire MBS universe and the balance sheets of brokerages like Bear, Lehman Brothers and Merrill Lynch began to expand sharply as traders wrestled with not only their own mortgage inventories but billions of dollars worth of bonds sold by increasingly anxious customers desperate to reduce their MBS holdings.

What’s more, Bear Stearns’ management’s handling of its hedge fund disaster suggested that the firm’s risk management — particularly their computer models — valuation procedures and financial strength were suspect. The Securities and Exchange Commission’s Office of Inspector General’s September 2008 report on Bear’s collapse stated that “significant questions were raised about some of Bear’ senior managements’ lack of involvement in handling the crisis.”

There is no good time for a brokerage to signal to a marketplace — especially one where they are one of the dominant players — that they own way too much of an asset class that is rapidly declining in value and that they don’t have the financial resources to absorb the inevitable losses.

The summer of 2007, however, was the worst possible time to send that message.

In short order Bear’s executives were working very hard to keep word of its troubled balance sheet from leaking.

Timothy Greene, co-head of the fixed income finance department, sent a June 25, 2007, email to his boss Paul Friedman, “We are being very careful not to signal any hint of liquidity distress and would not want to do so as a result of a spike in the balance sheet.”

Friedman’s response: “We’re going to think how to craft the message in terms of getting rid of aged positions, paring down risk, etc. so as NOT TO spook anyone.”

A vicious circle was emerging and Bear Stearns was in the middle of it.

When the MBS market collapsed, Bear’s counterparties (who likely had their own mortgages losses to contend with) quickly began demanding higher interest-rates to enter into repurchase agreements with the firm. As repo counterparties began to be scarce, there was nothing Bear could do — unlike commercial banks it did not have a diverse stream of funding sources — but to accept what was offered. Getting the capital to support its mortgage- and asset-backed securities stuffed balance sheet became more expensive, forcing Bear’s trading profits to drop. What’s worse is those MBS and ABS were dropping in value, leading to unexpectedly large write-downs. Watching the charge-offs erase book value and with no profits to offset it, customers and lenders alike began to reduce their exposure to the firm.

Bear’s chief financial officer Sam Molinaro would become its public face, reliably pounding the table at every opportunity to assert that come what may, the firm’s financial health was fine. On a June 22, 2007, conference call, for instance, he said the firm’s “financial condition remains strong” and that it had “ample liquidity.”

Unit chiefs, often facing anxious customers worried about whether their prime brokerage account at Bear was safe or if the firm would be around to meet its counterparty obligations in a derivative contract, would come to see matters differently.

Prime brokerage chief Steven Meyer, in a July 20, 2007, email to Warren Spector and Molinaro, wrote that “the impact of the hedge funds problem on the prime brokerage business is very significant, not least because it gave brokerage clients a reason to question Bear’s judgement and risk management practices.”

Meyer’s concerns were not idle.

Vicis Capital, a $5 billion hedge fund, became the first big fund to move its prime brokerage in July 2007 to Goldman Sachs from Bear Stearns, principally over concern about the firm’s MBS exposure, according to an excerpt of Sam Molinaro’s deposition in the Sherman suit.


In August 2007 the gap between what Bear executives told the public and what they discussed privately became pronounced.

After Standard & Poor’s signaled that it was likely to cut Bear’s credit rating on Aug. 3, the firm’s executives hosted a conference call to reassure investors. Molinaro again struck a confident tone and told participants that “with respect to liquidity, our balance sheet, capital base and liquidity profile remain strong.” Treasurer Robert Upton added, “Bear Stearns’ liquidity and capital position is very solid” and that “the firm’s liquidity position, capital adequacy and funding capacity remains extremely solid not withstanding the difficult market conditions.”

Yet at 7:22 a.m. that morning Sam Molinaro sent an email to Bear’s former treasurer and then clearing chief, Michael Minikes, “We need liquidity ASAP” after Minikes told him of the looming downgrade.

In the following days emails between Bear’s executives responsible for funding its balance sheet took on an increasingly bleak tone.

On Aug. 9, an email thread between Upton, repo chief Friedman and others discussed Bear’s loss of $1.65 billion of equity repo, or repurchase agreements using stocks as collateral, as opposed to the standard government or corporate bonds. Within days it had become a torrent, and Friedman laid out the brutal details in a long email to fixed-income co-head Jeff Mayer.

To start, he told Mayer about the loss of “$14.5 billion in funding” most of which had been used to fund the MBS trading desk’s whole loan and non-agency securities portfolio.

(Whole loans were loans to a single residential or commercial borrower that had not been carved into a bond. Non-agency bonds were carved from loan pools that mortgage guarantors Fannie Mae and Freddie Mac would not insure, usually because of credit concerns; these pools were the epicenter of the credit crisis.)

Nor did Friedman see any relief on the horizon.

Friedman told Mayer that “against (the loss of $14.5 billion) we’re taking in only $2.7 billion of money from [a] new source. We have an additional $3.1 billion of funding that is either already scheduled to be pulled or at risk of leaving. Roughly $500 (million) is going back this week. Another $1.9 billion is borrowed from (commercial paper) conduits that we are having trouble rolling.”

While Bear’s repo desk scrambled to keep the firm funded in mid-August, Sherman seized on its declining share price as an opportunity to buy stock for his personal account and a charitable foundation he controlled, ultimately purchasing 67,000 shares in the month at prices between $110.14 and $103.15.

Throughout the fall of 2007, despite getting daily–and sometimes hourly–updates about the funding difficulties, Molinaro and colleagues proclaimed to analysts, investors and the media the strength of Bear’s capital base and its access to myriad sources of funding. During the third quarter conference call on Sept. 20, Molinaro told investors the firm was “increasing our cash liquidity pool” and had been “building excess liquidity at the parent company.”

At the Merrill Lynch Banking and Financial Services conference on Nov. 14, 2007, Molinaro said, “Our capital and liquidity position, we think, is very strong. Liquidity, in particular, is as strong as it’s ever been. We think our funding structure is very prudent, mostly secured term repo facilities.”

Molinari presented a slide that said as of Aug. 31, 2007 the totality of Bear’s subprime securities exposure was $1.558 billion.

Yet in a January 2008 reply to an SEC letter seeking clarification on Bear’s subprime risk disclosures in 2007, Molinari said it was $2.97 billion as of August 31, 2007. He wrote that the firm had $770 million worth of retained interests in subprime securitizations and $2.2 billion of investments in securities backed by subprime loans.

The Southern Investigative Reporting Foundation called Molinaro, now the chief operating officer at UBS’s investment bank, to ask about this $1.41 billion differential in subprime exposure. He did not reply to voice messages left on his cellphone and his house.

Bear’s constant stumping about its solid financial health didn’t work with the constituency that most mattered: its lenders.

By mid-December, according to Sherman’s claim, Friedman wrote to Marano in an email that even if Bear was not downgraded and managed to “raise a couple [of] billion dollars of new equity [it would] still have all the same funding and liquidity issues [it has] now.”

Three days later, Marano emailed the new CEO Alan Schwartz, to demand capital be raised immediately: “The repo desk is in a constant state of concern with respect to funding the firm. We have inadequate long term and short term financing facilities. . . . We may have inadequate funding resources to address investment in technology for risk management and reporting of positions.”

The Southern Investigative Reporting Foundation spoke to Tom Marano — now the Denver-based CEO of vacation marketer Intrawest — and he said that, “While I was pretty hard on Alan, it was necessary. We needed more capital but I didn’t get through to him.” Marano declined additional comment about the case.


An exhibit that was attached to Sherman’s claim shows that the SEC was alert to Bear Stearns’ looming problems by late 2005 but granted “confidential treatment” status to its communications with the firm, thus exempting it from being publicly uploaded.

In its review of Bear’s 2005 10-K filing, the SEC had some pointed concerns about its disclosures of subprime MBS exposure and its failure to implement a firm wide value-at- risk limit. The SEC’s 2005 examination concluded that Bear’s risk management framework was problematic, relying on “outdated models created over a decade ago” and that Bear had “limited documentation on how the models work.”

Sherman’s lawyers allege that Bear’s risk management apparatus was nothing like the best-of-breed unit it portrayed to the public. Instead, they allege that the trading department came to dominate risk management operations. According to the 2005 SEC examination, Bear used a “bottom-up,” trader driven approach where “risk taking is evaluated first and foremost at the trading desk level.” Moreover, the SEC’s analysts found that “certain business heads can establish new trading limits and approve existing limit breaches with their sole written approval without direct approval from risk management.”

His lawyers also point to a report commissioned by Bear’s board in 2007 that assessed Bear’s risk management operations. The outside consultancy, Marsh & McLennan’s Oliver Wyman unit, wrote that “Bear’s risk policy and limits were proposed by the business units and frequently overridden.”

Bear even admitted in its Jan. 31, 2008, response to the SEC the possibility of their subprime exposure potentially being fatal.

“We believe that based on the Company’s level of involvement in subprime lending and the broader impact on the global credit markets, a material adverse impact on the Company’s: financial condition, results of operations or liquidity is reasonably possible.”

They went on to promise the SEC “in future filings we will consider our level of involvement in subprime lending, and we will seek to enhance our disclosure of positions, if necessary.”

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The Hidden History of Social Media’s Financial Gurus, a Truly Occasional Series: The Case of Joe Donahue

At any given moment, Joe Donahue, a cornerstone and an investor in the popular StockTwits investing community and a veteran of a quarter century of trading, may be making another intraday call on a stock for his community of subscribers who pay him nearly $800 a year for his trading system.

Financial social media, for which a few minutes to sign up for an account is the only investment needed, allows participation in a community as active and diverse as the markets themselves. But it begs a question: Who, exactly, is giving all this opinion and the analysis?

Far off, unpleasant things

Joseph William Donahue is a 25-year veteran of trading. He has done a little bit of everything including founding a pair of hedge funds: one fund that he said reached $500 million in assets and a second fund with former Major League Baseball pitcher Todd Stottlemyre. (The partnership soon split, however, with little capital apparently being raised and Stottlemyre joining multilevel marketing company ACN in 2010.)

A self-described polymath, Donahue charges a $799 annual subscription for full exposure to his positions and his many intraday market and trading commentaries.

For a trader looking for new perspective or some additional training, paying for Donahue’s service may be money well spent. (Donahue’s recent trading performance records are private and the Southern Investigative Reporting Foundation couldn’t obtain the track record for his two hedge funds.) But for people with an understanding of Wall Street history, his resume alone might prompt serious second thoughts before they reach for their wallet.

According to FINRA’s Brokercheck, Donahue’s career began promisingly enough in 1982 at Kidder Peabody’s retail brokerage unit and included stops at Smith, Barney, Shearson Lehman, Prudential-Bache and Oppenheimer. Apart from the fact that all of these firms are now Wall Street memories — save for Oppenheimer, which has become a troubled penny stock brokerage — they were members of Wall Street’s firmament. (The Financial Industry Regulatory Authority, or FINRA, is the self-regulatory arm of the brokerage industry that examines member firm’s and their employees to ensure compliance with regulations.)

Starting in 1991, for reasons that remain unclear, Donahue took the elevator down to Wall Street’s boiler room sublevels and stayed there for 10 years.

Regardless of Wall Street’s epic failures over the past decade, they remain a distant second to the laundry list of boiler room sins. All of the shops Donahue worked at are now gone, with most banished from FINRA. A.S. Goldmen and D.H. Blair, both former employers (he was only at D.H. Blair for three months), were indicted by former New York County District Attorney Robert Morgenthau for being “criminal enterprises,” and both firms would ultimately have their chief executives, as well as numerous brokers and administrators, sentenced to prison terms.

After A.S. Goldmen, Donahue joined The Boston Group (which was headquartered in Los Angeles) and headed up one of its New York offices for two years. In 1997, under heavy regulatory scrutiny for its dubious practices — including the boiler room standard, cancelling client “Sell” orders so that its inventory of “house” stocks didn’t decline in price — the firm ceased operations. In 2003 FINRA permanently banned its chief executive Robert DiMinico from the securities industry.

After one of Donahue’s A.S. Goldmen clients filed for arbitration in October 1994 for allegedly mismanaging an account, FINRA assessed both Donahue and A.S. Goldmen a penalty of just over $65,000 in August 1996.

In 2001, Donahue left the brokerage industry and founded Cornell Capital Partners with two other colleagues from the May, Davis Group (which, true to form, was expelled from FINRA in 2006.) A hedge fund that specialized in private investments in public equities, or PIPEs, the fund was profitable but had a high-profile relative to its size because its practice of structuring heavily dilutive stock transactions for its small- and micro-capitalization clients often angered investors, who saw the share price decline when the market was swamped with additional shares. Alternately, short sellers would focus on Cornell Capital-financed deals given the inevitable decline in share price from dilution. In 2004, Donahue, along with another founder, had his partnership interest bought out for $2.625 million (the filing does not break out what percentage was paid to Donahue.)

In 2012, five years after Cornell Capital changed its name to Yorkville Advisors, the SEC sued the fund for allegedly inflating the value of its portfolio.

The Southern Investigative Reporting Foundation sought to understand why a fellow who started off with name-brand employers, a love of markets and the prospects for making real money would, after almost a decade in that world, make a beeline for firms that wound up in prosecutorial crosshairs for everything from sales fraud to organized crime links.

In an exchange of emails with the foundation, Donahue did not address his boiler room background, other than to note he has disclosed everything and that “Anyone can google me and my history.” A search of his Twitter feed and his many blog posts, some going back to 2009, show that while he readily waxed nostalgic about his time at Bear Stearns and Shearson Lehman, not much was readily discoverable about his service in boiler rooms.

Describing the 1994 FINRA arbitration claim as the seemingly inevitable result of being a broker for a long period of time, Donahue said, “There will be a percentage of people that lose money and a percentage of them might make a claim. It happens.”

Howard Linzon, the venture capitalist and hedge fund manager who founded StockTwits, remained in Donahue’s corner, telling the foundation that he felt, “Joe is a fairly straight shooter” and that he didn’t care about something that happened in the 1990s.

“Is Joe still doing that boiler room stuff now? No, he’s not” he said.

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How to Effortlessly Earn a Riskless 90% on Bitcoins Through the Magic of Binary Options Trading

Let’s discuss an ambitious African immigrant named Obawtaye Folayan who appears to have a very big American dream but an unfortunate approach to realizing it.

Starting in the mid-’90s Folayan started laying down some real markers on the road to success, picking up a finance degree from Delaware State University and later a master’s degree in education administration from New Jersey’s Rider University in 2002. Two years later he would become principal of a school in Bridgeton, New Jersey.

But Folayan was a restless sort and moved on from the principal’s office to start a host of businesses, taking him from landscaping to a for-profit education initiative.

Like many a fellow before him, Folayan heard the siren song of Wall Street, and in 2012  he set up Folayan Financial Holdings, a Delaware-chartered company with some tall designs for the world of consumer financial services.

Give credit where it’s due: Folayan Financial Holdings sounds professional enough.

Then you take a look at the website of the company and the alarm bells start screaming.

Folayan Financial’s website should strike anyone familiar with how Wall Street markets itself as one of two things: Either it is an unfinished template, with a series of random names, words and titles thrown together like a poorly tossed salad before it is properly completed, or it is a crude parody, designed to elicit laughs from knowing finance industry insiders.

Consider the names and titles of the company’s managers: “Adam Smith” is “main manager,” and he might — or might not be — related to “Jennifer Smith,” who has the very un-Wall Street title of “team manager.” Rounding out the senior ranks is information technology chief “John Doe” and Anna Brown, “attorney.”

As noted above, Folayan has patterned itself after a Bank of America or Citigroup, offering a universe of financial services, like retail investments, investment banking, insurance, “holding services” and legal advice. Unlike Bank of America or Citigroup, which actually do those things, the tabs on the company’s website go nowhere.

The chief executive is the aforementioned Obawtaye Folayan whose days patrolling school hallways and issuing detentions are long past. The site says he personally oversees international assets worth “$4.4 billion.” Despite living in New Jersey, Folayan has never felt the need to obtain any securities industry licenses or register as an investment advisor.

He’s not alone, however, as “Isaac Rothschild,” a “senior account manager” with 30 years of global investment experience, is helping manage the assets and run the business. Rothschild, a surname with a profound lineage in finance, seems to have done the impossible in an internet age, putting together a 30-year career that includes holding no licenses or warranting any mentions in any Securities and Exchange Commission or Financial Industry Regulatory Authority filings. (Rothschild will make another, rather spectacular appearance below.)

Despite clearly seeking to do business with the U.S. investing public, Folayan Financial has no licenses and is registered with no U.S. regulator or agency; a search engine scan for some of these billions of dollars worth of transactions and assets turns up nothing. The company’s headquarters is in a virtual office complex in Mt. Laurel, New Jersey. It says it has been doing business since 1999 but its bare bones filings indicates it was organized in 2012.

A little additional digging turns up some very troubling things about Obawtaye Folayan. In October 2012 he pleaded guilty to simple assault; the New Jersey Board of Education stripped him of his teaching certificates in September. The idea of his considerable wealth is unlikely: He and his wife Malika — they appear to now live apart, according to a databases examined by the Southern Investigative Reporting Foundation — have nine judgments between them for unpaid consumer debt and last year lost a Pompano Beach, Florida, property to foreclosure.

Having a comically ill-conceived website is not, of course, a crime. Where things get interesting is sussing out whatever it is a pair of companies Folayan Financial owns, New York Stock Options and money manager NYSOHedge, are really up to.

Establishing a connection between Obawtaye Folayan and the two companies required some sifting. Here’s how the Southern Investigative Reporting Foundation established the links: The main number of New York Stock Options is 877-935-8468, a number that has been used by Folayan Financial. Moreover, in September 2012, the virtual office where Folayan Financial rents space posted a message to its Facebook account welcoming New York Stock Options and Folayan Financial. Finally, Folayan Financial’s website had key components of its directory left exposed, and its index and old payment processing details firmly tie the companies.

There are many excellent reasons for investors to stay far away from New York Stock Options and NYSOHedge, not the least of which is the fact that its strategy of trading binary options is assuredly spectacularly ill-suited for the passive retail investors they are seeking.

New York Stock Options circumvents the obvious complexity of the securities by ignoring the matter completely, instead making a pitch to prospective clients that is simplicity itself: trading binary options — no amount of capital is too small — is effectively riskless because both New York Stock Options and NYSOHedge employ hedging strategies that “Insure against loss of principal.”

It is no easy feat to count how many laws, both written and unwritten, this approach flouts.

On the off chance that investing without risk to capital wasn’t enough, NYSOHedge says it posts “average yields” of up to 123 percent in certain accounts; others book average “yields” of 84 percent and 90 percent. For comparison, check Bloomberg‘s list of the top-performing large hedge funds. (Shortly before this story was released, NYSOHedge took down its website.)

To evangelize the potential binary options trading pool, NYSO and NYSOHedge use video testimonials, satellite radio advertisements and YouTube videos to spread the word. There are plenty of eyebrow raising issues with the videos, such as the settings in generic, featureless offices, and the lack of detail about how the clients suddenly managed to amass compelling wealth through New York Stock Options. Visually, they are oddly sterile, with this video suggests 1980s pop icon Max Headroom more than it does the benefits from an esoteric options trading style.

(A brief aside: The man in the second video also appears in a video for a bitcoin rival, Dogecoin, hosted on Fiverr, a site where people can be paid, say, $5 for performing a service.)

Regulators might find it interesting that the people in the videos speak U.S. accented English. This matters because when the Southern Investigative Reporting Foundation sought comment, David Goldberg, a senior executive of New York Stock Options, said the company is a startup in the U.S. and has no U.S. customers. When pressed on how the company’s absence of U.S. investors was contradicted by the enthusiastic U.S. citizens in the videos, Goldberg declined further comment.

Where NYSOHedge might potentially be taking in some investor capital is through its recently announced decision to accept bitcoin — a peer-to-peer cryptocurrency — for its managed investment accounts. Bitcoin is a controversial asset class (one of bitcoin’s primary exchanges, Mt. Gox, is under duress and has not allowed withdrawals for several days) but for Folayan, the ability to move bitcoin assets rapidly across the world without prying compliance staff asking questions is perhaps attractive. Regardless, marketing to the bitcoin community seems central to the funds future since two weeks ago Obawtaye Folayan registered the BITX.US domain name.

The management of NYSO and NYSOHedge, like Folayan Financial, appears in no U.S filings; like the parent company, Isaac Rothschild is again listed as a senior manager, this time in charge of managing accounts over $100,000.

From a regulatory standpoint, New York Stock Options and NYSOHedge are complete ciphers.

Bizarrely, New York Stock Options insists repeatedly on its website that it is a member of the Independent Financial Regulatory Authority, a regulator whose influence is now more metaphysical than real since its website is no longer active. (The Internet Archive’s WayBack Machine had a cache of its site, fortunately.) To start, the phone number is now disconnected and the address given, 22 West Washington Street in Chicago, is another virtual office. A woman answering the phone for the office owner told the Southern Investigative Reporting Foundation that the Independent Financial Regulatory Authority had been gone since July “if not before that,” and had left no forwarding information.

In a series of email exchanges, New York Stock Options executive David Goldberg argued that not having a U.S. regulator — when operating on U.S. soil or planning to soliciting U.S. citizens — is not an issue since New York Stock Options is registered in Belize and doesn’t have any U.S. clients yet. Moreover, he insisted that New York Stock Options complies with all regulators in the jurisdictions it does operate in. He was scornful of a reporter’s query about regulators in North America and Europe having no record of his company.

“You obviously think America, Canada or Europe are the only place on earth firms are regulated,” said Goldberg. He then ended the conversation by accusing the Southern Investigative Reporting Foundation of being a front for BlackRock, the giant asset management firm. He did not elaborate on this theory and an email from Isaac Rothschild noted that the firm would not be commenting further.

Goldberg’s reference to New York Stock Options registration in Belize might not instill much confidence in its governance. According to the International Consortium of  Investigative Journalists Offshore Leaks database, New York Stock Options address in Belize is a mail drop used by several other offshore entities to shield assets and business activity.

During its brief, likely imaginary lifespan, the Independent Financial Regulatory Authority certainly tried an entirely different approach to guarding customer assets than its peers at the SEC or FINRA, and planned a $100,000 per plate “IFRA Awards Dinner” gala to celebrate the companies it did not regulate at the Chicago Waldorf Astoria. One of the main attractions of the event was the chance to meet “multibillionaire” and “part-owner of New York Stock Options” Isaac Rothschild. (A representative of the hotel told the Southern Investigative Research Foundation that she had no record of this event.)

Given the above, it is perhaps difficult to be shocked at the news that New York Stock Options is planning to join Goldman Sachs and Morgan Stanley in the ranks of publicly traded brokerages. A “preliminary prospectus announcement” posted on its website says a sale of six million shares at $25, raising $150 million, would  imply a $5.3 billion valuation.

Getting the sale done though will be no mean feat.

With a syndicate of Folayan Financial Holding and Turner Securities LLC as “lead joint book running managers,” and “Thompson LLC, Phillip Davis, Price, Steinberg & Smith Incorporated, Steven Goldberg & Co. and Isaac W. Rothschild & Co. Incorporated” there certainly are enough firms in the mix, it’s just that none of them exist.


The Southern Investigative Reporting Foundation went to great lengths to get comment from Obawtaye Folayan and New York Stock Options during this story.
Moreover, given the vast incongruities and departures from securities industry norms our reporting uncovered, we firmly communicated our deep concern about the legality of many of its business practices.

Getting someone on the phone was fruitless: repeated calls to all of the obtainable numbers for Folayan and his companies (from public and private databases) ended in disconnected phones or voice mailboxes that were invariably full. Other phone numbers we called for New York Stock Options included a Magic Jack account that had been discontinued and a Google Voice mailbox where repeated messages left for Folayan and his colleagues were not returned.

A series of email exchanges, referenced above, with New York Stock Options executive David Goldberg resulted in little substantive discussion; after initially agreeing to call the Southern Investigative Reporting Foundation, he did not follow through. As noted, the email discussion ended when Goldberg accused the Southern Investigative Reporting Foundation of colluding with a giant money manager.

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Meet Benjamin Wey, Media Mogul

Sometime on Sept. 3, Maureen Gearty, 56, of New York City started receiving emails and calls from old friends and colleagues asking about the details of her torrid affair with a man named Ronen Zakai, a former colleague at two since-shuttered small-cap boiler rooms.

Gearty told anyone who would listen she had never had any romantic involvement whatsoever with Zakai and that she was pretty certain she wouldn’t be hearing from him either since he was in a world of legal trouble for an alleged fraud involving some serious misuse of clients’ funds.

In January, less than 15 miles away from Gearty’s home in the borough of Queens, Dune Lawrence, 38, a highly decorated Bloomberg News reporter, went online one morning to find her picture splashed across a Web site with the headline “Is Dune Lawrence Racist?”

The two women are very different: Gearty is a 30-year veteran office manager of Wall Street’s rough-and-tumble boiler rooms, and Lawrence is an award-winning investigative reporter. Both became quite upset. Gearty was paralyzed by anger and disgust, she said, at the lies that seemed to metastasize from story to story, while Lawrence was taken aback by the bitter personal attacks, even if she understood the articles would not be seen as serious professional criticism of her journalism, she told her friends.

Although the two women have little in common, both had somehow managed to seriously anger the man who (very quietly) has backed a new Web site The Blot: Benjamin Wey a 42-year-old promoter of Chinese stocks. And so both women found themselves the subject of a series of relentlessly personal articles on The Blot, whose motto is “Never Be Boring.”


Figuring out Wey’s connection to The Blot took the Southern Investigative Reporting Foundation about 20 minutes.

Here’s how we did it:

Plugging the term “The Blot” into a search engine turned up a citation on CrunchBase, describing the publication’s office as being located on the 20th floor of 222 Broadway in New York City and listing Neil St. Clair as its founding publisher and editor. Confirming St. Clair’s role with The Blot was not hard; the New York Business Journal had profiled the new venture last July and even noted that the Web site had “a silent backer.”

Online searches for background on Neil St. Clair turned up his prior roles as an on-air reporter on New York City and Syracuse newscasts and that he is indeed operating a business from the 20th floor of 222 Broadway but not necessarily The Blot.

Additional Web searches surfaced St. Clair’s copyright claim for FNL Media, which is doing business as “” and listing a work address at 40 Wall Street on the 38th floor. The New York Secretary of State’s business directory did not list much further information, but The Blot’s LinkedIn profile also included the 40 Wall Street address.

Plugging “40 Wall Street, 38th floor” into a search engine indicates another business associated with that address, Benjamin Wey’s financial advisory outfit, the New York Global Group.

One of The Blot’s few advertisers is FIKA, an upscale coffee and chocolate emporium which counts Ben Wey as one of its investors. The same lawyer, Neal N. Beaton, of Holland & Knight LLP, serves as the registered agent for both FNL Media and Wey’s coffee investments. (A man pictured with Wey on the Swedish news Web site, Nordstejrnan, is John Bostany, a lawyer whose 40 Wall Street offices are located several floors below Wey and whose firm is suing Maureen Gearty.)

In January when the Southern Investigative Reporting Foundation called the New York Global Group’s number and asked to speak to a staffer at The Blot, the person answering the phone said she couldn’t transfer the call but would — after being requested to do so — pass a message to the editor, Alicia Lu. (Lu, however, did not return a call to the Southern Investigative Reporting Foundation. Nor did she phone back after a message was left using The Blot’s primary number. Nor did Lu reply to an email sent her.)

The Southern Investigative Reporting Foundation also called the two editors, Neil St. Clair and Alex Geana, who had been profiled in the New York Business Journal in mid-July around the time The Blot launched.

Reached on his cellphone, St. Clair was uncomfortable about discussing his role at The Blot, claiming that he was only a consultant who had helped launch the site. Pressed about the New York Business Journal’s description of him as “editor-in-chief” and “publisher,” St. Clair said he would not confirm or deny whether Wey had a role with the publication. Instead he noted that he was subject to a nondisclosure agreement.

Alex Geana was more forthcoming. He told the Southern Investigative Reporting Foundation that Wey fired him on Jan. 2 after he refused to publish the first piece about Dune Lawrence.

“I was sick and tired of these libelous hit pieces,” said Geana. “The [Gearty stuff] was bad enough but when we are calling a reporter a ‘racist’ and we have no evidence to support that charge; that is immoral.”

The fight that eventually cost Geana his job had been in the making for a while, according to Geana: The tension started simmering when Wey grew angry at Geana for requesting proof of the allegations being made about Gearty and Lawrence in articles sent to The Blot by four columnists and reporters — whom Geana had never met or spoken with and whom Wey refused to put him in contact with.

After Wey repeatedly refused to provide him “notes” that Wey claimed the Blot’s authors had obtained during their “research process,” Geana told Wey that he refused to publish the articles, Geana recalled.

Wey fired him shortly afterward, Geana said. The pieces appeared anyway. See a statement from Geana regarding his termination from The Blot.

Wey could not be reached for comment about Geana’s allegations.


Why Wey would create an organ like The Blot is a puzzling matter.

To arrive at a reason, it helps to understand that Maureen Gearty and Dune Lawrence, despite their differences, are very dangerous people to Ben Wey.

Wey is a stock promoter, a term of art on Wall Street as much as it is an actual job description.

Seen his way, Wey helps growing Chinese companies seeking access to the liquid U.S. capital markets find appropriate legal, accounting and financial advisers; the desired end result being a listing on an American stock exchange. Additionally, once a stock exchange listing is set up, he connects money managers to his client companies, with an eye toward helping the newly public companies navigate the challenging Wall Street investor-issuer relationships.

But Wey has not found it easy to accomplish all this.

The shares of Wey’s client companies have proved to be troubled investments in an asset class — Chinese reverse-merger stocks — that has suffered devastating price declines. New York Global Group’s clients have reliably separated investors and their capital, with one exception: Harbin Electric. (Wey took Harbin Electric private — at a sharp premium to its share price — in a management-led buyout.)

Earlier forays into stock sales, first as an Oklahoma based broker for Wilbanks Securities, and later as the owner (through his wife) of New York Global Securities, led to a series of regulatory headaches. (For his part, Wey is unrepentant for the controversies, telling the Financial Times in 2011 that with respect to the Oklahoma dispute — involving the sale of securities in a company in which he was an undisclosed adviser to — that he would do “the exact same thing.”)

In January 2012, the FBI raided Wey’s office and home. An FBI spokesman described the action as part of an “ongoing investigation.”

For Wey to be seen by potential Chinese clients as a credible promoter, he needs to not only get transactions done, but also to ensure stock is purchased by investors inclined to hold their positions and not panic at the first sign of bad news.

So when Gearty became a high-credibility witness last year for the Financial Industry Regulatory Authority, or FINRA, during its examination of First Merger Capital (a firm that Wey played a role in establishing and where two of his close allies had worked), she became a big threat to his interests.

Wey’s New York Global Group had an extremely tight relationship with the founders of First Merger Capital, brokers William Scholander and Talman Harris: Nearly 80 percent of First Merger Capital’s revenue came from trading the shares of just three clients of Wey: Deer Consumer Electronics, SmartHeat and CleanTech Innovations.

The First Merger Capital brokers were the subject of a lengthy FINRA inquiry last year examining a $350,000 payment from Wey client Deer Consumer Products, a maker of kitchen appliances. Gearty’s testimony, laid out in an unusually blunt 45-page FINRA examination document released in August, disclosed how the payment was, in effect, used to set up First Merger Capital, where Gearty worked with Zakai. (At the time of First Merger Capital’s organization in the fall of 2009, Zakai was serving a 30-day FINRA suspension for a violation at his previous employer.)

Wey’s company Deer Consumer Products provided funds for the purchase of the former Brentworth & Co. brokerage firm from another penny stock impresario and paid rent, bought furniture and computers — all to create a new brokerage that could reliably promote Wey’s companies’ shares.

Ultimately, what Gearty did is remove the lid on the workings of a mini penny-stock empire that, according to her testimony in the FINRA report, had worked quite well for Wey, Scholander and Harris (although markedly less so for their clients). She put Wey much closer to Wall Street’s dark underbelly than his relentless self-promotion would let on. According to her testimony, there was little difference between Wey’s New York Global Group and First Merger Capital: They shared the same office suite at 40 Wall Street as they had earlier at 14 Wall Street, where Scholander and Harris had owned a branch office of another deeply troubled penny stock trader, Seaboard Securities. The FINRA report noted that Wey, Scholander and Harris began their relationship in 2004 when they worked at Wey’s now shuttered New York Global Securities.

Moreover, although The Blot blasted Zakai as well as Gearty, the FINRA report indicates that Wey and Zakai had enjoyed a profitable working relationship before Zakai went to work at First Merger Capital.

When Zakai worked at collapsed boiler room between 2001 and 2006 Great Eastern Securities, he helped Wey market his first reverse merger deal in the United States, for Bodisen Biotech. (The role Wey played as an adviser to that Bodisen Biotech proved controversial enough that the company ended up firing him and the American Stock Exchange delisted the company in 2007.)

This past summer, FINRA decided to bar Wey’s allies Scholander and Harris from working as brokers in the securities industry based on, among other things, their failure to disclose the $350,000 payment they had received from Deer Consumer Products. In a withering assessment from FINRA’s examiners, their testimony was described in the report as “demonstrably false” and “a brazen attempt to falsify.”

Both brokers are appealing the FINRA decision, and until a final determination is released, they work at a firm they are co-owners of Cambridge Alliance Capital, a unit of Radnor Research and Trading. A receptionist at Cambridge Alliance told the Southern Investigative Reporting Foundation at the end of January that Scholander had not been seen in months and that he no longer worked there. When the receptionist was asked why he had left if he had told regulators he owned the firm, she hung up. Two calls to Radnor Research and Trading were not returned.

(In 2011, Scholander ran into trouble of an entirely different sort: According to the New York Post, he was arrested at a popular bar after he allegedly tried to take pictures of women as they used the toilet. He pleaded guilty to a criminal harassment charge and is being sued by a woman who said she caught him trying to photograph her.)

Both Harris and Scholander are also suing Gearty (as well as Zakai and his wife) for $10 million in damages, alleging, among other claims, that Gearty misappropriated their commission payments. Their suit was filed by John Bostany, a lawyer with personal connections to ex-First Merger Capital boiler-room stock sales veterans like Guy Durand (pictured in the middle of a Business Insider photo with Bostany at his right at a charity function) and who also sued a short seller on behalf of Wey client Deer Consumer Products. (The case was dismissed in November 2012 on First Amendment grounds.)

Harris and Scholander continue to profit from their relationship with Wey and were listed as shareholders of Nova Lifestyle, a furniture company accepted for listing on Nasdaq in January and whose stock price has been on something of a tear. The August 2011 Nova Lifestyle equity offering did not name Wey as a shareholder or adviser, but his sister Sarah Wei is listed as a seller of 690,000 shares through a portfolio managed by Witter Global Opportunities Ltd., a fund that also collaborates with Wey’s New York Global Group. (In addition, James Baxter, the president of Wey’s New York Global Group, sold 23,000 shares in the offering, through a holding company he and his two brothers own, Global Investment Alliance.)

Gearty, for her part, told the Southern Investigative Reporting Foundation last week that she is devastated to have been the subject of The Blot’s bombastic articles.

“I never slept with Zakai and no one [has] ever alleged it, ever. [Scholander, Harris and Wey] just want me to look bad for their fake lawsuit,” Gearty said. “I never took a penny of anyone’s money and no one who investigated these guys at FINRA or the Manhattan DA’s office ever said I did.”

“How could Zakai have given me gifts from client money when I never worked with him at his fund?” she said, responding to a claim in The Blot that she had siphoned off client monies from Zakai at an investment fund he had established after the collapse of First Merger Capital. “[The Blot] only said those things because I told [FINRA] the truth and they know I’m not rich and famous so I can’t hurt them back.”

Gearty said she did not benefit financially in an improper way when she worked at First Merger Capital and has not worked steadily since leaving the firm. She has been representing herself in a bid to fight off the Scholander and Harris lawsuit.


Wey’s beef with Dune Lawrence follows a pattern that has emerged recently of companies using the Internet to strike back at investigative reporters whose reporting they deem offensive or threatening.

And harassing reporters offline, through means apart from the Internet, is hardly new. In 1998, Dan Borislow, the chief executive of high-flying Telecom Tel-Save, had then reporter Alex Berenson followed by private investigators after he wrote critically about his company. More recently, Hewlett-Packard tried to obtain phone records of Wall Street Journal reporters and Allied Capital attempted to find the phone records of columnist Herb Greenberg and other company critics.

Like the suggestion that Gearty slept with an alleged thief, The Blot’s criticism of Dune Lawrence was obsessively personal: It alleged that she eats a problematic amount of Kentucky Fried Chicken meals to the detriment to her appearance, speaks Chinese poorly and takes bribes from short seller Jon Carnes.

The Blot did not, however, try to assert publicly online that Lawrence’s reporting has ever been wrong — nor have others, at least from what can be gleaned from an Internet search for lawsuits or substantive disagreements about her reporting.

To be certain, Lawrence’s work might win her few friends in China. With her colleague Michael Riley, Lawrence identified a lynchpin in a Chinese government-sanctioned computer-hacking unit. In December, Lawrence wrote about a long-running fraud at AgFeed Industries of China, a former client of Wey.

The Blot’s articles on Lawrence appear designed to create a lasting search engine optimization headache for her. For Lawrence’s Western readers, raised in a tradition of critical reporting and free speech, The Blot’s impact is likely to be muted; for her Chinese sources, who do not have this background, the charges may well resonate more.

When Lawrence wrote about short seller Jon Carnes in a 2013 story, it likely reinforced Wey’s oft-stated view that short sellers of Chinese companies use dishonest means to incite panic, usually through manipulating a crooked and lazy business press.

In turn, Carnes became the target of The Blot’s animus on Jan. 23 in a story that compared him to Jordan Belfort, the former chief executive of penny-stock brokerage Stratton Oakmont who served a jail sentence for defrauding his clients.

When Deer Consumer Products sued Carnes and his EOS Holdings fund in 2011, Wey and his colleagues likely had high hopes of a sharp reversal of fortune for Carnes, a man whose fund’s research had a role in helping expose fraud that resulted in the collapse and delisting of seven different Chinese issuers. Deer Consumer Products, however, lost its suit against Carnes, and Nasdaq delisted Deer Consumer Products in March 2012 for a host of fraud-related issues.

A disclosure is important here: The Southern Investigative Reporting Foundation has been a recipient of funds from Carnes through his charitable trust.

The war between short sellers and their critics took a sharply more serious turn when the British Columbia Securities Commission filed a claim in December that Carnes issued a misleading report on Silvercorp Metals, a company based in Vancouver with mines in China. In a statement posted on his Web site, Carnes said he is fighting the charges, which he characterized as “false and without merit.”


Two phone calls and email messages (bearing a set of detailed questions) for Wey seeking comment were not returned.

In recent weeks, as this article was being prepared, Wey began to use social media platforms to publicly link to articles from The Blot.

As he has done with other reporters whose work he does not like, Wey has extensively criticized the Southern Investigative Reporting Foundation and its board members on various online platforms in the past.

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Brookfield’s Looking-Glass World

Illustration: Edel Rodriguez
Illustration: Edel Rodriguez

A wry investor might be forgiven for concluding that peering at Toronto-based Brookfield Asset Management’s filings is akin to Lewis Carroll’s Alice peeking behind the mirror and finding a universe in reverse.

Consider the third-quarter earnings just released by the real estate management, energy and infrastructure conglomerate, disclosing a handsome $813 million in net income for those three months, walloping the $334 million the public company reported for the same period last year. But instead of popping corks, investors who read the filing will probably want to reach for a bottle of aspirin.

The reality is that a combination of legally permissible accounting maneuvers and Brookfield Asset Management’s singular definition of profit allowed it to script a victory.

Pulling the numbers apart, one can find a $77 million fair value gain, representing Brookfield Asset Management’s assessment of the appreciation of its assets. While asset values do rise and fall, and corporate managements do have to note such things, at Brookfield an increase in asset values lands in the income statement. Even though this makes the bottom line look better, a smart investor knows to discount every penny of it since this adds no cash to the business.

Also noteworthy is how a $525 million one-time gain booked from a litigation settlement became the quarter’s profit driver. This is where the accounting profession goes down the proverbial rabbit hole: Brookfield’s filings seem to follow the reasoning of a character in Lewis Carroll’s “Through the Looking-Glass”: “When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean — neither more nor less.”

The backstory of the litigation settlement is interesting on its own merits. It begins in 1990 when a relatively unknown unit of the AIG insurance colossus called AIG Financial Products struck a 25-year interest rate swap with Brookfield Asset Management’s predecessor, Edper, as Edper fell into serious financial trouble. From the start, it appears that much of the AIG Financial Products-Edper relationship was star-crossed. And in 2008 when AIG collapsed (before a $137 billion U.S. government rescue), Brookfield decided to terminate the agreement, arguing that this amounted to a default under the terms of their agreement, according to Brookfield Asset Management’s 2011 annual report.

Carried on Brookfield Asset Management’s books as a $1.4 billion prospective liability in the second quarter of this year — a spike from the $988 million reported at the end of 2011, the number served as the management team’s best estimate of what it would eventually have to shell out to square away the matter.

Ultimately Brookfield paid AIG $905 million to settle the suit.

What some investors might find slightly surreal is how, using established accounting rules, a company can settle a liability for less than its previously declared amount (for example, by buying back bonds below their face amount) and consider the transaction a profit. So even though $905 million in cash was sent out the door, Brookfield Asset Management claimed a “profit” of $525 million and flowed the figure through its income statement.

This speaks to the larger issue of Brookfield Asset Management’s quality of earnings, a matter discussed in detail in the Southern Investigative Reporting Foundation’s March 11 story on the company. Paper gains on an income statement contribute nothing to the growth of corporate value: Because there is no cash, the company can’t use these “earnings” to make timely investments, increase dividends or buy back shares.

Brookfield Asset Management is hardly the first company to benefit from paper gains: Big banks and securities brokers have perfected the gambit. But Brookfield Asset Management uses them to great effect.

Many of Brookfield Asset Management’s investors and investment bankers dismiss concerns about such issues because a higher income level (usually) serves as ballast to command a higher stock price. But there is a reason that Brookfield seems to have gone to great lengths to keep its share price higher: Partners Limited.

Amounting to what is in effect an old-line Wall Street partnership built into a publicly traded company, Partners Limited consists of a group of about 45 current and former corporate officers of Brookfield Asset Management who privately control 20 percent of its shares — and given Brookfield Asset Management’s dual-share structure, its operations and governance, Partners Limited is an oasis of concentrated corporate wealth. Considering Partner Limited’s big stake in Brookfield Asset Management and its other subsidiaries, and the widespread cross ownership of shares by Brookfield Asset Management and its subsidiaries, there is plenty of incentive for the managers of Brookfield Asset Management to use every last loophole to boost earnings.

With Partners Limited’s current worth exceeding $5 billion, no one has benefitted more from its public-private hybrid model than Brookfield Asset Management’s chief executive, Bruce Flatt. His stake in Partners Limited is now worth more than $713 million.

This is a far cry from the $77 million Brookfield Asset Management disclosed as his aggregate compensation for serving as its CEO from 2002 to 2004 elsewhere in the management information circular.

Regulatory concerns

Investors brave enough to wade through Brookfield’s opaque public filings might take solace in knowing that they aren’t the only ones with a laundry list of questions and concerns.

Recently the Securities and Exchange Commission has been peppering Brookfield with a series of increasingly probing queries and, in its own, stilted bureaucratic language, demanding some serious changes to how Brookfield and its subsidiaries disclose details about their operations to investors.

Brookfield Property Partners, a publicly traded limited partnership spun out of Brookfield Asset Management to hold its commercial real estate operations, has been an object of fascination for the SEC’s accounting mavens. Their communications, in a series of letters and responses carrying on for several months from 2012 to this year, represent an unusually bold turn for the SEC, an agency whose track record is anything but aggressive when it comes to parsing corporate filings to find looming investor headaches.

Using the 2011 annual report as a springboard, the SEC last year sent a series of letters to Brookfield Property demanding clarification of its valuation policy, which, as laid out in footnotes, states in part, “All properties are externally valued on a three-year rotation plan.”

To an investor reading the above, the implications appear both rational and plain: Brookfield Property — poised to be one of world’s leading real estate managers — calculates the fair value of its assets using a combination of its own (internal) assessments and, for a third of the properties each year, the input of qualified and independent consultants.

Except it doesn’t.

The SEC’s sustained questioning of Brookfield Property Partners last year about property valuation process eventually forced Brookfield Property Partners, in a written September 2012 reply, that it does not use “external valuations” to value its investment property. So investors can now see that Brookfield Property Partners describes the worth of its portfolio, much in the manner of Humpty Dumpty; the words selected mean whatever it says they are.

(Furthermore, while Brookfield Asset Management and Brookfield Property Partners are legally distinct entities, with separate investors, filings and boards of directors, Brookfield Asset Management directs all of Brookfield Property’s operations and consolidates its earnings and assets as its own—as it does for all its subsidiaries. Brookfield Asset Management insists that the boards of its subsidiaries are independent. Yet although the board of one subsidiary, Brookfield Infrastructure Partners, meets the legal definition of independent, as the Southern Investigative Reporting Foundation described in March, five of its eight members have deep economic ties to parent company Brookfield Asset Management.)

But what about all that fancy legal wording describing “internal and external appraisal,” which was prominently displayed and repeated throughout the filings of Brookfield Asset Management and its subsidiaries? It seems that this was primarily used for financing purposes. The goal was to give investors and lenders the distinct impression that Brookfield Property Partners relies on a rigorous arm’s-length process to value its portfolio when the reality was the opposite.

All seems to be fair in value

Plus there are big ramifications to some clever wording buried in the footnotes of Brookfield Property’s annual report.

Last year more than $1.3 billion in fair value changes were flowed into Brookfield Property Partners $2.7 billion in net income, according to its 2012 annual report. In other words, nearly 50 percent of its profits were attributed to accounting entries — existing only on paper — that had nothing to do with leasing or selling properties at a profit.

So here’s where a set of truly independent set of eyes reviewing Brookfield Property’s portfolio could mean something beyond an abstract legal concept, perhaps a check and balance. Indeed an independent review could result in a different opinion of the value of Brookfield Property’s billions of dollars of assets and perhaps a substantial change to its bottom line.

After all, if Brookfield Properties excluded fair value changes from its filing and reported earnings of $1.4 billion, the subsidiary might have warranted a sharply different stock price.

And Brookfield Asset Management seems to be quite mindful of its own stock price of late: After the Southern Investigative Reporting Foundation’s March article, Brookfield Asset Management launched an expensive share-buyback program. In putting up the company’s cash, a share buyback can serve to increase (or stabilize) a company’s stock price by removing the amount of shares publicly available — with the result of establishing a temporary floor for the share’s value. It is a popular practice, if rarely as successful as anticipated. (See a chart of Brookfield Asset Management’s buybacks.)

An obscure company called MS451 Inc.

Even though some investors might find it promising that the SEC has recently tried to prompt Brookfield Asset Management to be more transparent, a previous attempt by the SEC to elicit more disclosure in 2009 ended up with the agency backing off.

While few companies have financial filings as opaque as Brookfield Asset Management and its subsidiaries, occasionally the veil surrounding their operations can be pierced. And a diligent detective can piece together the lengths to which Brookfield Asset Management has gone to generate even the thinnest claim to income.

A 2008 related-party transaction by another Brookfield Asset Management subsidiary, its residential property developer Brookfield Homes, thatprompted the SEC to write an epic 2009 letter with a seemingly endless parade of disclosure-oriented questions.

One of the issues that caught the SEC’s attention was a deal struck late in the disastrous real estate year of 2008, when Brookfield Homes sold 451 land plots in the Morningside Ranch residential development outside of San Diego to a Brookfield Asset Management-affiliated related party. This was Brookfield Homes’ only land sale in the region for that year. Brookfield Asset Management revealed the stark terms of the deal in its 2008 annual report: On a $18.5 million sale, Brookfield Homes lost $15 million, suggesting that the land’s true value was $33.5 million.

In its letter in 2009, the SEC demanded more details about related-party aspects of the deal. But in a departure from the typical response of a public company to the U.S. regulatory body, Brookfield Homes refused to elaborate, saying that Brookfield Asset Management’s ownership stake in the entity purchasing the lots was less than 10 percent.

The SEC’s response a month later was unambiguous: The agency demanded full disclosure, arguing that regardless of the size of Brookfield Asset Management’s equity position, it had “a significant financial interest” in the related party.

Brookfield Homes’ subsequent reply was conciliatory: “The Company notes the Staff’s comment and will provide the requested disclosure in its next Definitive Proxy Statement.”

Yet Brookfield Homes’ next proxy statement (known in Canada as a management information circular), in 2010, did not contain the information requested nor did subsequent filings, despite the company’s assurances.

In 2011 Brookfield Homes was renamed Brookfield Residential Properties after an internal reorganization of its operations.

To date, there appears to be no record of the company ever providing the expanded disclosure. And a Brookfield Asset Management spokesman, who assured the Southern Investigative Reporting Foundation the company had indeed disclosed the information, declined to provide a link to a filing with it.

Fast-forward to the first quarter of 2013: The very same Morningside Ranch parcels at the heart of Brookfield Homes’ 2008 transaction suddenly pop up in the company’s corporate disclosures.

Tucked in the back of Brookfield Residential Properties’ filing for the first quarter of 2013 is a mention about an unnamed $29 million residential lot in California being purchased from Brookfield Asset Management during the three-month period.

In a departure from the typical corporate language for such transactions, the filing describes the payment as “measured at an exchange value of $29 million.” This suggests that cash may not have been used in the transaction.

Using public records, the Southern Investigative Reporting Foundation determined that the Morningside Ranch lots sold by Brookfield Homes in December 2008 were bought by an entity called MS451 Inc., and that by March 2013 MS451 Inc. had sold those lots to Brookfield Residential Properties.

According to California corporate documents, a Brookfield Homes executive named Stephen P. Doyle signed papers for both MS451 Inc. and Brookfield Homes during the late December 2008 transaction, as did Larry Cortes, then the chief financial officer of Brookfield Homes’ San Diego area operations and also CFO for MS451 Inc. At least four other Brookfield Homes executives had roles in MS451 Inc., according to these documents.

The Southern Investigative Reporting Foundation’s initial efforts to learn more about MS451 Inc. and its owners has led to still more questions. Dissolved in late March 2013 after the California lot deal closed, MS451 Inc. appears to have had three owners: Brookfield Asset Management, with a stake of less than 10 percent, and two brothers, real estate developers James and Charles Schmid, who are the chief executive and president, respectively, of Chelsea Investment Corp.

Brookfield Homes, Chelsea and MS451 Inc. have a few things in common: Two Brookfield Homes alumni (listed in filings as officers of MS451 Inc.) now work for Chelsea: The aforementioned Larry Cortes is currently a Chelsea project manager, and Liz Zepeda works for Chelsea as a risk analyst (the same role she played at Brookfield Homes).

The purpose of the Schmids’ involvement in the deal remains unclear. In deal documents, they are listed as individuals not corporate officers of Chelsea. Several phone calls made to James Schmid’s office requesting comment were not returned nor was a call to Charles Schmid’s home.

MS451 Inc.’s reasons for involvement with the property are not immediately apparent. And why did the property’s prepared lots stay undeveloped during the past half decade of record low interest rates?

Moreover, the 2008 transaction seems to have been conducted with MS451 Inc. receiving some very favorable terms. During a time of major financial stress for Brookfield Homes, the subsidiary accepted bonds as payment from MS451 Inc. — a company with no assets or operations — and not cash. (In 2008 Brookfield Asset Management provided a waiver when Brookfield Homes could not comply with its net debt to capitalization and minimum equity covenants, an issue the SEC had been quite curious about in its aforementioned 2009 letter.)

At least on paper, the owners of MS451 Inc. did well for themselves, realizing a profit of $10.5 million on the deal. And because of the related-party nature of the transaction, Brookfield Asset Management claimed the full amount of profit as its own. That’s the case even though Brookfield Asset Management directly earned only about $1 million from the deal, from its less than 10 percent stake.

While $10.5 million in consolidated earnings is immaterial when considering an income statement the size of Brookfield Asset Management’s, it does suggest a further question: How much of the company’s earnings come from related-party accounting maneuvers like this one involving MS451 Inc.? Indeed, as the Southern Investigative Reporting Foundation showed in March, Brookfield Asset Management regularly generates hundreds of millions in profit through complex related-party dealings.

In response to reporter questions, Andrew Willis, a Brookfield Asset Management spokesman, sent responses but failed to make any of this any clearer: Concerning the Brookfield Homes-Brookfield Residential Properties disclosure above, he said, “[Brookfield Residential Properties] disclosed the related party nature and valuation basis for both transactions.” He declined to elaborate further when asked follow-up questions.

Brookfield’s Brazilian headache

On Friday when Brookfield Asset Management released its third quarter results, it revealed an interesting development in another whole line of business in another corner of world – one involving potential fraud.

It revealed in the “Risks” section a new disclosure that the SEC and U.S. Department of Justice are investigating allegations that a Brazilian private equity unit had bribed local officials to approve certain real estate transactions. A public prosecutor in São Paulo has filed charges against three Brookfield Asset Management executives and seven municipal officials under the country’s anti-bribery statutes.

Long a key component of the Brookfield Asset Management empire, the Brazilian operations manage or own more than $13 billion worth of utilities and real estate. Indeed prior to becoming Brookfield Asset Management, the company was called Edper-Brascan, with Bras being short for Brazil.

The recent charges emerged following Brookfield Asset Management’s April 2010 dismissal of Daniela Spinola Gonzalez, the former chief financial officer of a Brookfield-managed real estate fund in São Paulo.

Reached by the Southern Investigative Reporting Foundation, Gonzalez said that in the spring of 2009 she uncovered a series of payments to São Paulo municipal officials aimed at obtaining approval of expansion projects at four different malls. Specifically she alleges they were designed to cover up the real estate fund’s lack of compliance with a series of pre-expansion mandates from the São Paulo building approval department designed to address a potential increase in traffic flow. When she discovered requests to approve large payments to holding companies she had never heard of, she investigated further and found municipal officials had set up entities to receive payments from the real estate fund.

Gonzalez alleges that when confronted her unit and corporate supervisors, including Steven J. Douglas, then the head of the Brookfield Asset Management’s international property portfolio, with news she felt sure would outrage them, she was told repeatedly, “This is the way of doing business in Brazil.” The angriest they got about the bribes, according to her, was when they chastised her for discussing sensitive fund business in an email. (In reporting on the claims of Gonzalez, the Southern Investigative Reporting Foundation examined a series of emails between Gonzalez and her supervisors, other internal Brookfield documents and a letter written to the SEC by her lawyers.)

Dismissed in April 2010, Gonzalez filed a labor grievance shortly thereafter in São Paulo. Brookfield Asset Management filed a lawsuit against her in 2011, alleging she had engaged in embezzlement; she says the charges are nothing more than “a complete fabrication to make me seem like a criminal.”

Asked about Gonzalez and her charges, Brookfield Asset Management spokesman Andrew Willis said, among other statements, “Notwithstanding the suspect source of the allegations, Brookfield conducted an investigation into these matters. The investigation found no evidence of wrongdoing by Brookfield or any of its employees.”

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Disclosure Diligence

Brookfield Asset Management’s disclosure practices have raised regulatory eyebrows before.

In a nine-page June 10, 2009, letter, the Securities and Exchange Commission raised with Brookfield a laundry list of concerns it had about Brookfield Asset Management’s home building subsidiary Brookfield Homes, requesting more detailed disclosure.

One issue was the Brookfield’s failure to disclose that Craig Laurie, Brookfield Homes’ chief financial officer, had also been serving as the CFO of Crystal River Capital, a company that was then being managed by another Brookfield Asset Management unit.

Brookfield Homes replied two weeks later, and among other things, agreed to disclose Laurie’s dual role. In 2011, Brookfield Homes became Brookfield Residential Properties.


For more coverage of Brookfield Asset Management, read “The Paper World of Brookfield Asset Management.”

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Northern Exposure

Beginning at about 9 a.m. on Jan. 24, 1996, in the offices of the Toronto law firm of Tory Tory DesLauriers & Binnington, a combative former Ontario Securities Commission regulator named Joseph Groia made a small piece of Canadian legal history by deposing a native South African named Jack Lorne Cockwell. Though not a shy man, the 55-year-old Cockwell had thus far achieved astounding career success, due in some measure, to avoiding people like Joe Groia.

Though Cockwell invariably bore impressively nondescript titles like vice chairman and took pains to keep out of the limelight, he had been chief strategist of the Edper Group and the architect of its constellation of nearly 360 separate subsidiaries. He had not been alone; he built a small band of intensely loyal colleagues who shared his singular view of business. Though Edper became many things over the years of its operation from the late 1960s to the mid-1990s, it began as a sleepy holding company for the shareholdings of its two original owners, Edward and Peter Bronfman, the scions of the Seagram’s liquor fortune.

The combination of the Bronfmans’ capital and the ruthless intelligence and vision of Cockwell’s team proved unstoppable and Canada’s business firmament bent before it. By the late 1980s, Edper controlled an empire that included everything from Labatt brewing company, Brazil’s largest utility, huge real estate holdings, the Toronto Blue Jays and mining giant Noranda.

Edper was no ordinary company by any measurement, in any era: At points in the late 1980s, nearly 15 percent of the Toronto Stock Exchange’s daily trading volume involved the shares of its various subsidiaries and more than 110,000 people drew their paycheck from one of its companies.

It had not ended as planned, however. After the debt crisis of 1989, Edper’s spiderweb structure, in which every unit seemingly owned the debt or the preferred shares of another, underwent a sudden rapid shift away from the diversified conglomerate model. By February 1993 its stakes in Labatt and pulp and paper giant MacMillan Bloedel were sold off in a single night in what Canadian business reporters took to calling “the great Edper lawn sale.”

Yet despite losing 90 percent of its market capitalization from 1989 to 1993, Edper survived. Emerging unscathed, Cockwell folded many of the company’s assets into Brascan, an already asset-rich Brazilian subsidiary. After a series of asset transfers, a newer, more streamlined company surfaced in 2005. The company, based in Toronto’s tony Brookfield Plaza, was renamed Brookfield Asset Management.

Groia’s deposition of Cockwell concerned the matter of Lionel Conacher’s case against Hees International Bancorp, which was one of the central components of Edper’s empire. Like all such cases, sharply divergent viewpoints came into play: Lionel Conacher, a Dartmouth College–educated former Citicorp banker, had been hired by Hees International Bancorp as assistant treasurer.

Conacher argued that Hees had failed to honor a key compensation clause and left him with worthless options, and Hees (represented by Cockwell) defended the company’s actions as proper and just. The merits of Conacher’s claim soon became secondary to what was uncovered during discovery: how Edper really worked.

Behind the corporate facade and the track record of success lay Edper’s universe of related-party deals and a nonstop continuum of managerial investments into or out of subsidiaries. Publicly, Cockwell and his colleagues proclaimed the benefits of having managers with a personal stake in their businesses; privately, the reality was often different.

The complexity of the effort is astounding. According to Conacher’s sworn affidavit, he and his Edper colleagues set up private investment companies that issued preferred shares to investment vehicles controlled by senior Edper managers like Cockwell’s brother Ian. Such managers then used the proceeds to buy shares in a subsidiary of a private holding company of Edper, which in turn held a mix of public and private shares in other Edper entities. Depending on the cash needs of management, the publicly held Hees could act as a financial intermediary, buying back shares or providing loans.

At the center of this whirlwind of loans and secret deals was Jack Cockwell and a small group of senior Edper executives. They held shares in Partners Holdings Inc., which Conacher described as a “financial partner with Peter Bronfman in the control of the Edper group.” And there was another layer: Quadco, a company that appeared to hold a controlling interest in Partners Holdings Inc., which was a partnership between the two Cockwell brothers and two other long-serving Edper executives, Tim Price and David Kerr.

The filings also disclosed an August 1993 deal involving Hees subsidiary Great Lakes Holdings and designed to help relieve some of the financial pressure on Hees executives as a result of loans they had assumed to buy stock in Hees or its subsidiaries. That August Hees allowed executives like Conacher to purchase shares at 50 Canadian cents and bought them back six months later in February 1994 at CA$7.04. The loan to purchase the shares came from Cockwell’s private management company and the more than CA$563,000 in proceeds from the Great Lakes trade were used to pay off a bank that wanted back the money it had loaned Conacher.

Roughly 10 million Canadian dollars in shareholder cash were transferred to Hees executives to pay off loans they had taken to participate in various equity investments.

Lurking within the Hees-Great Lakes Holdings deal was the real threat — one posed by the massive web of undisclosed private guarantees to a series of otherwise healthy operating companies, with Hees using public capital to stave off private risk.

After some additional legal wrangling, Conacher reached an out-of-court settlement with his former business associates within the year; the terms were never disclosed. Conacher, reached at his new employer, Roth Capital Markets, declined comment.


For more coverage of Brookfield Asset Management, read “The Paper World of Brookfield Asset Management.”

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A Rousing Relationship

A series of transactions beginning last winter involving Brookfield Asset Management and Rouse Properties (a New York-based mall developer in which Brookfield has a substantial investment) illustrates how complex financial moves with related parties can prove remarkably advantageous.

The backstory: Rouse Properties, a developer of Class B malls (a real estate industry term referring to malls that are nondominant competitors in their region, with sales of less than $400 a square foot), was spun out of General Growth Properties in August 2011.

In February 2012, Rouse conducted an unusual $200 million stock purchase rights offering, whereby existing shareholders were given the opportunity to “subscribe,” or buy, shares at $15 for one month when the shares were trading around $13.75. (Rights offerings are usually offered at a slight discount to the prevailing share price to motivate shareholders to participate without diluting their stake.)

Lasting a month, Rouse’s rights offering never reached the $15 level but instead of the embarrassment of a failed deal — less than 15 percent of Rouse’s non-Brookfield shareholders participated in the offering — Rouse got its money. That’s because Brookfield “backstopped” (or guaranteed) the completion of the deal — for a $6 million fee. After the deal was done in March 2012, Brookfield owned an additional 11.35 million shares, taking its stake in Rouse from 37 percent to 54 percent, giving it effective control over the company. Of note, Brookfield was able to do this without paying a control premium to Rouse’s investors.

Shortly after the rights offering was closed, Brookfield and Rouse engaged in a series of transactions that seem to show how Brookfield obtained a large block of Rouse shares by spending only $13.7 million.

It began January of last year, when $150 million of the cash Rouse raised was transferred to a wholly owned Brookfield subsidiary, Brookfield U.S. Holdings, that pays Rouse an annual floating interest rate of Libor plus 1.05 percent. According to Rouse’s filing, this was structured as a demand deposit due to mature on Feb. 14 of this year. No reason was given in either company’s filings for making the demand deposit at BBB-rated Brookfield as opposed to a traditional bank, like A-rated J.P. Morgan.

At the same time, Rouse opened a $100 million credit line with Brookfield U.S. Holdings that costs Libor plus 8.5 percent, plus a onetime initiation fee of $500,000, and had made $250,000 in interest payments through the third quarter. To date, the credit line does not appear to have been touched.

Visually, the cash transfers look like the list on the chart, below:


For more coverage of Brookfield Asset Management, read “The Paper World of Brookfield Asset Management.”

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The Paper World of Brookfield Asset Management

Enter the name of Toronto-based public company Brookfield Asset Management into a search engine and it delivers more than 1 million results. The global conglomerate, whose annual sales exceed $18 billion, controls ports in England, owns Manhattan’s prestigious World Financial Center and sells Chicago a fair measure of its electricity. Yet the massive enterprise is better known for what it owns than how it operates.

The Southern Investigative Reporting Foundation began a full-time investigation into Brookfield’s far-flung operations in late fall. This reporting and research uncovered a series of earnings quality problems, the presence of a mostly hidden ownership group that effectively controls Brookfield’s governance and corporate structure, and a business model that involves heavy reliance on related-party transactions with its subsidiaries.

Few companies bear a structure as complex as Brookfield’s: Analyzing the company’s organizational tree and its web of entities, stakes, partnerships and operating companies is to behold the work of gifted accountants and lawyers. Similarly, Brookfield’s financial filings are mind-boggling in their complexity.

A brief glance at a stock chart, which shows that Brookfield’s share price has been on a fairly steady climb from a low of $11 in 2009 to almost $40 in recent months, might give credence to the argument that the labyrinthine structure works.

No one doubts that Brookfield’s share price performance has pleased investors, but how it is achieved should matter.

Control without risk

Brookfield bears a pyramidal control structure, a design that U.S. regulators have frowned on since the 1930s. Simply stated, this type of structure lets a small group of shareholders exercise control of a business without putting a proportionate amount of capital at risk.

(This kind of corporate structure is often depicted by a pyramid; hence the name. It is legal and to varying degrees common in Europe, Asia and Canada. But it should not be confused with a pyramid scheme.)

As has been deeply parsed in academic literature, pyramidal control structures are either tremendously efficient or very worrisome, depending on one’s vantage point. Indeed, legendary investor Benjamin Graham devoted an entire chapter of his still influential 1934 book “Security Analysis” to their risks.

Those in the founding group can leverage their capital to effectively control a broad network of assets or investments; often members of this group do so by creating a holding company with the right to appoint half or more of the board of directors of the parent company.

In turn, these directors can oversee a series of acquisitions using the company’s capital, most of which belongs to other people.

For the shareholders outside of the control group — even if their capital is doing most of the buying — their influence upon the board of directors is perpetually limited, no matter how much they have invested.

Brookfield’s formula

Here’s how Brookfield’s pyramidal control structure works: Partners Limited, a private holding company with 45 equity holders (a mix of current and former Brookfield officers, with just eight publicly named) owns slightly more than 20 percent of Brookfield’s Class A shares via a combination of trusts and direct holdings valued at more than $4.7 billion. Partners Limited also owns 100 percent of Brookfield’s 85,120 Class B shares, allowing it to elect 50 percent of Brookfield’s board of directors. Owning just 20 percent of the Class A shares but electing half of Brookfield’s board, those who run the almost invisible Partners Limited end up with effective control over all Brookfield’s operations and governance, and anyone else who happens to be a Brookfield shareholder with a gripe cannot do much but grin and bear it.

Should an enterprising Brookfield shareholder summon the nerve to put forth a measure for a vote, its adoption requires approval from two-thirds of both the Class A and Class B shareholders alike. In other words, if the 45 Partners Limited shareholders who own Class B stakes believe a measure goes against their interests, the motion is dead even if 80 percent of the Class A holders approve it. Ultimately this creates a public-private hybrid: a corporation that has ready access to public capital but whose governance can be a private matter.

The use of A and B classes of shares is almost universally panned by governance advocates for its allegedly unfair treatment of minority shareholders. But Brookfield is hardly the only company with what is known as a dual-class share structure. The roster of companies with such a structure includes Google, Berkshire Hathaway and The New York Times Co. Whatever their merits, dual-class share structures are designed to keep the company’s operating assets in the hands of founders. When Berkshire Hathaway’s Warren Buffett likes another company, he does not use his publicly traded corporation as a springboard to build a string of downstream corporate investments via minority stakes; he generally buys all of it.

Want to know more about Partners Limited, its history and how it goes about business? Apart from mentions in Brookfield’s management information circular (equivalent to a U.S. corporate proxy statement), the entity is rarely mentioned in the filings of Brookfield and its subsidiaries. Examining public filings, the Southern Investigative Reporting Foundation came up with a list of 40 of the 45 current and former Partners Limited equity holders; a sizable number of them were instrumental to the rise and fall of Brookfield Asset Management’s high-profile predecessor, the Edper Group.

[module align=”left” width=”half” type=”aside”] See the Southern Investigative Reporting Foundation’s exclusive list identifying 40 Partners Limited equity holders — those who really call the shots at Brookfield Asset Management.[/module]

In response to a U.S. Securities and Enforcement Commission comment, Brookfield recently came close to acknowledging that it has a pyramidal control structure in the “Risk Factors” section of a prelaunch filing for its Brookfield Property Partners unit: “The company at the top of the chain may control the company at the bottom of the chain even if its effective equity position in the bottom company is less than such controlling interest,” the document states.

(With its shares traded on the Toronto and New York exchanges, Canada-based Brookfield submits filings to the SEC but does so as a foreign issuer, which allows it to legally bypass some U.S. laws.)

No matter how little Brookfield Asset Management controls economically of Brookfield Property Partners, Brookfield Asset Management will retain control of Brookfield Property Partners’ board.

All this fine print has paid off handsomely for Partners Limited.

Consider just this one, commercial real estate branch of the Brookfield Asset Management ownership tree: Partners Limited, with a stake worth $4.7 billion, is able to control Brookfield Asset Management, whose market capitalization is $23.8 billion. One of Brookfield Asset Management’s investments is its 50 percent stake in Brookfield Office Properties, a commercial real estate developer with $8.5 billion in market capitalization, that in turn owns 73 percent of Australian real estate investment trust Brookfield Prime Property Fund. With what ultimately amounts to a 7.3 percent blended equity stake in these three entities, the 45 people in Partners Limited exert managerial control over many billions of dollars’ worth of commercial real estate around the world.

Asked about the role Partners Limited plays in Brookfield Asset Management, Andy Willis, a company spokesman replied, in part, with the following:

“We believe [Partners Limited] creates a significant alignment of interests with our shareholders that sets us apart from other companies and is valued by shareholders and our clients alike. We believe that Partners’ participation in the ownership of Brookfield will result in greater long‐term value creation for all shareholders.”

The U.S. regulatory distaste for pyramidal control structures can be traced to the presidency of Franklin Delano Roosevelt. Then Federal Trade Commission analysts fervently argued that a series of collapses in the 1930s by pyramidal control structure companies (primarily utilities) had deepened the Great Depression. The FTC analysts seized on three things: real and potential abuses by “minority” shareholders (resulting in investors who did not exert control over corporate affairs), the prospects for one-sided related-party transactions — and most important — weak accounting controls that led to the inflation of asset values.

What the numbers really say

Investors in Brookfield have remained loyal to the corporation despite such governance issues perhaps because it has grown assets and earned billions of dollars annually. With Brookfield’s shares widely held in Canada and finding increasing favor among American money managers over the past few years, members of Partners Limited and the rest of Brookfield’s senior management likely are optimistic about prospects.

But a sunny outlook might not be what comes to mind after close scrutiny of Brookfield’s financial filings and an analysis of how the company interacts with several of its subsidiaries.

Despite its profits, Brookfield is not doing as well as investors might suppose.

Brookfield is a creature of the capital markets, relying on financing to fuel its growth and meet its commitments to investors, as the chart below shows. From the start of 2010 to the third quarter of 2012, Brookfield’s distributions — its dividend payments to investors  — were $272 million greater than its cash flow from operations, according to filings. Fortunately for Brookfield, its investors are a truly generous bunch; they helped the company eliminate this deficit and raise almost $1.75 billion more than it paid back out, ensuring that its increasing dividend obligations were met — with cash to spare.


But relying on a constant stream of investor capital has proved a substantial risk for many corporations — the 2008 credit crisis serves as an object lesson — since companies whose business models center on a constant stream of capital market funding hit trouble when the markets seize.

And U.S. tax policy toward dividends is a major stumbling block for companies with pyramidal control structures.  The primary method a pyramidal control structure company has to sustain itself — using preferred stock dividends to shuttle cash from the subsidiaries through the structure to the publicly traded holding company — becomes impractical when both the dividend payer and recipient are being taxed.

Postmodern accounting

Generations of businesspeople have assessed the success of enterprises based on a set of simple criteria: Are they profitable? Do they sell enough goods or services in a given period so that after fixed and variable costs are subtracted and taxes paid, something is left to reinvest, retain for future use or even return to shareholders?

Using net income as a barometer of financial achievement is not without its flaws; any business that requires a substantial investment or a longer time frame for its assets to generate a return is likely to eke out a meager income in the short term. But net income is a rational and understandable measurement of where a business stands.

Brookfield sees things very differently and suggests investors judge its success by relying, as the company does, on a measure called “total return” to accurately capture the growth in asset value and cash flow generation in its units. The company describes this view in its annual report as follows: “We define Total Return to include funds from operations plus the increase or decrease in the value of our assets over a period of time.” (“Funds from operations” consist of the cash flow from its businesses.)

Accordingly, Brookfield’s management says it is not the biggest fan of using net income to define profit because only “fair value” adjustments from its real estate and timber segments can be included but not any from its renewable power and energy businesses. (A company can make fair value adjustments if it decides that the market value of its assets has significantly changed from their book value.)

Whatever the merits of “total return” as a measurement, Brookfield’s investors would need to determine net income to gauge the return on their invested capital in comparison to other investment possibilities.

Management’s linguistic preferences are not the sum total of the drama surrounding Brookfield’s accounting, however. Its income statement has several line items that suggest flaws in the company’s earnings quality. 

A frequently debated subject in the accounting community, earnings quality is usually defined to include, in part, how closely a company’s reported net income tracks its so-called true income (or what it can easily convert to cash).

Those willing to put on the green eyeshade and examine Brookfield Asset Management’s 2011 Consolidated Statement of Operations can find $3.67 billion in net income. It’s an eye-opening number. More interesting, however, is discovering just how much of that figure is generated from accounting entries and not from profits related to business activity.

The problem starts a few rows above the line for net income where one can view the various streams that comprise it. In 2011, almost $1.29 billion, or 35 percent, of Brookfield’s profits came from fair value gains. (This figure, however, is listed as $968 million in the 2012 earnings release; it is not clear why there is a difference between the two filings.) For 2012, according to Brookfield’s most recent earnings release, more than 43 percent — or $1.19 billion — of its net income of $2.74 billion came in fair value changes.

Accounting standards allow for including fair value changes in net income. But any gimlet-eyed investor knows that they are nothing more than paper entries, and in Brookfield’s case, they represent its own assessment of its timber, commercial real estate and agricultural asset values; they have nothing to do with the cash typically associated with profits. Even though company executives may legally term a fair value change as profit, this sum cannot be used to pay dividends, build new plants or be readily tapped for a rainy day. All it represents is that the company thinks an asset has increased in value. As a key driver of the much larger net income figure, however, it certainly appears to have added some heft to Brookfield’s share price in recent times.

Consider a complex line item titled “equity accounted income” in the 2011 annual report’s Consolidated Statement of Operations, representing Brookfield’s share of income from its far-flung investments in entities it controls. Pegged at slightly more than $2.2 billion, this amounts to 60 percent of its total net income of $3.67 billion. Similar to fair value adjustments, equity accounted income is (mostly) noncash. For 2012, it totaled $1.24 billion and equaled more than 45 percent of earnings. (Brookfield released its 2012 earnings in mid-February but not its entire annual report, so details about the components of 2012 earnings are not yet available.)

The primary driver of the “equity accounted income” entry in 2011 was Brookfield’s high-profile 22 percent investment in General Growth Properties, a New York-based commercial real estate developer and manager. (Funds managed by Brookfield own another 18 percent of the stock.) Buried in the back of the annual report, this notation is easy enough to miss, but the carrying value — the value Brookfield assigns to the General Growth Properties position — was $1.17 billion more than its market value: Brookfield valued the highly liquid, New York Stock Exchange-traded shares of General Growth Properties at about 40 percent above the market’s valuation at the end of 2011. All told, about $1.4 billion from this one investment eventually wound up in equity accounted income, but it added only $204 million in cash to the till, according to the annual report. (In 2010, Brookfield reported equity accounted income of $765 million but its only source of actual cash from that input was $374 million in dividend payments from companies it had invested in.)

Thus, accounting entries are making Brookfield look really good. Without including fair value changes and equity accounted income, Brookfield’s earnings sharply decrease.

What does this situation look like numerically speaking? As shown in the chart below of Brookfield’s net income in the last couple of years, after adjusting for fair value changes and equity accounted income, the sum that might be called the “true profits” — the earnings from all the investments and assets Brookfield has the world over — is relatively low.


Investors may accept Brookfield’s desire to be analyzed this way but the SEC has publicly questioned how Brookfield used specific investment terms and its valuation methodology. In one instance in July 2011, the SEC noted its concern that Brookfield’s use of the phrase “cash flow from operations” was outside the standard definition. Despite the unambiguously skeptical tone in the SEC’s correspondence about the phrase, Brookfield held its line for more than five months. The company repeatedly parried the SEC’s concerns in a dispute that played out in a cat-and-mouse series of filings before Brookfield finally consented to change its wording in November. [module align=”right” width=”half” type=”aside”]Find out more about a host of concerns the SEC had in 2009 about another Brookfield subsidiary, Brookfield Homes.[/module]

The real number for Brookfield’s earnings is anyone’s guess. The sheer complexity of its income statement and management’s insistence on nontraditional measurements seem to work in Brookfield’s favor, as virtually no analysts or investors have raised public concerns in this regard.

As Brookfield’s auditor, the accounting giant Deloitte & Touche, notes in an article it wrote in 2002, the prevalence of noncash earnings is an important criteria in assessing earnings quality.

In 2011 Brookfield paid Deloitte $38.7 million for audit work for Brookfield and its subsidiaries. Below, view a chart showing how much Brookfield and other large Canadian corporations compensated their auditing firms.

The curious case of an infrastructure player

As is the case for some icebergs, much of Brookfield Asset Management’s activity is happening below the surface, at the level of its operating subsidiaries and limited partnerships.

Brookfield Asset Management’s approach to navigating the myriad disclosure, accounting and valuation challenges of its pyramidal control structure is perhaps most clearly seen in the filings of Brookfield Infrastructure Partners L.P., a publicly traded affiliate spun off from Brookfield Asset Management in early 2008.

Holding Brookfield Asset Management’s infrastructure investments in commodities like utilities, timber, toll roads and seaports, Brookfield Infrastructure Partners is structured as a publicly traded limited partnership. Though Brookfield Infrastructure Partners is legally autonomous from Brookfield Asset Management and sports brand-name investors like Morgan Stanley Investment Management and Fidelity Investments, there is no apparent practical distinction between the two. Brookfield Asset Management and Partners Limited currently owns about 29 percent of Brookfield Infrastructure Partners’ units (down from 60 percent in 2008) and acts as its general partner, earning a 1.25 percent management fee and incentive fees, which amounted to $53 million in 2011, according to the annual report.

(Using an unusual approach, Brookfield Asset Management calculates its management fee from enterprise value, meaning that the larger Brookfield Infrastructure Partners’ capitalization gets, the bigger the fee. Brookfield Asset Management also receives 25 percent of surplus cash each year from Brookfield Infrastructure Partners if Brookfield Asset Management’s quarterly distribution is more than $.305 per unit; it was $.370 per unit for the most recent quarter. Other limited partnerships have a similar clause for paying out additional dividends with surplus cash but have very strict guidelines about when it applies; in Brookfield Infrastructure Partners’ case, these extra distributions are at the “sole discretion” of the general partner, according to the 2011 annual report.)

For all practical purposes, Brookfield Infrastructure Partners exists solely on paper and has no employees or assets. What Brookfield Infrastructure Partners does have is a series of remote and indirect ownership claims on about 15 assets managed by Brookfield Asset Management employees and held in private-equity partnerships domiciled in Bermuda and controlled by Brookfield Asset Management.

Tracking Brookfield Infrastructure Partners’ cash flow is a fool’s errand: Its filings don’t indicate the cash flow from all its investments. Until recently Brookfield Infrastructure Partners (like Brookfield Asset Management) has had some rough times; it failed to generate enough cash from its operations to cover its distributions to unit holders in 2010 and 2011. This turned around sharply during the first nine months of 2012, when Brookfield Infrastructure Partners booked a surplus of $171 million. But look at the difference between the finances raised and what was invested: Brookfield Infrastructure Partners regularly raised more capital than it needed to finance asset purchases and had some left over.

Like its parent, Brookfield Infrastructure Partners has an earnings quality problem. As the consolidated statement of operations shows, the partnership reported $106 million in net income for 2012 but fair value changes amounted to $200 million of that. In 2011, the $187 million in net income for the partnership was dwarfed by $356 million in fair value changes.

In 2010, Brookfield Infrastructure Partners made a pair of accounting changes (described in Note 7 of its 2010 annual report as a $239 million “remeasurement gain” and a $194 million “bargain purchase gain”); these were related to the purchase of a remaining 60 percent stake in Prime Infrastructure Fund that it didn’t already own. (The fund was founded by Babcock & Brown, an Australian infrastructure finance investment firm that began liquidation in 2009.) The $433 million noncash gain was the majority of the year’s $467 million in net income for Brookfield Infrastruture Partners. In a 15-page response to the SEC’s questions about this gain and other accounting and valuation issues, the partnership offered a host of reasons why the book value of its new assets were markedly above the purchase price; the cited reasons included the appreciation of the Australian stock market from 2009 to 2010, as well as Brookfield Infrastructure Partners’ own unit price.

The conclusion is stark: Noncash accounting entries are saving Brookfield Infrastructure Partners and the market value of its units from some hard times and harder choices.

The charms of consolidation

The balance sheet gets even more convoluted. In 2010, Brookfield Infrastructure Partners began reporting its financials in accordance with International Financial Reporting Standards — as opposed to U.S. Generally Accepted Accounting Principles — after Canadian law mandated the switch. In an attempt to harmonize accounting treatments around the world, IFRS does away with GAAP’s strict definitions, granting financial managers wider latitude to determine the fair value of assets. The end result for Brookfield Infrastructure Partners has been remarkable.

In 2010, Brookfield Infrastructure Partners reported its 2009 balance sheets using both GAAP and IFRS. Under GAAP, Brookfield Infrastructure Partners reported $1.07 billion in assets. Under IFRS, Brookfield Infrastructure Partners’ assets ballooned to slightly more than $6 billion.


Recall that nothing save the accounting system had changed; it was the same company through and through, except one with a much larger balance sheet. And indeed from the spring of 2010 onward, the price of Brookfield Infrastructure Partners’ units have found much more favor in the market.

Brookfield Infrastructure Partners has been able to do this because as it switched to IFRS, it also changed its policy about an accounting concept called consolidation. At its core, consolidation is an easy concept to grasp; it occurs when Company A takes Company B’s financial statements onto its books and presents the combined results to investors. (This usually happens when Company A owns a majority of Company B’s equity, giving it effective control over Company B’s governance and operations.)

Under U.S. GAAP, consolidation can take place when a company owns 80 percent of another; but with IFRS, a corporation has plenty of freedom to define consolidation.

So Brookfield Infrastructure Partners consolidated the financials of five companies it had invested in even though its stake was less than 80 percent. It seems this move amounted to a deft legal maneuver, whereby Brookfield Asset Management — which managed these investments — ceded to Brookfield Infrastructure Partners the voting rights for these companies, giving the latter the right to select board members and direct corporate actions.

A fair question to ask is, What changed after the voting rights transfer? The answer is apparently not very much. The Brookfield Asset Management executives in charge of Brookfield Infrastructure Partners before this ceding of voting rights were the same executives, in the same roles and with the same incentives, as the ones afterward.

What wasn’t immaterial was Brookfield Infrastructure Partners’ ability to add about $2.4 billion of assets to its 2010 balance sheet from two investments, Longview Timber and Island Timber L.P., even though it had less than a 40 percent equity stakes in each.

The SEC’s Division of Corporate Finance raised specific questions in its previously mentioned Jan. 31, 2012, letter about Brookfield Infrastructure Partners’ consolidation practices.

Consolidation of investments in which Brookfield Infrastructure Partners has a minority stake has not been a one-off occurrence. In 2012 Brookfield Asset Management purchased minority stakes in Warwick Gas Storage and Columbian Regulated Distribution (22 percent and 17 percent, respectively) and then transferred the utilities’ voting rights to Brookfield Infrastructure Partners, which consolidated the companies on its balance sheet.

But finding consistency in Brookfield Infrastructure Partners’ approach to consolidation is difficult, as it has made investments in seven companies (with the equity stake ranging from 10 percent to 50 percent) that did not lead to a consolidation, according to its documents.

The most important aspect of Brookfield Infrastructure Partners’ consolidation policy is the part we know the least about: cash flow. While consolidating select minority stakes certainly improves the appearance of Brookfield Infrastructure Partners’ income statement and balance sheet, this also skews any attempt to figure out just how much cash is flowing into the partnership from these investments.

When it comes to discussing the merits of consolidating its minority stakes, Brookfield says this is done for shareholders and analysts, so they can get a “much clearer depiction of [Brookfield Infrastructure Partners’] underlying investments by showing on a consolidated basis the company’s assets, liabilities and financial performance.”

Asked by email how consolidation makes these metrics clearer, Brookfield’s spokesman refused further comment.

A question of independence

Using the standard interpretation of good corporate governance, an autonomous board of directors is supposed to serve as the investors’ advocate and ensure that senior management is effective in building shareholder value.

Brookfield Infrastructure Partners’ eight-member board of directors includes seven individuals classified as independent. Research shows, however, that five of the eight have clear professional, economic or board ties to Brookfield Asset Management and its subsidiaries.

When pressed on the matter, Brookfield Asset Management disputed the notion that Brookfield Infrastructure Partners’ board of directors lacks autonomy. Responding to questions from the Southern Investigative Reporting Foundation, Brookfield Asset Management stated, The BIP board has eight directors of which seven are independent. The BIP board approves all significant matters involving BIP. BIP also has fully independent audit, compensation and governance committees which are required to approve the matters within their purview.”

[module align=”left” width=”half” type=”aside”]Read about a former Edper executive’s affidavit stating he and his colleagues set up private investment companies that issued preferred shares to investment vehicles controlled by Edper senior managers.[/module]

What exactly constitutes an independent corporate board is certainly the subject of much debate. Following the letter of the law, Brookfield Asset Management can term Trevor Eyton an independent member of its board as long as he has not drawn a paycheck from Brookfield within the prior three years and has no family members working for the company. Yet this ignores the fact that from 1979 to 1997, Eyton (a longtime shareholder in Partners Limited and its predecessors) served variously as chief executive and chairman of Brascan, a key Brookfield subsidiary, and also had been for an extended period one of the most public executives of Brookfield’s predecessor, Edper.

The terrific value of related parties

One area where little doubt remains about Brookfield’s intent is its frequent use of related-party transactions; they happen so often — across so many subsidiaries — that they are clearly part of an overall corporate strategy. The risks inherent with doing a lot of related-party business are apparent: Non-arm’s-length transactions can disproportionately benefit one party’s investors at the expense of the other’s. Such a practice also raises concerns about whether certain deals can be replicated outside of the pyramidal control structure.

One related party transaction stands apart from all others: Buried deep in the rear of Brookfield Renewable Energy’s 2011 annual report are the details surrounding two adjustments to a pair of power purchase agreements with Brookfield Asset Management-controlled parties. Brookfield Renewable Energy, an electricity-generating partnership that’s 68 percent owned by Brookfield Asset Management and that sold 55 percent of its output in 2011 to Brookfield Asset Management-related parties, was able to amend two power purchase agreements with its wholly owned subsidiaries Mississagi Power Trust and Great Lakes Power Limited on remarkably favorable terms.

How favorable? In one instance, the new contract was repriced 50 percent higher; another time it was 20 percent. As far as the Southern Investigative Reporting Foundation can discern, this appears to be an unusual event within the renewable power industry. (Power purchase agreements, typically struck for 10- or 20-year durations, are indeed repriced annually, but only to account for an agreed-upon change in an inflation measure, such as the consumer price index. The delivery price, however, is almost never touched and if it is, it certainly is not augmented 50 percent.)

[module align=”right” width=”half” type=”aside”]Take a closer look at another Brookfield related-party transaction that involved a rights offering with Rouse Properties. [/module]

The results from the changed contracts were indeed significant, amounting to $140 million in additional revenue, 17 percent of Brookfield Renewable Energy’s 2011 earnings before interest, taxes, depreciation and taxes (EBITDA) and 33 percent of its funds from operations. More important to Brookfield Renewable Energy, its annual report discloses that these power purchase agreement revisions were pure profit, contributing an additional $140 million in Ebitda and funds from operations.

Brookfield Asset Management, for its role in the upward revision of the two power purchase agreements, was paid $292.3 million Canadian dollars. The payments kicked off a complex chain of transactions, according to a publicly filed merger document from 2011, resulting in Brookfield Asset Management’s receiving an additional $292.3 million in Brookfield Renewable Energy units.

Getting paid to revise power purchase agreements upward was not always so complex. In 2009, a pair of such revisions netted Brookfield Asset Management a $349 million cash payment, according to Brookfield Renewable Energy’s annual report.

For providing management and “energy marketing services” to Brookfield Renewable Energy, according to its annual report, Brookfield Asset Management was paid a total of $40 million in 2011.

Brookfield’s response

The Southern Investigative Reporting Foundation does its reporting based on publicly available documents and seeks to fully engage with the subjects of its reporting.

So it was when it came to the foundation’s reporting about Brookfield Asset Management.

After the Southern Investigative Reporting Foundation conducted preliminary reporting for many weeks, it submitted detailed questions via email to Brookfield on Feb. 8 and Feb. 11. On Feb. 15 the Southern Investigative Reporting Foundation had a phone conversation with Willis, Brookfield’s media relations chief and a former business journalist. Among other issues, the foundation’s disclosure and trading policies were discussed, and it was reiterated that no one at the foundation has any economic interest in Brookfield’s shares, long or short, and no one outside the reporting foundation sees its work prior to release. Plans were discussed about setting up interviews of some Brookfield executives.

Prior to the call, Brookfield’s Willis also provided the Southern Investigative Reporting Foundation a letter of introduction and the company’s replies to the first two sets of questions.

On Feb. 17 the foundation submitted a third round of questions.

Brookfield’s Willis said on Feb. 19 that the company refused to answer further questions and had referred the matter to its U.S. legal counsel, Kasowitz, Benson, Torres & Friedman LLP; the firm informed the Southern Investigative Reporting Foundation that its client was considering legal action.

While engaged in other reporting assignments, members of the board of the Southern Investigative Reporting Foundation have previously experienced contentious exchanges with Kasowitz, Benson, Torres & Friedman as well as with Michael Sitrick, who is now serving as an outside public relations adviser to Brookfield. (Sitrick has provided media representation to Kasowitz, Benson clients who have unsuccessfully sued short-sellers and analysts, allegedly for conspiring to damage their share prices.)