Two hedge fund managers and their firms have been charged by The Securities and Exchange Commission of fraudulently funneling more than $1 billion of investor money into a Ponzi scheme operated by Minnesota businessman Thomas Petters.
The case also is a reminder that there are enough suckers available to fall for some cockamamie scheme.
The regulator alleges in its civil suit that Bruce F. Prévost and David W. Harrold and their Florida firms Palm Beach Capital Management LP and Palm Beach Capital Management LLC falsely assured investors their money would be safeguarded by collateral accounts and described a phony process for protecting their assets. When Petters was unable to make payments on investments held by the funds they managed, Prévost, Harrold, and their firms concealed it from investors by concocting sham note exchange transactions with Petters.
Last year, Petters and Gregory Bell and his hedge fund firm Lancelot Management LLC, were charged by the SEC for facilitating the scheme.
The SEC ‘s complaint alleges that Prévost, Harrold, and their firms invested more than $1 billion in hedge fund assets with Petters and pocketing more than $58 million in fees.
Here is how the scheme worked, in yet another case of, what were the investors thinking?
Petters promised investors their money would be used to finance the purchase of vast amounts of consumer electronics by vendors who then re-sold the merchandise to “Big Box” retailers such as Wal-Mart and Costco. Not exactly long-short equity or macro investing, huh?
However, the SEC says that in reality, Petters’s “purchase order inventory financing” business was merely a Ponzi scheme. There were no inventory transactions.
Rather, Petters sold promissory notes to feeder funds like those controlled by Prévost, Harrold, and their firms and used some of the note proceeds to pay returns to earlier investors, diverting the rest of the cash to his own purposes.
In other words, Prevost and Harrold played the same role Fairfield Greenwich and others played with Bernie Madoff.
According to the SEC’s complaint, Prévost, Harrold, and their firms funneled money into the Petters Ponzi scheme beginning as early as 2004 through at least June 2008. Prévost and Harrold sold interests in their Palm Beach Funds to individuals, foundations, family trusts and other hedge funds throughout the US.
The Palm Beach Funds invested all investor contributions into the Petters Ponzi Scheme and were holding more than $1 billion worth of notes when the scheme collapsed.
So, basically these guys pocketed huge fees for merely sending investor money elsewhere. Nice work if you can get it.
The SEC alleges that Prévost, Harrold, and their firms falsely assured investors that the inventory financing transactions were structured in such a way that after the retailers received their merchandise from vendors, they were supposed to send their payments for the merchandise directly into the funds’ collateral accounts to pay off the notes held by the funds. This arrangement was intended to protect investors inasmuch as the receipt of funds directly from the retailers would ostensibly verify their participation in each transaction, the SEC explained.
But in reality, money for the repayment of notes held by the funds always came directly from Petters and never came from any retailers. Prévost and Harrold did not disclose this material fact to investors in the funds, and instead continued to lie about the operation of the collateral accounts, the SEC explained.
The SEC also alleges that Prévost, Harrold, and their firms devised with Petters a series of bogus note exchange transactions beginning around February 2008.
In any case, the SEC is seeking a permanent injunction against Prévost, Harrold, and their firms, as well as an order of disgorgement, including prejudgment interest and financial penalties.
Of course, stay tuned to see whether a criminal case follows.
