Stanford's secrecy about tier three investments

Houston Chronicle:

Investors willing to entrust $5 million to Stanford International Bank got the royal treatment in a Caribbean paradise.

There was the flight to Antigua on one of the company’s private jets, lunch at the festive Sticky Wicket restaurant, a one-on-one presentation from the bank president and senior investment officer and a dinner party at the exclusive Pavilion restaurant. Snorkeling, an island tour and other outings were also common, all part of the effort to impress existing investors or woo new ones.

But when investors asked probing questions — like how the bank made market-beating profits year after year or how investments were monitored — a polite but persistent shroud came down, according to documents filed by the Securities and Exchange Commission last week in a civil fraud case.

“I was trained not to divulge too much information,” said Michael Zarich, the former senior investment officer with the bank, in a transcript of interviews done by SEC agents earlier this month.

The documents form the foundation for the civil complaint the SEC filed against the bank, two Houston-based financial services companies, Texas billionaire R. Allen Stanford and two other executives in his companies, Jim Davis and Laura Pendergest-Holt. The SEC alleges the defendants exaggerated claims about returns on certificates of deposit and a mutual fund in order to attract investors to buy the products and veteran financial advisers to sell them.

Zarich went to work for Stanford in 1999 and was tapped for the Antigua post in 2005. At first he thought he would have access to all of the bank’s investments, including the single largest portion, known internally as Tier Three. But over time it became clear he had access to information about less than 20 percent of the banks’ assets, and that only Davis and Stanford had access to more.

Zarich’s half of a tag-team presentation to investors with the bank’s president, Juan Rodriguez-Tolentino, stressed the safety of the investments — that 20 analysts in the company’s Memphis office monitored investments spread among 25 banks and funds throughout the world. But Zarich said he never mentioned that those analysts didn’t keep tabs on the Tier Three funds.

And if investors asked why Stanford used an obscure accounting firm in Antigua, CAS Hewlett & Co., he would tell clients a larger firm would take a chunk out of their investment returns, and besides, big accounting firms were far from perfect, the documents show.

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Zarich was hardly the only person at Stanford in the dark about how the company made its claimed high returns, according to the documents. Steve Riordan spent nearly two years as a consultant helping the company try to reconcile conflicts in its own data about returns and what clients were seeing.

In an SEC interview, Riordan said when he reviewed the data the returns sometimes seemed plausible, but at other times “in my estimation there was not any way in hell that return is correct.”

After a while Riordan said he stopped relying on any data he received from the bank in Antigua. “I didn’t have any confidence in any of the documents that they had sent to me,” he said.

Even one of the defendants in the SEC case, Pendergest-Holt, said she didn’t know how Tier Three funds were managed. She has worked for Stanford since 1997 and has known Davis since she was a teenager .

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This suggest that the SEC did not do a good investigation of Stanford until recently. No good securities investigator would have left these questions unanswered. The Texas Securities Board apparently passed this investigation off to the SEC, but it had a good hammer that it could have used. Failure to keep adequate books and records is usually considered a fraudulent business practice in an operation of this size and scope. That presents someone like Stanford with a dilemma. They either fork over the records or give up their right to do business.

There is no way Stanford should have been able to get away with his failure to disclose material information about the tier three investments. Even if it is an exempt security sold in an exempt transaction the investor has the right to the information he would get from a prospectus. The failure to provide that information should be difficult to defend.