Advisory Firm Executives Who Circle the Wagons May Pay a Price
The cover-up, they say, is worse than the crime. Itís a maxim that advisory firm executives would be wise to keep in mind when confronted with a serious violation or crime committed by their firm.
Take the case of Marsha Bass, former chief operating officer of MayfieldGentry Realty Advisors, a Michigan-based advisory firm, who, on January 28, as part of a settlement with the SEC, was barred from the securities industry for one year after the U.S. District Court for the Eastern District of Michigan fined her $35,000 on January 21.
The actions were taken after Bass, along with three other top executives of MayfieldGentry Ė its chief compliance officer/general counsel, chief financial officer and chief investment officer Ė allegedly participated in the cover-up of the alleged theft years before of $3.1 million from a major pension fund client, the Police and Fire Retirement System of the City of Detroit (PFRS), by MayfieldGentry and its founder and chief executive officer, to purchase two California shopping centers.
The job of a firmís general counsel and chief compliance officer, "is to protect the firm by starting the damage control, not by covering up," said Montgomery McCracken of counsel Terrance Reilly. An argument by any senior executive that it was covering up a crime under the belief that it was protecting the firm "would never pass the smell test," he said.
"The SEC expects gatekeepers such as lawyers or compliance officers to be a first line of defense, and they should resist temptations to cover something up," said Sidley Austin partner Gerald Russello. "If you are in a fiduciary position, you cannot hide or conceal fraudulent activity. A manager or compliance officer who discovers previous potential misconduct should consult with in-house or outside counsel to determine whether the conduct needs to be reported and remedied."
"The principals discussed different scenarios for paying back the PFRS, including selling the California properties and implementing cost-cutting measures," the SEC said in its June 10, 2013 complaint to the U.S. District Court. "But the principals did not discuss disclosing the theft to the PFRS. Ö This decision was based on the principalsí fear that the PFRS would fire [the firm] upon learning of the theft. A vast majority of the compensation earned by [the firmís] principals was directly attributable to the management and transaction fee [the firm] earned from its work for the PFRS."
MayfieldGentry and its founder and chief executive officer, Chauncey Mayfield, were ordered by the U.S. District Court on June 26, 2013 to pay disgorgement to PFRS of $3.1 million. The court did not order the firm and Mayfield to pay a civil money penalty or pre-judgment interest, however, citing the firmís financial condition. On July 31, 2013, in a separate settlement, the SEC permanently barred Mayfield from the securities industry and revoked the firmís registration.
Charges are pending in U.S. District Court against the firmís CCO, CFO and chief investment officer, and the SEC has not yet taken administrative actions against these individuals. Whatever the outcome, officers of firms should be aware that when they cover up a firmís misdeeds, they run the risk of getting themselves in water of a particularly high temperature.
The firm and the pension fund
PFRS, as of June 3, 2011, held more than $3.8 billion on behalf of more than 8,000 active duty members of Detroitís police and fire departments. The pension fund, from 2008 through 2011, paid retirees and their beneficiaries, on average, less than $30,000 each in annual retirement benefits, according to the SEC.
MayfieldGentry, which had $750 million in assets under management, began managing PFRS assets in 2002. The pension fund was consistently the firmís largest source of income, a source that only grew larger in 2004, when PFRS selected the firm to take over management of $140 million in properties it owned, the agency said.
In terms of managing PFRSí real estate investments, MayfieldGentry managed and controlled one of the pension fundís bank accounts, the PFRS Master Account, according to the SEC complaint. The bank account, which contained rental income and refinancing proceeds generated by PFRSí real estate investment, contained approximately $16 million as of January 2008.
Thatís a significant amount of money, but despite the fact that MayfieldGentry was managing it, the firm "did not provide PFRS with any reporting regarding the account," the SEC said.
The shopping centers and the money
In January 2007, MayfieldGentry, which was looking to invest in shopping centers, agreed to acquire two in California for approximately $7.4 million. It secured a bank loan for $4.3 million, but at the end of 2007, with the purchase apparently not yet completed, had only $200,000 in cash on hand for the remainder, according to the agency.
What to do? According to the SEC, the advisory firm and Mayfield decided to "quietly steal" $3.1 million from the pension fund.
The initial theft, if the allegation is true, occurred at the end of January 2008, when Mayfield directed his CFO to wire $400,000 from the PFRS Master Account for a down payment on the shopping centers. "The PFRS, however, was not an investor in the California properties and had not authorized [the firm] or any of its principals to use $400,000 of its assets to [the firmís] purchase of the California properties," the SEC said. "The California properties were not presented to the PFRS as an investment opportunity, and the PFRS did not otherwise seek to participate in any investment in the California properties."
"In other words," the agency said, "Mayfield and [the firm] simply took $400,000 of the PFRSís money without permission."
To complete the purchase of the two properties in February 2008, the firm allegedly took the remaining $2.7 million from the PFRS Master Account, according to the complaint.
"The stolen $3.1 million could have provided a year of benefits for more than 100 retired police officers, firefighters and surviving spouses and children," the SEC said.
One might think that the transfer of this much money from a firmís main client would not go unnoticed, and, in fact, according to the SEC, it did not. The CFO, in reviewing the closing documents from the sale in March 2008, noticed that, despite the fact that PFRS had funded $3.1 million of the shopping centersí purchase, it was not listed as the owner, but that MayfieldGentry was, according to the complaint.
When the CFO asked Mayfield why this was the case, Mayfield told him that he had run out of time to get the purchase approved by the pension fund, and that he was now looking for rich investors to take the pension fund out of the deal, the SEC said. But, the agency alleged, they did not discuss informing the pension fund that the $3.1 million had been surreptitiously taken from the PFRS Master Fund.
The CFO continued to follow up with Mayfield over the following three months, but there was no progress made in lining up new investors to take PFRS out of the deal. At that point, according to the agency, the U.S. real estate market collapsed, causing the California properties to lose value, and it became apparent that there would be no outside investors to take the pension fund out of the deal.
The situation continued through 2011, but while the CFO and Mayfield continued to discuss options to replace the stolen funds, they never disclosed the alleged theft, the SEC said. In fact, the CFO never included the California properties in any of the firmís financial reports to PFRS.
The other executives, including Bass, learned of the situation in May 2011, when they met, without Mayfield, to discuss budgeting and cost-cutting. Once they became aware of the $3.1 million theft, the agency said, they "did not make any effort to inform the PFRS of the theft. Instead, [they] engaged in affirmative efforts to conceal the theft from the PFRS."
They also attended PFRS board meetings to conduct existing business and propose new business, and allegedly left any mention of the $3.1 million out of an "extremely detailed and voluminous" 2012 budget document that the SEC said "exhaustively reviewed" the firmís advisory activities on behalf of PFRS.
Discovery and aftermath
"In late April 2012 Ė more than four years after the theft of the $3.1 million, and nearly a year after all of [the firmís] principals knew of the theft Ė [the firm] faxed an undated letter to the PFRS," the agency said. "The letter disclosed to the PFRS, for the first time, that [the firm] used PFRS funds to purchase the California properties, and that the properties were never titled to the PFRS."
As might be expected, PFRS wasted little time in taking action. It terminated its business relationship with MayfieldGentry on May 3, 2012, stating that it did so for cause.
"Shortly thereafter, all of [the firmís] other clients terminated their business relationships with [the firm]," the agency said, adding that the firm has since transitioned the real estate assets it was managing to other entities, and is in the process of winding down its operations." The pension fund also filed suit against the firm.
Mayfield Gentry and Mayfield were charged with violating Sections 206(1) and 206(2) of the Advisers Act, both of which prohibit fraud. Bass and the other executives were charged with aiding and abetting the firmís and Mayfieldís violations. Attorneys representing the firm, Mayfield and Bass did not respond to messages seeking comment.