Weisel Accused of Fraud

Includes: SF, TWPG
by: John Lounsbury
Stephen H. Brinck Jr had just nine calendar days to raise $25 million cash and he had only $136,000 on hand. None of us ever want to be in that place.
On January 22, 2008, the comptroller of Thomas Weisel Partners (TWRG), a San Francisco investment bank, told Brink, the head of the fixed income department, he had until the end of the month to raise money to pay executive bonuses.
Good at the Job
Brinck was apparently very good at his job. He had for several months prior been moving clients (and the firm itself) away from a class of investments known as ARS (auction rate securities). He feared that these securities might not continue to perform in the future as they had in the past.
Auction rate securities have been widely criticized recently as fraudulent in and of themselves. These were vehicles that were represented by their creators and pushed by salesmen as highly liquid "good as cash" short-term securities that paid a higher rate of interest than similar investment options, such as money market accounts. In fact, most investors did not know that these were mostly longer term securities and the liquidity depended on frequent auctions which reset the valuations and interest rates.
As long as the auction transaction volume exceeded the liquidation volume these were liquid. But, because the valuations could be reset at every auction, even thought liquidity might be sufficient, there could never be any assurance that these were as good as cash. It appears that Brinck was aware of these risks and was taking action to move away from the table.
A Modified Ponzi Scheme
As long as new money kept coming in, the claims of existing ARS holders could be paid. Absent new money there was no cash available to meet demands of ARS holders, except for interest as received and eventual maturity. Of course, ARS could be traded away from the auctions, but the entire scheme was based on the auctions working. This arrangement has many similarities to some high grade investments offered by Mr. Ponzi about a century ago. They did offer a feature that Mr. Ponzi did not: with the exception of defaults, the capital was returned eventually and there were real interest premiums earned until maturity.
So it turns out that many ARS were not liquid and were not "good as cash". Those representations were very Ponzi-like.
Saving the Bonuses
Apparently most of the securities that Brinck had available for liquidation to raise the $25 million were ARS that remained from the previous trading efforts. There were no ARS auctions scheduled before the deadline. Brinck was able to raise $9 million by selling some ARS “away from the market”. To meet the deadline it seems he chose to raise the remaining cash by taking cash from the accounts of three corporate clients and transferring in the equivalent face value ARS.
The bonuses were paid.
Come the Deluge
Right after these transactions, the prescience of Steve Brinck was confirmed as the ARS market completely froze in less than a month. It took the three clients 17 months to recover their money. Weisel eventually repurchased the securities at par.
And Brinck, who may have taken the actions to protect his job at Weisel, was gone from the company in six months. Internet searches by the author have been unable to locate if and where Brinck might be employed today.
FINRA Fraud Charges
Today these actions resulted in the San Francisco investment bank, Thomas Weisel Partners (TWPG), being accused by FINRA (Financial Industry Regulatory Authority) of civil fraud. The charges include:

1. The former head of Weisel's fixed income department "stuffed" the accounts of three corporate clients with ARS (auction rate securities).

2. The moves were not authorized by the clients.

3. The moves were made to raise $15.7 million to pay executive bonuses.
Brinck is also named a respondent in the complaint.

Weisel to Disappear
The charges are not expected to affect the recently announced acquisition of Weisel by Stifel Financial Corporation (SF). Investigation of the ARS stuffing activity has been going on since at least last July and last quarter Weisel placed $4 million in reserve against a possible future settlement or fine.
Stifil is paying approximately $300 million in an all stock transaction. The market capitalization of TWPG is $243 million as I write. In 2006, the market cap was over $760 million. That’s over half a billion dollars gone, but I doubt the executives ever missed a bonus.

Sources: Ilaina Jonas for
Reuters, Thomas Stempel for Reuters, Gwen Robinson at FT/Alphaville and Suzanne Kapner at ft.com.
Disclosure: No positions.