NFA Drops Sentinel Ball.. SEC Picks Up Sentinel Ball

by: Greg Newton August 21, 2007

Greg Newton

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The National Futures Association, the alleged self-regulatory disorganization for the U.S. futures industry, appears to have perpetrated a blunder of potentially impressive consequences for investors in the failed Sentinel Management Group Inc. And, it seems, tried to paper over its dilatory response to the cash management company’s rapidly deteriorating financial situation.

Late Friday, the NFA filed a member responsibility action prohibiting Sentinel from:

Liquidating, selling, transferring, encumbering, or otherwise disposing of any securities, investments, or other assets; or
Distributing, disbursing or transferring any funds, including to existing customers, without the prior approval of NFA.

The action was not, as is the regulator’s ordinary practice—at least as it relates to its regular dismantling of two-bit forex bucket shops— announced in a press release; rather it was buried in Sentinel’s NFA Basic record. The action included an affidavit by compliance director Sharon Pendleton reporting than an Aug. 14 inspection at Sentinel’s offices found that the company had:

...failed to maintain adequate books and records, including records to demonstrate the location of all Seg III Account’s assets, and whether or not the account’s assets are in any way encumbered.

The delay in filing the action also allowed Sentinel to conclude a controversial transaction in which Citadel Investment Group LLC, the Chicago-based hedge fund, last Thursday bought what now appears to have been a substantial proportion of Sentinel’s unencumbered assets. Neither NFA general counsel Tom Sexton, nor spokesman Larry Dykeman, had by pixel-time deigned response to an email asking whether the NFA had deliberately delayed its member responsibility action to allow consummation of the Citadel transaction.

The circumstances of the NFA’s action have some parallels—in a greatly shortened time-frame—with its investigation of Paul Eustace’s Philadelphia Alternative Asset Management Inc. In that case, the NFA initiated an investigation in Sep. 2004, in response to a customer complaint, but took no formal action until the fund collapsed in Jun. 2005.

Along the way it found that Man Financial (now MF Global) senior vice president Thomas Gilmartin held a 20 percent equity interest in PAAM that should have been declared on its NFA registration documents; however, instead of instituting formal proceedings, it allowed Gilmartin to quietly dispose of the shareholding.

It also failed to inform Man Financial of Gilmartin’s PAAM shareholding, thus preventing it from addressing the potential conflicts of interest created by by Gilmartin acting as PAAM’s broker.

National Futures Association in the matter of:
Sentinel Management Group Inc
Notice of Member Responsibility Action
Aug. 17 2007

NFA began Eustace inquiry in 2004
NakedShorts Oct. 5 2005

Selected lowlights from Monday’s U.S. Securities and Exchange Commission complaint against Sentinel Management Group Inc, filed in federal court in Chicago:

Among its improper activities, Sentinel transferred at least $460 million...from client investment accounts to Sentinel’s proprietary ‘house’ account. Sentinel also used securities from client accounts as collateral to obtain a $321 million line of credit as well as additional leveraged financing. The bank that extended the $321 million line of credit to Sentinel...intends to sell securities pledged as collateral for the loan...as soon as Aug. 22 2007.
Sentinel did not disclose to its clients its practices of commingling, transferring and misappropriating their assets, or inform them that their investment portfolios were highly leveraged...To the contrary, Sentinel provided its clients with daily account statements that did not reflect the improper activities.
Sentinel’s explanation of its redemption suspension was false and misleading.
Undisclosed Misappropriation and Commingling of Client Assets
...Sentinel e-mailed customer account statements to its clients that were materially false and misleading...Customer statements...represented that the face value of the securities...was, in the aggregate, more than $670 million. Contrary to these representations, the Bank of New York custodial statement showed only approximately $93 million of securities...
...Sentinel placed at least $460 million of clients’ securities...in Sentinel’s house account...and, significantly, was available to be pledged as collateral. When SEC examiners asked Sentinel representatives which securities in the ‘house’ account were owned by clients...Sentinel representatives responded that it could not identify who owned those securities.
Undisclosed Leveraging of Client Assets
Sentinel pledged securities belonging to clients in order to obtain a line of credit from the Bank of New York for its own benefit. The credit...reached as high as $500 million in Jun. 2007 and is now $321 million...clients had no way of knowing that their assets had been used by Sentinel to obtain financing for its own purposes.
...Sentinel had used $1.5 billion in securities owned by the clients to obtain financing three times the value of those securities....the financing was used to purchase additional securities. However the client statements prepared and distributed by Sentinel did not reflect any of this activity.

Oh, read the damn thing yourself.

US Securities and Exchange Commission v. Sentinel Management Group Inc
US District Court for the Northern District of Ill.
Aug. 20 2007

So, congratulations then, Phil and Eric Bloom, and their material contribution to last week’s global credit market crisis which, on Friday, caused the Federal Reserve Board to not only crack the discount window at the New York Fed, but also invite, even solicit, applications.

For what, it transpires, was not the potentially systemic financial meltdown. But rather a good old-fashioned Ponzi scheme, built on nothing more complicated than the use of client assets as collateral for your own, as yet uncertain, ends.

NakedShorts is proud to have known you, back in the day. And NakedShorts will be prouder yet when Patrick Fitzgerald—you know, the Scooter Libby guy—gets done with the extraordinary rendition paperwork and puts you on a plane to that special CIA interview room in Cairo.

Or, as A. Slightly-Excitable Reader exclaimed on being allowed a preview of the SEC complaint filed in Chicago Tuesday (and linked below):

OH MY..not only are these guys CROOKS, but they are going to have a public beheading since THE FED HAD TO HIT THE GAS TO KEEP THE MARKETS FROM MELTING DOWN BECAUSE SENTINEL BLEW UP AND EVERYONE THOUGH THE SKY WAS FALLING.

One can only hope.