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  • The MRI Story - Not Graceful Dahlia, But Carrion Rafflesia


    MRI's staff member thought her firm's investment strategy was like graceful dahlia, but in reality, it was carrion rafflesia, With his exceptional marketing skill, Fujinaga attracted unwary Japanese wealthy individuals and built this $1.3 billion fallacious empire in Las Vegas, which managed a medical account receivable investment strategy.

    Case Profile

    Fund Name

    MRI International

    Investment Manager

    MRI International, Inc.

    Portfolio Manager

    Edwin Yoshihiro Fujinaga

    Junzo Suzuki

    Other Notable Parties


    Investment Strategy

    Asset Based Lending



    Estimated AUM

    $1,365 million

    Estimated Losses

    $1,365 million

    Major Misconducts

    1. To be determined

    (click to enlarge)

    Source: Agura Monogatari Nikki

    From Las Vegas with Lies

    On April 26, 2012, Japan's Securities and Exchange Surveillance Commission announced it had cancelled the registration as an asset manager of little known Nevada-based MRI International, Inc. ("MRI") and Financial Services Agency began investigation for MRI's potential misconducts.

    According to various reports and its own website (which was subsequently shut down), MRI raised over $1.3 billion from 8,700 investors in Japan and promised to deliver 6.0-8.5% annual returns through investing in medical account receivable in the United States.

    The medical account receivable system (MARS) is one type of asset based lending strategy where an investor purchase account receivable for various medicals fees from healthcare providers at discount and receive money from the insurance companies. These medical receivables are usually covered by a private insurer the patient has a policy with, so the investor is not exposed to credit risk of the policyholder.

    MRI's investment strategy ran into a problem when their cash balance depleted after making payments to existing investors using proceeds from new subscriptions. When the regulators visited their Tokyo office, they found that the funds had only a few million dollars.

    The actual amount MRI raised and managed was not known yet, but the total loss from MRI could outsize AIJ's $1 billion (See Case N.5 AIJ). The structure and strategy of the scheme was quite similar to Petters (See Case N.3 Petters).

    Fujinaga the Marketing Maven

    What differentiates MRI from other asset managers is its marketing technique. MRI was founded and amanged by Edwin Yoshihiro Fujinaga ("Yoshinaga"), a Japanese American, who understood preferences of Japan's wealthy investors. MRI set the minimum investment at relatively low so that suspicious investors can start with a small amount. As MRI paid dividend and principal back to the investors on time, they feel more confident with the program and invest with a bigger amount. MRI's 6.0-9.6% returns look very attractive for Japanese savers who only earned 0.01% interest on their deposit over the last decade. Investors with over $3 million are invited to the firm's invitation-only gorgeous tour in Las Vegas, which included an onsite visit at its headquarter using the firm's limo.

    MRI's Investment Program

    Minimum Investment

    JPY 1.5 million (approximately $15,000)

    Dividend Yield

    JPY: 6.0-9.6%

    USD: 6.5-10.32%

    Investment Period

    2-5 Years


    JPY or USD

    Source: MRI International Victims Group (

    Leaving Las Vegas??

    At this point, I do not know if there was any sign of misconducts which investors can potentially find out before investing, but found that Fujinaga's arrest record in 2012. On July 16, 2012, 65-year old Asian man was arrested and jailed.

    (click to enlarge)

    IRS Investigation

    There was another case in which Fujinaga was sued by US IRS on March 2013. According to the initial claim, the IRS requested information to make a determination of the source and accuracy of revenue for MRI, but Fujimori ignored the court-ordered summons at least twice. This motion was probably a part of the investigation launched by the Japanese regulators who do not have a jurisdiction to investigate the foreign entity. The exhibition attached to this court document shows that MRI's office expense on the 2009 Form 1120 amounted over $6 million.

    Last Blog Update: Flowers of This Week

    MRI also managed several websites, including a blog where its Japanese staff updated the firm's trivial events providing investors with more friendly impression of the company. The last blog post, written by a staff member Ms. Yamazaki on April 18, 2013, was about "Flowers of This Week":


    This is Yamazaki at MRI International Client Service Center.

    This week's flowers at our office entrance are dahlias and roses.

    Dalias from Mexico hit a big boom in the 19th century in Europe. After many years of breeding, there are so many kinds of dahlias are grown commercially.

    Josephine, wife of Napoleon, loved dahlia's graceful and gorgeous appearance and planted many rare species to show off.

    We wish MRI International's MARS investment program to be like those beautiful flowers for our clients."

    Unfortunately, she did not know her company was not growing beautiful dahlia, but carrion Rafflesia.


    "Japan regulators may pursue charges against U.S.-based asset manager MRI," Reuters, April 26, 2013,

    Reference Material, Securities and Exchange Surveillance Commission, April 26, 2013, (Japanese only)

    Edwin Y. Fujinaga and MRI International v. United States of America, District Court for The District of Nevada, April 11, 2013,

    May 02 3:25 PM | Link | Comment!
  • Hedge Fund Case Study On Petters


    Less attention is paid to Thomas Petters thanks to Bernie Madoff's enormous fraud, he successfully played his own show over 13 years. His illegitimate asset based lending scheme seems very simple and the promised returns were too good to be true. Then, why did so many investors miss his misconduct for such a long time?

    A golden rule to avoid a potential fraud is: there is no free lunch. But, there are three other critical steps investors could have taken to avoid the massive losses they suffered.

    Case Profile

    Fund Name

    1. Arrowhead - Arrowhead Capital Finance Ltd.; Arrowhead Capital Partners II L.P.; Elistone Fund
    2. Lancelot - Lancelot Investors Fund, L.P.; Lancelot Investors Fund II, L.P.; Lancelot Investors Fund, Ltd.
    3. Palm Beach -Palm Beach Finance Partners, LP; Palm Beach Finance II, LP; Palm Beach Offshore, Ltd.; Palm Beach Offshore II, Ltd.
    4. Stewardship - Stewardship Credit Arbitrage Fund, LLC; Stewardship Credit Arbitrage Fund, Ltd.

    Investment Managers

    1. Petters Company, Inc.
    2. Petters Group Worldwide, LLC.
    3. Arrowhead Capital Management, LLC / Blue Point Management Ltd./Integrated Alternative Investment Limited
    4. Lancelot Investment Management LLC
    5. Palm Beach Capital Management LP / Palm Beach Capital Management LLC
    6. Stewardship Investment Advisors, LLC / Acorn Capital Group, LLC

    Portfolio Managers

    1. Thomas Petters (Petters)
    2. Arrowhead - James Fry and Michelle Palm (Arrowhead)
    3. Lancelot - Gregory Bell (Lancelot)
    4. Palm Beach - Bruce Prevost; David Harrold
    5. Stewardship - Marlon Quan (Stewardship)

    Other Notable Parties

    PC Funding, LLC; Thousand Lakes, LLC; SPF Funding, LLC; PL Ltd., Inc.; Edge One, LLC; MGC Finance, Inc.; PAC Fund, LLC

    Investment Strategy

    Asset Based Lending, or Purchase Order Inventory Financing



    Estimated AUM

    $3.65 billion

    Estimated Losses

    Over $3 billion

    Major Misconducts

    1. Conspiracy
    2. Money laundering
    3. Misappropriation of assets
    4. Fraudulent reporting


    From as early as 1995 through September 2008, Thomas Petters ("Petters"), a prominent businessman in Minnesota, perpetrated a massive Ponzi scheme through the sale of promissory notes to investors. While Petters' $3.65 billion fraud dwarfs Bernie Madoff's $65 billion, it is still the third largest hedge fund fraud case as of today (Jan 2012).

    After failing several retail businesses, Petters started a wholesale brokerage business, which later became Petters Co, Inc., ("Petters Co") in 1988, and traded closeout, overstock and bankrupt company merchandises, which were usually traded with a huge discount. Petters Co and its affiliates bought those merchandises and sold them to "Big Box" retailers such as Wal-Mart and Costco, but such transactions usually took up to 180 days to complete and that the sellers or manufacturers demanded payment up front while the retailers did not pay until the merchandise was delivered. In order to finance this 180-day period ("purchase order inventory financing"), Petters issued a short-term (up to 180-day) promissory note with a large coupon payment (from 10 to 18% p.a.) to at least 20 investors.

    There were at least four fund operators of feeder funds, which are set up primarily to purchase secured notes from Petters Co and its affiliates. Shortly after the arrest of Petters, SEC accused all four operators, including their principals, for knowingly supporting the fraud scheme. According to various court documents, these feeder funds raised more than $4 billion from their investors, including well-known fund of hedge funds operators.

    Fund Operators of Feeder Funds


    Capital Raised

    Lancelot Investment Management LLC

    Gregory M. Bell


    Palm Beach Capital Management LP

    Bruce Prevost & David Harrold


    Arrowhead Capital Management, LLC

    James Fry & Michelle Palm


    Stewardship Investment Advisors LLC

    Marlon Quan


    Source: various court documents; figures are rounded

    Many feeder funds are structured to purchase the notes from subsidiaries or affiliates of Petters Co. In order to show legitimacy of the scheme, Petters Co. established bank lock box accounts, or "Escrow" account, over which Petters Co has no control. All payments from the Big Box retailers shall be paid into the accounts. Each feeder fund had a slightly different scheme, but the fundamentals are basically the same. The following diagram is the scheme used by Stewardship.

    (click to enlarge)

    Source: SEC vs. Stewardship (2009)

    Doug Kelly, a personal lawyer of Petters, became a court-appointed receiver in the Petters' bankruptcy and filed about 200 lawsuits, seeking to recover about $2 billion. As of Dec 2010, he had collected about $200 million.


    Petters fabricated purchase orders from retailers and used them as collaterals to borrow money through hedge funds. In reality, paying 10-18% interests on highly secured paper sounds too good to be true and the scheme crafted by Petters was relatively simple compared to other Ponzi schemes. So, why did many investors, who directly purchased the Petters paper or indirectly invested in the feeder funds, fail to detect his misconduct?

    The reason he could run this $3 billion Ponzi scheme over so many years was largely due to negligence of investors and lack of operational due diligence. The stable return stream of the feeder funds (1.0-1.5% a month with almost no fluctuation) was, if true, attractive not only for individual investors, but also institutional investors who obsessively sought "low volatility, low correlation" opportunities.

    The payment scheme with the lock box accounts described above should have worked well if it were operated and monitored properly by the direct holders of the notes (i.e., feeder funds). But, it was a sham as the feeder fund operators never conducted due diligence as promised.

    Petters and his affiliates indeed knew very well how to manipulate investors' psychology and many investors thought they were invested with a legitimate lending practice:

    1. By being informed that all promissory notes were secured by purchase orders from the Big Box retailers, investors made themselves believe that Petters should have not made such obvious lies
    2. Multi-layered schemes, including subsidiaries/affiliates of Petters Co and feeder funds
    3. The lock box account scheme gave false sense of security
    4. Payments were made on time for over 13 years of its existence until very late stage of the scheme
    5. No audit was legally required at the level of borrowers (Petters Co and its affiliates), even though annual audit for the feeder funds were conducted by reputable audit firms (they might have missed several key issues during the audits)


    Conduct extensive background checks on all related parties

    1. This is one of many cases in which background checks should have helped investors to avoid investing in the scheme. But, it was important for investors to conduct all related parties since investors tend to conduct background checks on principals of feeder funds for various reasons (mainly due to the high cost to execute background checks).
    2. For example, on May 22, 2005, a potential investor emailed one of the feeder fund operators, stating that a third party "report indicated that Mr. Petters's background includes a criminal history (fraud or forgery convictions, possibly with prison time served), along with significant civil litigation, including a recent $5 million fraud suit." In fact, Petters had been convicted of several felonies, including a 1983 conviction for writing a bad check, a 1989 conviction for forgery (for which he served time in prison), and a 1990 conviction for theft by check.
    3. New York hedge fund manager Richard Bookbinder of Bookbinder Capital Management passed on an investment after he learned that Petters had lied on a Dun & Bradstreet questionnaire about earning a degree from St. Cloud State University.
    4. Mr. Bookbinder late said, "Things popped up and we didn't feel comfortable. When people gave money [to Petters] they didn't ask, 'Who's this guy? What's his background?' The question is: This information was out there in 2002. We looked at it and we're a small firm; why didn't other people look at it?"

    Confirmation on the Big Box retailers and their payments to the lock box accounts

    1. In 2005, AG Deutsche Zentral-Genossenschaftsbank Frankfurt Am Main ("DZ Bank"), a German lender, discovered that the lock box account did not function as Stewardship represented in its offering materials. DZ Bank made this discovery in the course of performing due diligence for a line of credit to Stewardship's operating company called Acorn Capital Group, LLC.
    2. In 2008, Acorn sought a loan from Fortress Investment Group LLC ("Fortress"), but Fortress decided not to loan Acorn money after it learned that the Big Box retailers did not make payments directly into the lock box accounts as explained by Acorn.
    3. For an investor of a feeder fund, it could be difficult to obtain transaction details of the lock box accounts. However, it is possible to conduct due diligence by calling some of the Big Box retailers whether they recognize Petters Co and its affiliates as counterparties of the transactions and whether they recognize purchase orders, which many feeder fund operators claimed as collaterals for the notes they purchased.

    Confirmation of registration as a Registered Investment Advisor

    1. Arrowhead Capital Management LLC ("Arrowhead LLC"), and Arrowhead Finance told their investors and potential investors that Arrowhead Corp. (predecessor of Arrowhead LLC) and, later, Arrowhead LLC were registered with the SEC as investment commission. While Arrowhead Corp did registered with the SEC on November 27, 1995, but terminated its registration on July 7, 1997 before Arrowhead raised any capital for its funds. A quick online check at the SEC website should have revealed that it was not true and investors should have considered it as a red flag.


    U.S. Securities and Exchange Commission (2009). Litigation Release No. 21124 / July 10, 2009. SEC Website

    U.S. Securities and Exchange Commission v. Thomas J. Petters, Gregory M. Bell, and Lancelot Investment Management LLC, and Inna Goldman, Inna Goldman (2009). U.S. District Court for the District of Minnesota.

    U.S. Securities and Exchange Commission v. Marlon Quan, Acorn Capital Group, LLC and Stewardship Investment Advisors, LLC, et al (2009). U.S. District Court for the District of Minnesota

    U.S. Securities and Exchange Commission v. Marlon Quan, Acorn Capital Group, LLC and Stewardship Investment Advisors, LLC, et al (2009). U.S. District Court for the District of Minnesota

    Ellerbrock Family Trust, LLC; Belmont Strategic Income Fund, LP, on behalf of themselves and all other similarly situated v. McGladrey & Pullen, LLP (2009). U.S. District Court for the District of Minnesota

    Lancelot Investors Fund, LP, Lancelot Investment Management, LP v. Thomas Joseph Petters, Thousand Lakes, LLC, Petters Company, Inc., Nationwide International Resources, Inc., Enchanted Family Buying Company, Larry Reynolds, Michael Catain, Deanna Coleman, & Robert White (2009). U.S. District Court for the District of Minnesota

    Moylan, Martin. "J. P. Morga Chase sued to recover Petters fraud funds", Minnesota Public Radio website, December 30, 2010

    Mar 04 6:43 AM | Link | Comment!
  • Hedge Fund Fraud Case Study On PAAMCo


    How important is it to have an established infrastructure for a hedge fund start-up? A trading error or loss of important financial data may cause severe costs to an investment manager and investors, directly and indirectly, but such losses are not irreversible if a manager is truly talented. A hedge fund business, especially at the start-up stage, is quite simple as its administrative burdens can be outsourced to service providers, such as prime brokers and administrators. Therefore, until very recent, it was difficult to justify for a start-up hedge fund to hire COO or CFO to establish solid infrastructure beyond a trading platform, instead of hiring another skillful analyst or trader using the same amount of money.

    However, the real value of having an independent back office professional from a portfolio manager is quite significant when it comes to prevent misconducts of the portfolio manager. A start-up hedge fund is a risky business because the manager takes big risks on his own wealth and future. If its performance deteriorates, even for a short-time, and investors start taking money out, turning around the business is like swimming against the current. The fear of losing everything often pushes the manager to go wild.

    Verification of functional back office is an important process of due diligence and PAAMCo's fraud case in 2002 is a good case study how it could have been helpful for investors.

    Case Profile

    Fund Name

    Philadelphia Alternative Asset Fund, LP

    Philadelphia Alternative Feeder Fund LLC

    Philadelphia Alternative Asset Fund, Ltd.

    Option Capital Fund LP

    Investment Manager

    Philadelphia Alternative Asset Management Company, LLC

    Portfolio Manager

    Paul M. Eustace

    Other Notable Parties

    Thomas Gilmartin

    Investment Strategy



    Oct 2002

    Estimated AUM

    $278 million

    Estimated Losses

    $210 million

    Major Misconducts

    1. Failure to disclose trading losses suffered in a subaccount hidden from service providers
    2. Misrepresentation of trading performance
    3. Artificially inflating net asset values


    Paul Eustace ("Eustace") was a whiz-kid who gained fame at Trout Trading Management (now known as Tewksbury Capital Management, Ltd.), a prominent CTA firm established by his childhood friend Monroe Trout, where he served as president until 1998.

    Eustace established Philadelphia Alternative Asset Management Company, LLC ("PAAMCo") with Thomas Gilmartin, his college roommate and Vice President of the prime brokerage department at Man Group ("Man"). Eustace's experiences at Trout helped to allure not only investors into the commodity trading funds, but also well-respected business magnets like Paul Wallace, vice-chairman of the Philadelphia Stock Exchange, as director of PAAMCo.

    Eustace launched Option Capital Fund ("Option Capital") in spring 2001 and Philadelphia Alternative Asset Fund, LP ("LP Fund") in 2002. Although Eustace successfully raised about $35 million, PAAMCo's investment operations were not profitable. Both Option Capital and LP Fund were controlled and overseen only by Eustace, general partner of both funds, and investment performance was reported by Eustace to investors directly. Instead of telling investors that the funds were losing money, Eustace fabricated performance probably since March 2003.

    Eustace also launched Philadelphia Alternative Asset Fund, Ltd. ("Offshore Fund") and Philadelphia Alternative Feeder Fund LLC ("Onshore Feeder") to solicit new investors without disclosing the losses in both Option Capital and LP Fund. Again, Eustace's capital raising effort was very successful and PAAMCo raised more than $250 million from at least 60 investors for the new funds. Unlike Option Capital and LP Fund, Offshore Fund and Onshore Feeder were both administered by UBS Fund Services in the Cayman Islands ("UBS") and the performance was reported to investors by UBS.

    Despite the mounting losses in Option Capital and LP Fund, both Offshore Fund and Onshore Feeder generated steady returns until early 2005, when Eustace made a wrong call on U.S. interest rates and suffered from substantial losses. Eustace hid losses from investors and a fund administrator with a hope that he can turn things around by the summer. But, his hope was never materialized as CFTC filed an injunctive action against Paul Eustace on June 22, 2005 and shut down the funds immediately afterwards.


    A big question was how Eustace hid the losses from the eyes of legitimate professional firms like UBS and Deloitte & Touche ("Deloitte"), an audit firm for both Offshore Fund and Onshore Feeder. UBS was hired as a fund administrator and responsible for calculating NAVs on behalf of the funds since inception of the funds. Deloitte duly executed audit for the fund's activities until Dec 2004 and found no illegitimate activities.

    The answer was found at Man Financial ("Man"), prime broker of the funds. In March 2005, in order to hide losses in trading accounts, Eustace opened a new secret trading account ("50 account") where he allocated all loss making trades. Because Eustace had hidden the existence of the secret account from UBS, which did not have a direct access to the 50 account, UBS only received reports from Man only on the profitable trades, but not the losing trades in the "50 account." The total losses in the 50 account reached $179 million before it was seized by CFTC.

    Thomas Gilmartin ("Gilmartin"), then-vice president of Man Financial and a college friend of Eustace helped Eustace to establish the 50 account and purportedly hid it from UBS and Deloitte, and even from the funds' offshore directors. Later investigation found that Gilmartin owned an economic interest in PAAMCo, the management company which collected both management and incentive fees. Were it known to investors, this could be a red flag, but the fact was never revealed until the official investigation was launched.

    The Receiver of defunct funds managed by PAAMCo accused both Man and UBS of negligently allowing Eustace to hide $179 million in loss-making trades. Man initially denied the claim and counter-sued UBS, saying it should have spotted the problems, but later settled with the receiver and agreed to pay $69 million into a restoration fund and $6 million in legal fees and expenses. UBS also settled and agreed to pay $19 million.


    This is one of rare cases where it was extremely difficult for investors to spot the misconducts of the investment manager even after fraud occurred in early 2005. Offshore Fund and Onshore Feeder Fund were legitimately managed until Dec 2004, when Deloitte conducted its audit. The operational review of UBS shall end up with no result as the administrator itself believed that it has established automatic feeds from all accounts held at the funds' prime brokers, including Man.

    Does Check-and-Balance System Exist?

    1. PAAMCo, established in King of Prussia, PA and operated in Canada, was essentially a two-men shop, Eustace and his young trader, and had no operational professionals. Thanks to the recent technological advancement and electronic executions, a CTA fund can theoretically be managed by one trader with help from prime brokers. However, a potential investor could have pointed out the PAAMCo's business lacked adult-supervision, or check-and-balance system in its business. For the entire period of operations of PAAMCo, Eustace set up a wire and approved it by himself. This eventually allowed him to create a bogus trading account at Man without anyone but Eustace and Gilmartin knowing its existence. It is possible to find it out by interviewing Eustace's assistant trader about what role he is playing at the firm.
    2. It is still difficult to conclude the legitimacy of business by solely identifying the lack of check-and-balance system because it is not a fraud by itself. However, with over $250 mm AUM, the firm was able to spend money on the infrastructure and there must be a VERY good reason if a portfolio manager decides not to do so.

    Check "Other" Funds Managed by the Investment Manager

    1. According to the court records and various media resources, Eustace marketed Offshore Fund and Onshore Feeder as successors for Option Capital and LP Fund, both of which were suffering substantial losses.
    2. A potential investor could have requested financial statements of both funds to verify Eustace's past track records.
    3. Both funds were also managed by Eustace himself, not by PAAMCo and not registered with NFA as commodity trading pools either (we can only find the trace for Offshore Fund and Onshore Feeder on the NFA's website). The reason why these two entities were not subject for the NFA registration was, as revealed later in the bankruptcy court, that they did not have any trading operations, but simply entered into various swap agreements called Collateralized Swap Agreements (between Offshore Fund and LP Fund and between LP Fund and Option Capital), so that both LP Fund and Option Capital can participate in the performance of Offshore Fund without actual trading activities. This set up was unfortunately beyond understanding of potential investors unless they obtain audited financial statements for LP Fund and Option Capital, but the lack of registration for the previous two entity could have been a good reason for a potential investor to cause a request for more information.

    (click to enlarge)

    Feb 20 2:12 PM | Link | Comment!
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