|THE GENI LENDERS: How a Saudi Arms Dealer and His Cronies Used a Penny Stock to Wipe Out a Minnesota Brokerage Firm|
By Stephanie Ayres
Los Angeles, California
GenesisIntermedia.com Inc was a small company based in Van Nuys, California whose main business activity was placing internet kiosks in shopping centers. But to penny stock traders and a group of high-stakes manipulators, it was GENI, a Nasdaq stock with some shady associates which was used as the vehicle of two manipulation scheems which collided abruptly when GENI's stock price crashed just after September 11, 2001.
In addition to the large losses this caused to public shareholders, there was also news that GENI's crash somehow had also brought down two securities firms, one in New Jersey and the other in Minnesota. These were not penny stock boiler rooms. How could a single penny stock manipulation cause so much havoc?
The GENI Founders
The miniscule GenesisIntermedia.com Inc filed for its initial public offering (IPO) of common stock in June 1999. The company planned to issue 2 million shares with the almost equally unknown Millennium Financial Group as its lead underwriter. The company's CEO was identified as Ramy El-Batrawi (who is reported to sometimes use the name Remy Al-Batswani), not exactly a household name to attract attention. For most people, including some who would later be affected by the stock's rise and fall, GENI's IPO was a non-event.
It was not until some eight months later, about February 2000, that El-Batrawi's somewhat more notorious business associate emerged from the shadows to begin buying enormous quantities of GENI stock. This big buyer was Ultimate Holdings, a Bermuda company controlled by reputed Saudi Arabian arms dealer Adnan Khashoggi, who had been a key figure in the clandestine dealings of the late 1980s known as the "Iran-Contra Affair." The Iran-Contra scandal encompassed a series of events in which which certain US government officials had allegedly schemed with Khashoggi and others to illegally sell military parts to the Government of Iran (which was subject to a US embargo on such trade) and then misappropriate the proceeds of those sales to secretly make illegal payments to support a Central American paramilitary group known as the "Contras," who were also subject to a Congressional ban on receipt of US military assistance.
In the course of the controversial congressional hearings to sort out the underground financial and arms networks which were used to carry out these deals, Khashoggi, an independent international arms dealer, was identified as a facilitator in the secret deal between the Americans and the Iranians. Since the days of Iran-Contra, Khashoggi acquired another type of notoriety.
For years he has been a fugitive from the Government of Thailand, which charged him as one of the key figures in the collapse of the Bangkok Bank of Commerce, described by the Thais as one of the largest financial scandals in the history of their country. A former official of the Bangkok Bank of Commerce, Rakesh Saxena, is also wanted by the Thai government and has been reported living in western Canada under the surveillance of the Canadian government.
El-Batrawi is frequently identified in court documents related to the GENI case as a longtime business associate of Khashoggi, but the exact nature of that relationship, what deals they worked on, or the origins and background of El-Batrawi, for that matter, are all somewhat murky.
All of this lends an air of intrigue to the GENI scheme which sometimes distracts attention from what the schemers were up to. This was no ordinary pump-and-dump scheme. Apparently not content with the mere millions that the average stock manipulation can generate, the GENI schemers seemingly had larger ambitions. Their plan involved a practice called securities lending. It was truly devious.
How stock lending works
The loaning of stocks among brokerage firms is an activity largely unknown to small investors. Some securities firms allow wealthy customers to sell stocks short. Short sellers expect a stock's price to drop, borrow stock to sell with the intention of replacing the stock when the price does drop. If the price rises instead, the short seller must still replace the stock, but will have to do so at a loss instead of a profit.
A brokerage firm may need to borrow stock from another broker to accomodate short-selling customers, and there are other legitimate activities that may cause a firm to need shares which it does not currently hold. Many brokerages which borrow or loan securities have accounts with a clearinghouse called the Depository Trust Company through which loaned securities pass on their way from one brokerage to another.
Securities lending among properly-licensed securities firms (who are the only ones who are legally eligible to do this) is subject to regulation by the SEC. It is effectively an exception to the restriction on lending activities by brokerage firms and investment banks adopted as a reform after the 1930s Depression.
Investigations of the 1929 stock market crash singled out margin lending (where brokers loan customers the money to buy stocks) as an important factor aggravating the widespread impoverishment which followed the crash. Not just the wealthy, it was found, but many average Americans had been borrowing to gamble on the stock market in the 1920s. They lost not only their own money, but ended up owing debts on stocks that became worthless.
Because of this problem, the ability of brokerages to loan money to individuals to buy stocks has been strictly limited since then. Loans between brokerage firms are treated differently. The firm borrowing stock will put up cash or cash-equivalent collateral (such as certain US Treasury securities) equal to the stock's market-value at the time of the loan.
This is an important feature for the GENI story. If during the course of the loan the market value of the borrowed securites changes significantly, the borrower must adjust the collateral amount accordingly. (1)
For example, if 10,000 shares of a stock called ABC was loaned when the market price was $10 per share, the borrower would put up $100,000 of collateral. If the price went up to $15 per share, the borrower would have to put up an additional $50,000 of collateral with the stock lender. If the price went down to $5 per share, the stock lender would return $50,000 of collateral to the borrower. This is illustrated in the following diagram:
Herein lies the key to the alleged GENI manipulation scheme. The GENI principal El-Batrawi and his associate Khashoggi's Ultimate Holdings held a majority of the company's shares. They loaned shares of GENI stock to a brokerage firm, which loaned them to another brokerage firm. which loaned them to another brokerage firm, which loaned them to yet another brokerage firm. This last firm, which was the real borrower, put up the cash collateral, which was passed from firm to firm back down the line to the lenders, El-Batrawi and Ultimate Holdings.
Meanwhile, El-Batrawi and Ultimate began issuing upbeat public statements about GENI's prospects. They allegedly made secret payments to at least one television stock commentator, Courtney Smith, who reportedly touted GENI on networks such as CNN, CNBC, and Bloomberg. As the public pump-and-dump scheme got underway, the buying pushed the price up. This meant more collateral for the lenders-- El-Batrawi and Ultimate. (2).
But when the stock price crashed-- the lenders (El-Batrawi and Ultimate)-- were then supposed to return much fo the collateral they had received to adjust for the lower market price. But when GENI's stock price crashed, they had disappeared.
In the meantime, the original securities borrower had passed the securities to other firms in the chain and recovered its collateral from them. So the firms in the middle of the chain were the ones who were stuck with the almost worthless GENI stock and unable to recover the collateral which had ballooned to over $200 million by September 2001. Here was the really big squeeze, which according to lawsuits filed over this case, was intentionally engineered by the GENI principals and a group of brokerage firm insiders.
The Brokerage Insiders
It would take more than the usual network of penny stock boiler rooms and promoters to pull off such a scheme. For this GENI hooked up with some allegedly corrupt insiders. One of these insiders, Richard Evangelista, worked at Native Nations Securities in New Jersey, the brokerage that borrowed the GENI stock from Ultimate and El-Batrawi. Another was Wayne Breedon, who managed securities lending at the Toronto, Ontario office of Deutsche Bank Securities, which became the "real" borrower in the chain, the last to receive the GENI stock and which put up the cash collateral.
Guarding the gate to this fraudsters' goldmine was Kenneth D'Angelo, a New Jersey businessman and convicted felon whose experience with fraudulent stock-lending schemes dated back to the 1980s. Before going with Deutsche Bank, Breedon had worked at D'Angelo's RBF International, a company which drew on D'Angelo's particular expertise to act as a finder of securities for lending purposes.
In the GENI scheme, D'Angelo brought El-Batrawi and Ultimate to Native Nations which borrowed large quantities of GENI stock from them. Native Nations re-loaned the stock (via several intermediaries) to Deutsche Bank Securities, where Breedon allegedly arranged for the cash collateral to flow back to Native Nations and then to El-Batrawi and Ultimate. As the stock price rose, Deutsche Bank sent additional cash collateral down the line to El-Batrawi and Ultimate.
A lawsuit filed by the bankruptcy trustee of the firm hardest hit by the scheme alleges that El-Batrawi and Khashoggi never intended to pay back this "collateral," that D'Angelo, Evangelista, and Breedon were aware of this, and planned to receive large payoffs for helping them loot the brokerage firm that was stuck with covering the collateral on the GENI stock.
If this was the case, then who would return Deutsche Bank Securities' cash collateral, which had soared to over $200 million as the firm piled up over 5 million shares of GENI and the stock price soared from its IPO value of $8.50 per share to about $60 per share by 2001? The GENI figures had allegedly absconded with the cash they received (what they did with it is still a mystery), and Native Nations Securities did not have enough cash to cover the loss.
There were other securities firms in this stock-loaning chain who, alleged the bankruptcy trustee's case, were being set up for the squeeze. First in line was MJK Clearing Inc of Minneapolis. Evangelista, the Native Nations conspirator, contacted MJK's securities lending manager, Thomas Brooks, and convinced him to borrow GENI stock which was to be re-loaned to several other brokerage firms.
MJK was to be merely a conduit. Since this was not unusual and Deutsche Bank was to be the final borrower, MJK presumably had no reason to be concerned and agreed to participate. Thus MJK Clearing and several other brokerage firms became borrowers and lenders of GENI. Cash collateral passed through their hands on its way from Deutsche Bank to Native Nations and on to El-Batrawi and Khashoggi.
Sometime in mid 2001 Breedon at Deutsche Bank Securities began to reduce the bank's exposure to loss by returning GENI stock to some of the other firms in the chain. These firms returned Deutsche Bank Securities' collateral and replaced Deutsche Bank Securities as the final borrower of the stock.
When GENI's stock price crashed in the confusion following the events of September 11, 2001, these firms looked to MJK Clearning to recover collateral because of the price drop. MJK in turn looked to Native Nations, which had nowhere to look because the alleged recipients of the cash-- El-Batrawi and Ultimate-- were nowhere to be found.
Native Nations had no cash to pay MJK and closed down. MJK was still being pressed for a collateral payment of about $60 million by brokerages holding GENI stock. MJK had insufficient cash to cover this and notified NASD and the SEC of the shortage. The Securities Investor Protection Corporation (SIPC) was called in . SIPC is an organization which insures against the failure of brokerage firms. MJK Clearing quickly became the largest case in the SIPC's history. MJK Clearing filed bankruptcy on or about September 27, 2001.
A trustee appointed by the bankruptcy court was charged with presiding over the orderly liquidation of MJK's affairs and also of investigating the situation that had led to its rapid demise. Out of this investigation came a major lawsuit filed by the MJK trustee, Minnesota attorney James P. Stephenson, against Deutsche Bank, Deutsche Bank Securities, Breedon, RBF, D'Angelo, Evangelista, GenesisIntermedia.com Inc, El-Batrawi, Ultimate Holdings, Khashoggi, and Bradford Keiller, a Las Vegas attorney and businessman who had allegedly participated int he public trading of GENI stock which helped drive the price up.
When the stock crashed, MJK was being called upon for about $60 million of collateral, but it was owed about $209 million by Native Nations, which was forced into bankruptcy in 2002 (3). The firm had claimed in public statements that a "rogue broker" (presumably Evangelista) had altered its books to cover up information about the stock lending scheme.
Evangelista had been with the firm since about 1993 as a senior officer. Until early 2001 Native Nations had been called Freeman Securities Inc. A change of ownership resulted in the name change. Freeman/Native Nations had been cited in an SEC action in 1993 over stock-loan dealings with Kenneth D'Angelo. According to the MJK trustee's complaint, Native Nations had been the weak link in the scheme. The conspirators allegedly had tried to avoid a decline in the GENI price so that no one would demand collateral from Native Nations.
Clues about inappropriate securities lending came with the outside audit of Native Nations financial statements for the year 2000. Someone reportedly altered stock loan information on the firm's records to show that the stock which had been borrowed from Ultimate and El-Batrawi had come instead from other other securities firms. Auditor confirmation letters sent to these firms revealed that they were not the lenders of the GENI stock. Confronted with this information, Native Nations allegedly prepared a formal stock lending agreement with the real lenders of the GENI stock, such as Ultimate Holdings, falsely identifying Khashoggi's Ultimate as a securities broker-dealer.
The complexity of this scheme served to prolong the time needed to investigate it. Except for the bankruptcy trustee's civil case, there have been isolated actions by authorities against several, but not all, participants in the scheme:
1. Native Nations Securities: filed bankruptcy in August 2002. The MJK trustee reported filing a creditor claim for about $226 million to enforce a June 2002 court judgment against Native Nations in favor of MJK.
2. MJK Clearing Inc: assumed the brunt of the scheme's effects (along with the SIPC) which covered certain of its customer accounts. MJK filed bankruptcy almost immediately after the GENI crash and ceased operations, causing the sudden and unexpected loss of about 200 jobs of its former employees.
3. Thomas Brooks: MJK's stock loan manager was sued by the SEC in June 2003. The complaint alleged that Brooks contributed to the fraud by letting Native Nations talk him into not demanding collateral from the New Jersey firm as part of the lending arrangement over the GENI stock and the ICII bonds. The SEC also alleged that Native Nations promised to pay MJK higher fees for this consideration, and that Brooks was in a position to profit personally from this, since MJK reportedly paid him 30% of its revenue from the stock-lending conduit activities his department generated. The SEC also alleged that Brooks falsified records at MJK concerning the arrangement with Native Nations.
4. Kenneth D'Angelo: pleaded guilty in September 2003 to criminal charges of conspiracy to commit securities fraud and wire fraud in a federal case in Los Angeles. D'Angelo and RBF International were sued by the SEC in September 2003.
5. Courtney Smith: arrested February 7, 2005 after being charged in a nine-count indictment by a federal grand jury in Los Angeles, including one count of conspiracy and eight counts of federal securities law violations for his alleged conspiracy with GENI principals to tout the stock on national television and elsewhere in exchange for undisclosed compensation laundered through his girlfriend's business.
6. GenesisIntermedia.com Inc: GENI stock was relegated to the "pink sheets." The MJK trustee reports that neither El=Batrawi or Khashoggi filed answers in his lawsuit and reportedly haven't filed answers in a class action securities suit over GENI in which they were named. Their whereabouts were apparently unknown. What they did with the approximately $160 million they made off with is also unknown.
(1) The practice is called "marking the securities to market."
(2) El-Batrawi and Ultimate Holdings were identified in most court fiings as the only holders of enough shares to have been able to provide the quantities of stock that were actually loaned.
(3) Most of the $209 million owed by Native Nations to MJK Clearing for securities loan collateral was for loans of GENI stock. However a smaller portion of this total related to lending of the corporate bonds of Imperial Credit Industries Inc. (ICII), the parent company of Southern Pacific Bank of Torrance, California.
In a type of subplot to the GENI story, two businessmen, Michael Riley and William Curtis, schemed to get control of ICII by buying up its corporate debt, an old robber baron tactic, except that Riley and Curtis used the Native Nations-Deutsche Bank securities-lending chain to finance the purchase of the bonds themselves.
Riley and Curtis arranged to buy ICII bonds. Before the settlement date when they had to pay for these bonds, Riley and Curtis loaned them to Native Nations-- in exchange for cash collateral which ultimately came from Deutsche Bank via MJK Clearing and other firms. According to the MJK bankruptcy trustee's complaint, Riley and Curtis used the cash they received to pay for the bonds they had already loaned. Allegedly they obtained control of over 50% of ICII's outstanding bonds and bullied their way onto the company's board.
ICII was vulnerable because it had been incurring large losses, over $150 million in both 2000 and 2001, much of this related to subprime automobile loan financing and other activities of its subsidiary, Southern Pacific Bank, which was closed in February 2003 by the California Commissioner of Financial Institutions. According to a February 7, 2003 statement from the FDIC, Southern Pacific Bank had about $1 billion of assets (outstanding loans) and about $850 million of deposits. The FDIC estimated the cost of its failure to the Bank Insurance Fund at about $134.5 million.
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FINANCIAL CRIME NEWS, June 2005
© STEPHANIE AYRES 2004-2005 ALL RIGHTS RESERVED