FRM debacle: Opportunities ignored and overlooked
The legislative inquiry into the Financial Resources Mortgage Inc. affair, allegedly the biggest Ponzi scheme in New Hampshire history, started by looking at the law, but it appears to be ending with calls for accountability by those who didn’t enforce the law, starting with Banking Commissioner Peter Hildreth.“When it got right down to it, the state screwed up not a little bit, but monumentally and it caused people to lose their life savings,” said Al McIlvene, a lender and leader of a group insisting that “it wasn’t a matter of laws, but of men” that led to the FRM debacle.“Hildreth repeatedly failed to enforce the banking laws of New Hampshire. He should have been fired months ago,” said McIlvene.That’s not all, said McIlvene: the state is liable and should reimburse the lenders, and the bankruptcy trustee is only victimizing them all over again by asking them to return the interest they had received before the firm went under.How did the hearings get to this point? Lawmakers were tasked with figuring out with what went wrong, and what they as legislators can do to fix things so it won’t happen again.The hearings opened with a detailed analysis by lawyers trying to figure out what different state agencies could do under existing laws and how the laws could be altered to prevent a similar scandal. After all, part of the failure of the state to detect the FRM mess was the ability of the company to find cracks in the laws, allowing it to hide from regulation.It turns out each agency could have done a lot more than each said it could do, so the focus of the legislative inquiry shifted to the agencies themselves — partly due to infighting among the agencies and partly due to the ongoing stories of those hurt in the scandal.It was also because of various documents released in the midst of the hearings, especially the attorney general’s report, a supposedly objective assessment that, while admonishing against finger-pointing, pointed the finger at the Bureau of Securities Regulation and away from the Banking Department and the AG’s own failures.
Missed opportunitiesBut those hurt by the FRM weren’t buying it. For the Securities Bureau to be blamed, they would have to be viewed as investors, not lenders whose loans were used by FRM to fund mortgages. And that would mean that FRM was a securities company, and all those properties that secured their investments actually now belonged to the bankrupt estate.FRM was a mortgage company licensed by the Banking Department. The lenders’ investments were tied to particular properties. There were deeds filed in courthouses. The lenders had no idea that the money invested in a particular project was pooled into a secret slush fund at CL&M, an unlicensed entity that did business with FRM and should have been licensed and examined by the Banking Department but never was.Senior Assistant Attorney General Richard Head insisted that the investment instruments should be treated as securities, appearances notwithstanding. But it is hard to regulate something as one thing when it appears to be something else.Banking Department auditors looked at FRM’s books every 18 months, and as Mary Jurta — the head of the department’s Consumer Credit Division, which handled the audits — said, she never “tripped on anything that smacked of a security.”Jurta didn’t dwell on the fact that the department cited CL&M as an unlicensed mortgager in its examinations, but never forced it to be licensed — it just kept on asking it to give up a few residential loans.The AG’s office also missed its chance to uncover the slush fund. While glossed over in its report, it was front and center in Attorney General Michael Delaney’s own testimony to the panel.“The Department of Justice made serious mistakes in handling the FRM matter. We missed opportunities to expose fraud,” he said.When questioned, Head said that the closest the office came to unraveling the fraud was after Christopher Carter contacted the agency — twice.Both Head and Delaney implied that the first Carter contact was a cold call to “the investigator of the day,” one of 30 or so he had to field, though Delaney did acknowledge that Carter was well known to the department, a former assistant attorney general who previously prosecuted homicides.This was accurate as far as it goes, Carter told NHBR, but it is not the complete story. First, both Head and Delaney failed to mention that Carter was a senior assistant attorney general — the same title Head holds now. And before he prosecuted homicides, he prosecuted white-collar crimes.“I worked for these guys for years. I was down the hall from them. They know what I did,” Carter said.Second, Carter said that while he doesn’t remember many details of the conversation, he said he told them about a slush fund and it would be clear in a state Supreme Court brief he had filed on behalf of a client.
Whose authority?In the beginning, however, the focus was on the Securities Bureau. After all, it was Securities that fielded the first complaint — a complaint that actually used the phrase, “Ponzi scheme” — though that complaint came when Hildreth was director of the bureau.No action was taken under Hildreth, but Securities Bureau attorney Jeffrey Spill picked up the case shortly after he joined the bureau’s staff and pursued it under Hildreth’s successor, Mark Connolly, even though the original complaint was dropped as part of an out-of-court settlement.At that time, the bureau did argue that FRM was engaging in the sale of unregistered securities and sought full restitution for preferred shareholders (who included Commissioner Hildreth’s brother).But FRM’s lawyers insisted that it was a banking matter. And when Securities tried to obtain bank exams from the Banking Department, the department declined, saying the examinations were confidential.What Securities suspected was that FRM didn’t have the money to pay back investors in full. It went to the AG’s office to ask it to freeze FRM’s assets, but the office said it couldn’t — in fact, it maintains it can’t, since it lacks the authority to do so.But the AG’s office did have the power to obtain a “temporary or permanent injunction, restraining order or writ of mandamus” — actions that several attorneys have said really amount to the same thing.“My reading of the Securities Act is that in June of 2003, it gave the Attorney General’s Office the authority to seek the appointment of a receiver, which would have effectively frozen the assets of any entity subject to the receivership,” David A. Anderson, an attorney with Pierce Atwood LLP in Portsmouth told NHBR.Head didn’t dispute that, but the AG’s office thought the request would never have made it past a judge.“Any action in Superior Court would then have been evaluated against the facts as they were presented by the Securities Bureau,” Head told NHBR. “They were not, for example, requesting that the business be shut down. They did not believe there was widespread fraud.”On its own, the Securities Bureau went ahead with a hearing in July 2003, but the hearing officer declined to make a decision, figuring that the firm could never pay investors back if it had to do it all at once. The firm did pay most investors back at the time, but the Securities Bureau didn’t formally bring the matter to a close in 2007, when it obtained a cease and desist order after finding FRM was still selling unregistered securities.
‘Failure of state regulations’FRM changed its methods after that. While the company commingled funds, and grouped people together in various trusts, it did tie almost all of its investments to a particular piece of real estate (though it still dabbled in some actual securities, which is the subject of a civil action by the Securities and Exchange Commission).Thus FRM no longer dealt in securities, said the Securities Bureau, which brought in an expert — for which it paid $2,000 — to back its claim. The AG’s office paid an expert at least $50,000 to contest that view.But the argument was really over very narrow ground.Both sides agreed that it was Banking, not Securities, that should license the entities. What is in dispute is whether Securities had enforcement powers over entities it doesn’t regulate when securities are involved.While Connolly said his agency couldn’t “kick down doors” to audit the company, the AG said it could have conducted the equivalent of an audit.“We did not need to break down the doors of FRM. We needed to basically inquire into the sources of the funds to establish pooled monies, and that was the root of the failure of the state regulations,” Delaney said.But Head brought out another failure — the failure of the Banking Department to look beyond residential mortgages.The department, Head said under questioning by the New Hampshire House’s staff attorney, had enough evidence to know that while residential commercial loans were not sold by certain entities, it was the agency’s “duty to look at the financial integrity of the entity — not at just those limited mortgages.”But the AG’s office would be at fault for transferring consumer complaints about commercial mortgages over to banking in the first place, since those aren’t regulated the Banking Department.If they weren’t under the Banking Department’s jurisdiction, “they would fall to the attorney general,” said Head.Bob Sanders can be reached at email@example.com.