Banking units embroiled in lawsuit

 Deutsche Bank, Nomura subsidiaries are accused of scheme that led to failure of US brokerage

The Globe & Mail
By Karen Howlett
December 23, 2002

The Canadian subsidiaries of banking giants Deutsche Bank and Nomura Bank are accused of orchestrating an alleged stock lending and market manipulation scheme that led to the largest failure of a U.S. brokerage firm in 30 years, millions in losses for other brokerages, and an FBI probe into a former Nasdaq-listed company.

Deutsche Bank Securities Ltd. and employee Wayne Breedon are also accused of helping a small U.S. broker dealer that was a key player in the scheme to falsify its financial statements so it could stay in business, recently unsealed court documents show.

The tangled tale features Saudi arms dealer Adnan Khashoggi and his business partner Ramy El-Batrawi; a convicted stock-loan felon Kenneth D'Angelo; and hundreds of hours of tape-recorded phone conversations describing the alleged market manipulations.

The trustee for MJK Clearing Inc., a Minneapolis stockbrokerage that collapsed in September, 2001, is seeking to recover more than $335-million (U.S.) in damages from several individuals and companies, including Deutsche Bank, Mr. Khashoggi and Mr. El-Batrawi, according to its amended complaint filed in U.S. Bankruptcy Court, District of Minnesota.

Deutsche Bank has not yet filed a defence and none of the allegations have been proved in court. "We basically can't comment on pending litigation," spokesman Ted Meyer said.

Nomura is not named in the government-appointed trustee's complaint. It is being sued along with Deutsche Bank by E-Trade Securities Inc., which claims to be the second-biggest victim of the scheme after MJK.

"We totally refute the suggestion that we have any liability whatsoever relating to the demise of MJK," Nomura spokeswoman Susan Atran said. In fact, the bank has launched its own lawsuit against E-Trade, claiming the firm owes it $10-million.

Mark Dworsky, a lawyer for E-Trade, declined to comment.

The case involves the alleged price manipulation of three separate companies' securities over a two-year period beginning in the summer of 1999. The securities were allegedly dumped on MJK and other brokerages at vastly inflated prices.

The trustee for MJK alleges that the scheme was financed by Deutsche Bank and orchestrated by three long-time friends: Mr. Breedon, head of stock lending in Deutsche Bank Securities' Toronto office, who is now on administrative leave; convicted stock-loan felon Mr. D'Angelo; and Richard Evangelista, then senior manager of a small brokerage known as Native Nations Securities Inc.

Mr. Khashoggi's involvement was through his Bermuda investment company, Ultimate Holdings Ltd., which provided shares of a Los Angeles-based telemarketer called GenesisIntermedia Inc. for the stock-loan transactions. Genesis is now under investigation by securities regulators and the FBI. Mr. Khashoggi, a fugitive from justice, is wanted by Thai police on suspicion of embezzling $64-million from the failed Bangkok Bank of Commerce in 1996.

The case has attracted much interest on Bay Street because of the way the players allegedly took an ostensibly innocuous activity -- stock lending -- and stood it on its head, said a compliance executive at a major firm.

Deutsche Bank's Mr. Breedon and his associates allegedly co-ordinated stock loan transactions with dozens of American and Canadian brokerage firms, including CIBC World Markets and National Bank Financial. Sources said the two Canadian firms were not among the losers.

None of these firms would have had any reason to suspect that anything was allegedly amiss when they got the call to lend or borrow stock, the compliance officer said. Brokerage firms routinely borrow hundreds of millions of shares from each other every business day to cover short positions, or provide liquidity for the markets.

According to the court documents, the scheme began in the summer of 1999 with the initial public offering of Genesis on the Nasdaq Stock Market. While two million shares were purportedly sold to the public at $8.50 each, the shares never really left Mr. El-Batrawi's control, the trustee alleges.

Mr. El-Batrawi and Ultimate Holdings lent millions of Genesis shares to Deutsche Bank via Native Nations and MJK, according to the complaint. In exchange for the securities, Deutsche Bank sent cash to Mr. El-Batrawi and Ultimate through the other brokerages. The transactions were simply a way to turn stock owned by Mr. Khashoggi and Mr. El-Batrawi into cash, the trustee alleges.

Once most of the stock was at Deutsche Bank and out of public circulation. Mr. El-Batrawi allegedly engaged in a flurry of buying and selling to make it appear there was genuine interest in the stock.

Mr. Breedon was in almost daily phone contact with Mr. D'Angelo discussing Genesis' stock price, according to transcripts of taped calls filed in the courts. "I made sure, yeah, I made sure it didn't go over 17," Mr. D'Angelo tells him in early November, 2000. "We're gonna be much higher next week. . . . To get everything done. He's gonna push the stock up a quarter of a point or half a point every day," Mr. D'Angelo says another day, referring to Mr. El-Batrawi.

By Dec. 31, 2000, Deutsche Bank was holding five million Genesis shares, more than 80 per cent of the entire float. But by lending the shares to MJK and other brokerages, Mr. Breedon and his associates could have these unsuspecting firms keep advancing more cash as collateral for the shares as the price increased. In that way, the brokerages became unwitting buyers at inflated prices and the trio did not have to unload the shares into the market.

(A brokerage borrows stock from another firm in return for cash collateral equal to the market value of the stock. As the price fluctuates while the stock is on loan, the brokerages engage in a process called marking to market. If the stock goes up that day, the borrowing brokerage sends more cash to the lender. If the value goes down, the lending brokerage returns cash to the borrower.)

During the nearly two-year period that Genesis was allegedly being manipulated, Deutsche Bank also propped up Native Nations with monthly cash infusions that permitted the firm to stay in business, the trustee's complaint alleges.

Deutsche Bank sent large amounts of cash to Native Nations at or near month-end and then took the money back at the beginning of the following month, it alleges, adding that the cash provided the "window dressing" Native Nations needed to falsify its financial statements.

Eventually, the scheme collapsed following the Sept. 11 terrorist attacks, when the "market rigging" of Genesis' stock price could no longer be sustained, the trustee's complaint alleges. Native Nations went out of business, taking MJK down with it.

Genesis' stock price began plummeting after reaching a peak of $60. Nasdaq suspended trading in Genesis' shares on Sept. 25, 2001, following the company's disclosure that the U.S. Securities and Exchange Commission had launched a formal investigation and the Federal Bureau of Investigation had interviewed two former employees, the first indication of a criminal probe. Mr. El-Batrawi stepped down as chairman and chief executive officer of Genesis in October, 2001. Genesis was delisted from Nasdaq on Jan. 29, 2002, and now trades over the counter for pennies a share.

When the stock price dropped, Deutsche Bank got its cash collateral back from the brokers, eventually leaving MJK and other intermediate brokers "holding the proverbial bag filled with virtually worthless securities," the trustee's complaint alleges. It also made at least $7-million in fees.

The trustee accuses Deutsche Bank's senior management of deliberately ignoring various details about the alleged scheme that came to their attention several times in 2001.

Mr. Breedon had no immediate supervisors in Deutsche Bank Securities' Toronto office during most of 2001, thus making him the de facto head of the firm's securities lending in its Canadian subsidiary.

The implosion of Genesis' stock price has led to a flurry of lawsuits and countersuits. The trustee is suing former officers of MJK for negligence, breach of fiduciary duty and mismanagement. It is acting on behalf of the Securities Investor Protection Corp., which is in the process of liquidating MJK, the largest rescue in the agency's 30-year history.


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