OSC targets BMO Nesbitt Burns as prime bank fraud conduit
by Brent Mudry
September 18, 2002
In the first major regulatory attack on a major Bay Street brokerage over serious know-your-client deficiencies in recent memory, the Ontario Securities Commission has targeted BMO Nesbitt Burns and two senior Toronto brokers for recently servicing controversial client Patrick Fraser Kenyon Pierrepont Lett, who singlehandedly caused the near-collapse of Gordon Capital a decade ago.
The OSC claims that Mr. Lett, serviced by John Craig Dunn, who ended a 16-year career as manager of Nesbitt's Mississauga branch in February, and senior broker John Steven Hawkyard, terminated by the branch last month, deposited $21-million in corporate accounts for his own clients, including several notorious U.S. prime bank fraudsters and an offshore insider trader wanted by U.S. authorities. (All figures are in U.S. dollars unless otherwise noted.)
Mr. Lett opened the Nesbitt accounts, in the names of Milehouse Investment Management Corp. and Pierrepont Trading Inc., two companies he controlled, in 1995, barely two years after he was given a six-month ban by the OSC in mid-1993 for the Gordon Capital debacle. The regulator claims that for several years, Nesbitt either ignored or made lame compliance responses, to serious warning signs from staff of the Toronto Stock Exchange, the OSC and the Alberta Securities Commission.
Among the charges, the OSC is citing Nesbitt with failure to supervise, a relatively new type of offence which gained currency with U.S. regulators after Kidder Peabody's Joe Jett rogue trader fiasco.
The case should be particularly embarrassing for Nesbitt and its parent, Bank of Montreal, as it demonstrates continued money laundering prevention failures in the wake of the Exchange Bank and Trust scandal in Vancouver. In that case, the British Columbia Securities Commission, on behalf of the United States Securities and Exchange Commission, froze the $19-million account of EBT, an offshore bank run by securities violator Terry Neal, at Bank of Montreal's main downtown branch. Soon after, regulators and Stockwatch revealed the EBT account was largely a prime money laundering account for assorted stock crooks and violators, notably Ed Durante, a New York Mafia-linked promoter with a 20-year record.
Mr. Lett was hardly a stranger on Bay Street -- in fact he was almost a household name, especially in compliance circles. In 1991, with the help of Eric Rachar, a Gordon partner responsible for the derivative products group in Toronto, Mr. Lett came close to causing the collapse of the established brokerage, forcing it to take out a $90-million (Canadian) emergency loan to meet regulatory capital obligations.
The fiasco traces back to July 16, 1990, when Gordon made a series of loans of Government of Canada bonds, reaching $1.1-billion by May 22, 1991, purportedly to National Trust as principal. (All Gordon Capital figures are in Canadian dollars.) While the loans were secured by an inferior value of provincial and corporate bonds, this was acceptable under securities regulations as National Trust was a designated financial institution, or DFI.
"Rachar also caused Gordon to enter into transactions with Lett and Citibank involving certificates of deposit, bearer deposit notes, bond forward purchase contracts and securities lending agreements. Because of Rachar's misrepresentations, Gordon accepted worthless collateral which exposed it to high risk," states a 1999 Supreme Court of Canada decision.
The bad news came on June 14, 1991, when James Connacher, the chairman and chief executive officer of Gordon, received a call from National Trust executive Jon Paysant, who expressed concern about an account described as the Rachar-Lett account. Three days later, senior officers of Gordon Capital and National Trust met to question "unusual" features of this account. National dropped two bombshells: telling Gordon that it was acting only as agent, not principal, for the Rachar-Lett account, and revealing since June 14, this account had $51-million less collateral than the Government of Canada bonds.
Mr. Rachar was hauled in and repeatedly lied to Peter Bailey, Gordon's compliance officer, and an outside lawyer, about serious irregularities with the account. "On June 26 ... Bailey and Rachar met with Lett. Bailey determined Rachar had lied, suspended him and denied him access to Gordon's premises. Gordon notified the Toronto Stock Exchange, who notified the Ontario Securities Commission, that there had been a misrepresentation by Rachar and that it had a margin deficiency," states the court decision. Gordon quickly retained Peat Marwick Thorne and then Lindquist Avey Macdonald Askerville for forensic investigations, while compliance manager Mr. Bailey told his bosses the firm would have to put up more than $80-million of regulatory capital.
On June 27, 1991, less than two weeks after the fateful call from National Trust, Gordon was forced to get a $90-million emergency loan. Mr. Bailey, who suspected a secret relationship between Mr. Rachar and Mr. Lett, had his hunch confirmed six weeks later with evidence of a personal benefit. "In fact, National advised Gordon that it had discovered a cheque payable to Rachar for $800,000 in account of Lett at Montreal," states the court decision.
Mr. Lett himself subsequently misled OSC staff in their investigation of the Gordon debacle, as had his registration suspended for six months in June, 1993.
While respectable brokerages might be expected to shun potential clients with a history like Mr. Lett's, Nesbitt welcomed him in late 1995, when he opened Milehouse accounts at both the brokerage's Mississauga branch and its flagship branch at 1 First Canadian Place in Toronto, and a Pierrepoint account. Mr. Dunn, the Mississauga branch manager since 1986, was the investment adviser responsible for the Milehouse and Pierrepoint account at his branch.
Mr. Lett was later also serviced by broker Mr. Hawkyard, who moved to work as a broker at Mr. Dunn's branch in November, 1997, after serving a one-year stint as manager of private banking services at parent Bank of Montreal's Mississauga bank branch, at the same location.
The OSC claims that seven investors subsequently deposited $21-million in the Lett accounts at Nesbitt or the Milehouse account at Bank of Montreal, for investing in an intended trading program.
Mr. Lett had quite a select circle of prestigious clients. The biggest, with $8-million invested, was an offshore chap called Constantin Nasses of Monaco, who was charged with insider trading in the U.S. in 1986 and has failed to yet deny or otherwise respond to the charges.
Mr. Lett's No. 2 client, with $5.2-million, was Alfred Huascar Velarde, a Virginia lawyer cited by the SEC in June, 1999, for aiding and abetting a small but notable prime bank scheme. Client No. 3, with $4.5-million, was Lenzburg Capital, which had its Milehouse Nesbitt accounts frozen on April 16, 1998, by the ASC and on May 22, 1998, by the OSC, for failing to return funds to investors as agreed in a settlement agreement.
Mr. Lett's most notorious client, with $1.27-million, was Greater Ministries International Inc., a Florida-based evangelical missionary fraud operation. The three other clients are unidentified: two residents of New York, with $1-million each, and a Florida resident, with $250,000.
It is unclear from OSC documents whether Nesbitt and Bank of Montreal were used as key conduits by these violators in fraudulent prime bank schemes, but the timing chronology is similar. The OSC notes that between January, 1996, and October, 1999, Mr. Dunn provided, directly or throught others, Mr. Lett with 18 proof of funds letters regarding the Milehouse and Pierrepoint accounts at Nesbitt.
The Ontario regulator also notes these letters were provided to a third party as a necessary component of the "intended trading 'program' scam." "This program was to include the purchase on margin of a bank guarantee or debenture, issued by a foreign bank, through the Lett accounts at Nesbitt. The proceeds from the purchase were to be directed to the third party who was represented as having access to a high yield trading program," states the OSC.
"A portion of the profits on the subsequent sale of the bank notes were represented to be used for projects associated with the United States government (i.e. an American foreign policy initiative) or for humanitarian purposes," states the regulator. (This description is remarkably similar to the Greater Ministries modus operandi.)
The OSC claims these proof of funds letters falsely stated balances of $10-million to $100-million in the Lett accounts, which did not match the true balances. The letters also stated funds would be "held" in the accounts, while in reality Nesbitt had no mechanism for such a hold on the Lett accounts.
In addition, and more seriously, some of the letters attested to the legitimacy of the Lett funds, stating they were "clear," "clean," "of non-criminal origin," "unencumbered" or "legitimately earned or obtained." The OSC claims that in reality, neither Nesbitt, Mr. Dunn nor Mr. Hawkyard made attempts to verify the source of funds deposited in the Lett accounts.
Besides disregarding Mr. Lett's Gordon fiasco, the OSC also claims that Nesbitt and its Mississauga and compliance personnel were basically asleep at the switch for years.
In early 1996, the broker for Mr. Lett's First Canadian Place account signed a letter drafted by Mr. Lett in which he sought to present an inflated impression of the value of assets held in his account. Nesbitt's branch manager and retail compliance officer became aware of this situation at the time and instructed the broker to never again author such a letter.
Later that year, a TSE investigator advised a Nesbitt compliance officer that he had learned of an inquiry by in relation to Mr. Lett and advised Nesbitt that the TSE had shut down an operation that involved Lett and was dealing in prime bank notes.
Two years, later, in April and May of 1998, the ASC and OSC issued freeze orders on Lenzburg funds in Mr. Lett's Milehouse accounts at Nesbitt's Mississauga branch.
That May, a senior compliance officer of Nesbitt, after a brief but detailed internal investigation, recommended that the Lett accounts be closed.
What happened next was comical foxes-running-the-henhouse material.
"In May, 1998, Nesbitt placed restrictions on Dunn and his actions in relation to the Lett Accounts. Dunn was told not to sign any letters unless the letter was approved by Compliance or legal department and was told that Lett could not deposit funds into the Milehouse account unless Nesbitt was satisfied that the funds belonged to Milehouse or Lett," states the OSC. "In spite of the restrictions, Dunn continued to prepare, sign and caused others to sign Proof of Funds Letters. The restrictions were ineffectual because Nesbitt relied on Dunn to provide information."
It is unclear when Nesbitt discovered Mr. Lett's clients were unsavoury rogues or what other steps it took, but the picture was not pretty.
Mr. Velarde, who deposited $5.2-million in the Lett accounts, was a relatively small fish. In a case launched June 8, 1999, the SEC named Mr. Velarde in a $6.2-million prime bank scheme which defrauded, amongst other victims, an Ecuadorian charity for underprivileged girls, between December, 1997, and June, 1998. Mr. Velarde promptly settled out in a consent settlement, with a $20,000 fine and a promise to do his best to refrain from future securities violations.
The kingpins in this prime bank fraud were Mr. Velarde's former law partner, Washington lawyer Lewis Rivlin, and Edwin Earl Huling III, who worked at Mr. Rivlin's law office. The fraudulent trading program used the auspices of Chrysanthos Chrysostomour, formerly the Metropolitan of Limassol, a bishop in the Greek Orthodox Church in Cyprus, and used offshore accounts in the British Virgin Islands.
On Aug. 23, 2001, Mr. Rivlin was found liable for securities fraud and ordered to pay $6.5-million in disgorgement and interest. The judge at the five-day trial, in October, 2000, found that Mr. Rivlin's purported trading program was "a complete scam." A Federal Reserve Board official testified that the hallmarks of such bogus prime bank schemes include overly complex and nonsensical "gobbledygook."
Mr. Lett's most notable client, however, was Greater Ministries, a massive prime banking fraud on a breathtaking scale. The Greater Ministries swindle, which was launched in March, 1993, when Gerald Payne kicked off a "double your money" gift exchange, defrauded investors out of an estimated $448-million. In August, 2001, the elderly religious minister was sentenced to 27 years in federal prison.
Mr. Payne, now 66, is no stranger to jail. The former contractor went to prison in 1979 for lying to a grand jury in another case. This March, he was convicted in the Greater Ministries case of 19 counts of money laundering, conspiracy and wire fraud. The ailing fraudster has reportedly had at least four strokes in prison so far. "This is one of the largest Ponzi-type schemes ever investigated," Internal Revenue Service spokesman Dave Burris told the media after Mr. Payne was convicted by a jury. At least seven other Greater Ministries players have also been found guilty of fraud.
The bizarre Greater Ministries shtick included Mr. Payne's plan to set up and arm an independent island nation on Greater Royal Island in the Bahamas, and a spiel about 200 gold mines and vast deposits of gold in Liberia with $40-billion worth of gold just 15 feet below the surface.
The Tampa Tribune, which has chronicled the Greater Ministries saga, notes that GM spokesman Niko Shefer served six years of a 14-year prison sentence for bank fraud and was also involved in a Liberian mining promotion which collapsed in 1997, wiping out investors, according to South African newspapers.
Some cursory due diligence by Nesbitt Burns would have shown that Greater Ministries has a regulatory record dating back to at least July, 1995, when Pennyslvania state securities regulators issued their first cease and desist order against its unregistered securities program. Florida officials followed suit two months later, followed by regulators in California in August, 1998, and Ohio the next month, according to The Tribune.
In July, 1998, Colorado state regulators and federal banking officials shut down Best Bank of Boulder, which collapsed and caused $20-million in purported losses to Greater Ministries.
Greater Ministries took on its critics in April, 1997, when it launched an unsuccessful $10-billion suit against The Tampa Tribune and two other newspapers, in which it and the Church of the Avenger accused the media of an "all out attack on the mere existence of Christianity in America."
The long-running massive fraud ground down to a thudding halt on March 12, 1999, when Mr. Payne and six co-conspirators were arrested in Tampa and numerous mail fraud and money laundering charges.
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