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The $600 Million Teddy Bear Case

08/02/2010 03:40 pm ET | Updated May 25, 2011

Way back in February 2009, BrokeAndBroker.com detailed the story about the The $600 Million Teddy Bear: WG Trading.

On February 25, 2009, the Securities and Exchange Commission issued a 22-page Complaint: Securities and Exchange Commission v. WG Trading Investors, L.P., WG Trading Company, Limited Partnership, Westridge Capital Management, Inc., Paul Greenwood And Stephen Walsh, (Defendants) And Robin Greenwood And Janet Walsh (Relief Defendants) (SDNY, 09-CV-1750). The SEC characterized the matter as an "emergency enforcement action to halt ongoing securities fraud involving the misappropriation of hundreds of millions of dollars of investor assets." In reality, the WG Trading case represents yet another long-term fraud (described in the Complaint as dating back to 1996) that went undetected by our nation's many regulators and prosecutors for far too long with disastrous consequences.

Exposure and Enhanced Management

The Defendants are charged with soliciting institutional investors, including educational institutions and public pension/retirement plans, by promising to invest in a so-called "enhanced equity index strategy." Starting at Paragraph 21, the Complaint details the supposed intricacies of this scam.

First off, you got "exposure." Oh, how I love that term of art! Invest with us and we will give you "exposure" to the market. The minute you start hearing such gobbledygook, head for the hills! Nonetheless, like most porn movies, the strategy here involved a lot of exposure to a stock index. The Defendants explained that they would be making purchases of " long positions in equity index futures that provided exposure to the entire index." Now that's a very difficult market strategy. Hmmm . . . if I buy an S&P 500 index future I get exposure to the entire index. My, what a complicated concept. Sort of like, if I buy one share of Apple stock I get some kind of exposure to... what...no...wait a minute...don't tell me....I'm getting it...it's exposure to an entire one-share of interest in the Apple company. Right?

If you feel that you understand the arcane exposure strategy, then read on.

We are now going to discuss the second prong of Defendants' sophisticated investment plan: the "enhanced cash management." This is a very complex spin on the prior exposure thingy. Here, instead of buying the futures index, the Defendants would sell the index short and buy the underlying index equities. You got that? You sell short the index but also buy the underlying stocks. You do that to lock in a rate of interest. Of course, as part of this super sophisticated exposure and enhanced management technique, the Defendants often took the extreme measure of doing the exact opposite of the complicated sell/buy program. Yes...indeed....they engineered the buy of the index and a sell of the underlying stocks. That's the famed double reverse flip with a half gainer into the index pool.

Getting Stiffed by a Steiff

According to the SEC's Complaint, those Defendants "used client money invested in WGTI as their personal piggy-bank to furnish lavish and luxurious lifestyle which include the purchase of multi-million dollar homes, a horse farm, cars, horses, and rare collectibles such as Steiff teddy bears." See Paragraph 2 of the Complaint. And we're not talking chicken feed here. No, this is $667 million in investor funds, of which Greenwood and Walsh are accused of misappropriating $554 million--okay, well, sure, the SEC does allow that some of that money went to Greenwood's spouse (R. Greenwood) and to Walsh's ex-spouse (J. Walsh). You also have to give these guys some credit for bravado. As recently as February 5, 2009 -- in the midst of the Madoff case and the growing rumors about Stanford, and, well, add all those other lurid names as you see fit -- the Defendants raised another $21 million from the University of Pittsburgh, an existing client.

On February 5, 2009, the National Futures Association (NFA) started an audit of Defendants and those good auditors were likely astonished to discover that the balance sheet showed only $95 million had been invested in the stock arbitrage strategy. Some $573 million was largely in notes payable to WGTI from Greenwood and Walsh--notes dating back to 1996! Apparently not getting the answers and assurance the NFA regulators sought, the organization suspended Greenwood's and Walsh's NFA membership. What had NFA uncovered? Nothing more complicated than an apparent effort by Greenwood and Walsh to take investors money from the business, use it for their own personal desires, and to cover the withdrawals through the issuance of personal promissory notes. That was the third prong of their strategy. First prong was the exposure. Second prong was the enhanced cash management. Third prong was take the suckers for all their worth and we'll issue promissory notes back to the firm.

If the allegations are proven true, it's no small wonder that the SEC beat a hasty retreat to the courthouse and sought an immediate temporary restraining order and asset freezes. Then there is also the sensible demand for disgorgement of the ill-gotten gains and for civil money penalties. Now it's not like WG Trading Company (WGTC) was some fly-by-night pennystock promoter. Certainly not -- if that were the case, I'm sure our regulatory community would have been all over such a little fraudster. No, in this case, WGTC is a New York Stock Exchange (NYSE) member firm. That always meant that you were just a cut above the riff raff. How times have changed.

Time for Some Answers?

Here are some tough questions that I think the public needs to demand are answered:

  1. How many times did the NFA, NYSE, NASD, FINRA, CFTC, and SEC examine the Defendants since 1996, and what were the findings?
  2. Why are we only now learning about this (and other) multi-year frauds (many of a decade or more duration)--why did the regulators fail to detect the misconduct earlier?
  3. Why did the promissory note scenario escape regulatory scrutiny for over a decade?
  4. Who was personally in charge of NFA, NYSE, NASD, FINRA, CFTC, and SEC's regulatory program as it related to the Defendants and what explanations do those individuals offer for the apparent failures to detect the serious fraud?

The 2010 Recap

As things presently stand, in August 2010, from at least 1996 through February 2009, Greenwood and others ran a fraudulent commodities trading and investment advisory scheme using an entity they controlled called WG Trading Investors. Through a marketer, Greenwood and others solicited $7.6 billion in investor funds on the understanding that they would invest the funds in a program called "equity index arbitrage," which they represented was a conservative trading strategy that had outperformed the results of the S&P 500 Index for more than 10 years.

Contrary to their representations to their investors, Greenwood and others misappropriated at least $331 million in investor funds, and, among other things, used the funds to construct Greenwood's home, purchase expensive collectible items, and operate a horse farm. Greenwood and others also diverted investor funds to satisfy obligations on investments that were unrelated to the "equity index arbitrage" trading business.

Greenwood and others executed promissory notes in favor of WG Investors to, among other things, conceal trading losses and their misappropriation of investor funds. These promissory notes totaled approximately $554 million, of which approximately $293 million was Greenwood's.

Greenwood and others also created and caused others to create false account statements that were sent to clients to reflect fictitious returns consistent with the returns that had been promised to those clients.

Guilty Pleas

Duffy

On July 21, 2009, Deborah Duffy, the former Chief Compliance Officer of WG Trading Company, pled guilty to conspiracy, securities fraud, and money laundering, for her role in the fraud scheme. See the SEC Complaintand the SEC Order Instituting Administrative Proceedings/Settlement.

Greenwood

On July 28, 2010, sixty-three-year-old Paul Greenwood pled guilty before United States District Judge Miriam Goldman Cedarbaum to a six-count Indictment charging him with conspiracy, securities fraud, commodities fraud, wire fraud, and money laundering for running a fraudulent commodities trading and investment advisory scheme while a principal of WG Trading Company and WG Trading Investors. See the Department of Justice Press Release.

Greenwood pled guilty to six charges, which carry the following maximum penalties:

  1. Conspiracy. 5 years in prison; fine of $250,000, or twice the gross gain or loss from the crime
  2. Securities Fraud. 20 years in prison; fine of 5 million, or twice the gross gain or loss from the crime
  3. Commodities Fraud. 10 years in prison; fine of 1 million, or twice the gross gain or loss from the crime
  4. Two Counts of Wire Fraud. 20 years in prison; fine of 250,000, or twice the gross gain or loss from the crime
  5. Money Laundering. 10 years in prison; fine of 250,000, or twice the gross gain or loss from the crime, or twice the amount of criminally derived property involved in the transaction

Pursuant to a plea agreement, Greenwood agreed to forfeit at least $331 million, which represents the amount of funds that were misappropriated and diverted to make an investment in Signal Apparel Company, Inc., which was not disclosed to investors.

Last Man Standing

Stephen Walsh, another principal of WG Trading Company and WG Trading Investors, is charged with conspiracy, securities fraud, commodities fraud, wire fraud, and money laundering for his role in orchestrating and perpetrating the fraud scheme. Walsh allegedly used investor funds for himself and to make large cash payments to his ex-wife and, like Greenwood, executed $261 million worth of promissory notes in favor of WG Investors to conceal trading losses and the misappropriation of investor funds. The charges against Walsh remain pending, and he is presumed innocent unless and until proven guilty.

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