SECURITIES AND EXCHANGE COMMISSION
Litigation Release No 16356 / November 17, 1999
SEC v. PATRICK H. MCCARTHY, Civil Action No. 1-99-CV-2003 (U.S. District Court for the Middle District of Pennsylvania)(YK)
SEC FILES FRAUD ACTION AGAINST SENIOR ADVISER TO FORMER PENNSYLVANIA STATE TREASURER IN CONNECTION WITH STATE BOND OFFERINGS
The Securities and Exchange Commission today filed a complaint for securities fraud against Patrick H. McCarthy, a Philadelphia attorney and former fund raiser and senior adviser to the past Treasurer of the Commonwealth of Pennsylvania. The complaint charges McCarthy with arranging for his law firm to receive undisclosed compensation, in violation of his fiduciary duty, for influencing the selection of a securities dealer in two Pennsylvania refunding bond offerings in 1994.
In a refunding bond offering, an issuer gets the benefit of lower current interest rates on its debt by issuing "refunding bonds" and immediately investing the proceeds in a portfolio of U.S. Treasury or agency securities structured to pay the principal and interest on old, higher interest rate bonds. The Commission's complaint alleges that, although not a Commonwealth employee, McCarthy was viewed by senior staff as the most powerful person in the Pennsylvania Treasurer's office, after the Treasurer and the Executive Deputy Treasurer, at the time of the 1994 refunding bond offerings. Dennis E. Thiemann, then a longtime consultant to Arthurs Lestrange & Company, a Pittsburgh-based broker-dealer which served as the Commonwealth's financial adviser for the offerings, obtained Arthurs Lestrange's agreement that the firm would pay Thiemann one-third of its deal revenues if Thiemann could find a larger broker-dealer which would agree to sell the Treasury securities to the Commonwealth, split its fees with Arthurs Lestrange, and pay 60 percent of the total to Arthurs Lestrange. Thiemann then approached his friend, John M. Seidman, who ran a private consulting firm called JMS Associates, and whom Thiemann believed had contacts within the Treasurer's office. Seidman and Thiemann discussed several firms, including Alex. Brown and Sons Incorporated, which Seidman knew was the financial adviser to the Treasurer's office. Seidman also was a friend of McCarthy, and knew that McCarthy had a long-standing relationship with Alex. Brown's municipal securities business. McCarthy was then approached for his assistance in arranging for Alex. Brown to be appointed to sell the Treasury securities.
The complaint alleges that McCarthy then contacted Alex. Brown and offered that Alex. Brown could be appointed to sell the Treasury securities if it would split fees with Arthurs Lestrange, and pay Arthurs Lestrange 60 percent of the total. McCarthy then used his influence to have Alex. Brown appointed over the objections of the Treasurer's senior staff. After the first refunding closed in March 1994, Arthurs Lestrange paid one-third of its revenues, or $520,891 to Thiemann's firm, HDI, Inc. HDI, in turn, paid $175,250 to JMS Associates and $172,000 to McCarthy's law firm, and retained $173,641. The Commission's actions do not allege that Alex. Brown or Arthurs Lestrange knew about HDI's payments to JMS Associates or to McCarthy's firm. When senior staff in the Treasurer's office became aware and protested that Alex. Brown had overcharged the Commonwealth for the Treasury securities, McCarthy supported Alex. Brown. Alex. Brown later entered into an agreement to retain McCarthy's firm for $20,000 per month, commencing in June 1994, and McCarthy again used his influence to have Alex. Brown selected to sell the Treasury securities for a second Pennsylvania refunding in June 1994 over the objections of the Treasurer's staff. The Commission's complaint alleges that, while promoting Alex. Brown's interests in the Treasurer's office in connection with both the March and June 1994 refundings, McCarthy knowingly or recklessly failed to disclose to the Treasurer's office or to the Commonwealth that he had a conflict of interest arising from his payment arrangements with Thiemann and Alex. Brown.
Simultaneously with the filing of the complaint, and without admitting or denying the Commission's allegations, McCarthy consented to the entry of a final judgment against him. The final judgment enjoins McCarthy from violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder. The final judgment also requires McCarthy to pay a civil penalty of $100,000. McCarthy's law firm voluntarily returned to Pennsylvania the $172,000 obtained from HDI and all of the retainer fees received from Alex. Brown after June 1994, plus interest, and is not the subject of a Commission action.
Also simultaneously with the filing of the complaint, the Commission instituted several administrative proceedings charging securities law violations by other individuals and entitites involved with the Pennsylvania refundings. BT Alex. Brown Incorporated, Alex. Brown's corporate successor, consented to a Commission order which finds that Alex. Brown willfully violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5. Alex. Brown misrepresented the size of the markup charged on the portfolio of Treasury securities sold to Pennsylvania for the March 1994 refunding as 4.5 basis points in price, when it was actually 45 basis points, and failed to disclose fully the fee-splitting arrangement with Arthurs Lestrange. The order also finds that Alex. Brown willfully violated Sections 17(a)(2) and (3) of the Securities Act by charging excessive, undisclosed markups. Without admitting or denying the Commission's findings, BT Alex. Brown agreed to be censured, to cease and desist from future violations, to pay $603,996 in disgorgement related to the March 1994 Pennsylvania refunding, and to comply with undertakings to pay an additional $14,701,250 to settle claims with the Commission, the Internal Revenue Service, and the United States Attorney for the Southern District of New York relating to other refunding bond offerings in which Alex. Brown sold U.S. Treasury securities to bond issuers. Of that amount, $127,674 will be paid directly to certain issuers of refunding bonds.
In a separate administrative proceeding, the Commission's Division of Enforcement has charged Kevin G. Quinn, the head of Alex. Brown's Public Finance Department at the time of the March 1994 Pennsylvania bond refunding, and the lead Alex. Brown banker responsible for that refunding, with willfully violating Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5. In the proceeding against Quinn, the Division alleges that he misrepresented the size of the markup on the Treasury securities which Alex. Brown sold in the Pennsylvania refunding, and that he failed to disclose the nature, purpose, and extent of Alex. Brown's fee-splitting arrangement with Arthurs Lestrange. The case will be heard by an administrative law judge.
Thiemann, HDI, Seidman, and JMS Associates consented to Commission orders finding that they were causes of McCarthy's violations under Section 8A of the Securities Act and Section 21C of the Exchange Act. Without admitting or denying the Commission's findings, they each consented to orders that they cease and desist from committing or causing violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5. The orders also require HDI and JMS Associates to disgorge the sums they obtained from the March 1994 refunding revenues ($173,641 and $175,250 respectively) plus prejudgment interest.
Arthurs Lestrange and Michael P. Bova, head of municipal finance for Arthurs Lestrange at the time of the 1994 Pennsylvania refundings, consented to a Commission order which finds that they willfully violated Sections 17(a)(2) and (3) of the Securities Act. Although Bova informed Commonwealth officials by letter that Arthurs Lestrange and Alex. Brown were pooling fees, Arthurs Lestrange and Bova failed to disclose that Arthurs Lestrange would receive the largest portion of the pooled revenues, nothwithstanding that its own contribution would be much smaller than that of Alex. Brown. Bova's letter also failed to disclose that Arthurs Lestrange had agreed to pay one-third of its revenues to Thiemann's company for bringing to Arthurs Lestrange a share of the deal revenues generated by Alex. Brown. Without admitting or denying the Commission's findings, Arthurs Lestrange and Bova consented to censures and to orders that they cease and desist from future violations. In additon, Arthurs Lestrange will pay a $100,000 penalty, and Bova will pay a $35,000 penalty.
Douglas E. Carter, Quinn's successor as head of the Alex. Brown Public Finance Department, and lead banker for the June 1994 Pennsylvania refunding, consented to a Commission order which finds that he willfully violated Sections 17(a)(2) and (3) of the Securities Act. The order finds that Carter knew or should have known that Alex. Brown had overcharged the Commonwealth 45 basis points instead of the agreed 4.5 basis points on the Treasury portfolio for the March 1994 refunding, and that he did not disclose this fact to the Treasurer's office. Without admitting or denying the Commission's findings, Carter consented to be censured, to cease and desist from future violations, and to pay a penalty of $35,000.
The Commission thanks the United States Attorney for the Southern District of New York, the Department of Justice, the Department of the Treasury, the Internal Revenue Service, and the Commonwealth of Pennsylvania for their cooperation in this matter.