The Commission announced today that it has brought securities fraud charges against Simon Hershon and three of his "InterBank Companies" in connection with the offer and sale of $189 million in debt securities between 1997 and 2002. The corporate defendants are InterBank Funding Corporation ("IBF"), IBF Collateralized Finance Corporation ("CFC") and IBF VI - Secured Lending Corporation ("Fund VI"). In addition to fraud, the Complaint charges that defendants CFC and Fund VI are operating unlawfully as unregistered investment companies in violation of the Investment Company Act of 1940 (the "ICA"). On June 7, 2002, in anticipation that the Commission would be filing this action, the three corporate defendants filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court in New York. The bankruptcy filings will not prevent the prosecution of the Commission's claims in federal district court.
Defendant Hershon owns all or the majority interest in several affiliated companies that together constitute the so-called InterBank Companies. The InterBank Companies are engaged in an investment business, and IBF provides the capital for these investments through three (formerly seven) wholly owned special purpose corporations or "funds" (the "IBF Funds"), including CFC and Fund VI. Between February 1996 and February 2002, the original seven IBF Funds raised nearly $195 million from about 3,100 investors in successive offerings, consisting primarily of unsecured subordinated high yielding notes in private placements. Nearly half of this total was raised in 2001. CFC is the largest IBF Fund with $182 million in notes on its books. Fund VI has raised about $7.2 million through the public offering of unsecured, high yield bonds.
The IBF Funds have been able to operate over the past six years only because IBF routinely moved offering proceeds between these entities in order to meet their cash flow needs - amounting to tens of millions of dollars of inter-fund transfers. These material related-party transfers were never disclosed to investors. Nor did the defendants disclose the extent to which interest payments to investors were paid out of offering proceeds.
Moreover, the defendants failed to disclose millions of dollars in transfers between IBF and the IBF Funds that were designed to hide - and did hide from investors - millions of dollars in losses sustained by the investment loan portfolios of the IBF Funds. As a result, the financial statements of the IBF Funds materially overstated net income, and return statistics that IBF regularly published about the IBF Funds were materially overstated, in some instances by as much as 50 percent.
In addition, the defendants' securities offerings to date have been unlawful because CFC and Fund VI are operating as unregistered investment companies and are not in compliance with any of the requirements of the ICA. Indeed, noncompliance with two provisions of the ICA is vital to the operations of these two entities - the prohibition against extreme leverage and the prohibition on affiliated transactions.
The IBF Funds depend entirely upon debt financing to provide the capital for the InterBank Companies' investment program, which involves making high-risk loans and other risky investments. Further, CFC's and Fund VI's respective business depends upon being able to invest in and through affiliated parties. Most of their investments involve prohibited affiliated party transactions.
The defendants are:
Hershon, age 54, who resides in Arlington, Virginia. Hershon is the chief executive officer ("CEO"), president and director of CFC, and he is the CEO and a director of Fund VI. He obtained a Masters and Doctorate in Business Administration from Harvard University in 1973 and 1975, respectively. Hershon formed the first InterBank Company in 1977. In 1996, Hershon formed IBF and the first IBF Fund.
IBF is a Delaware corporation with its principal place of business in Washington, D.C. IBF is the parent of the IBF Funds. It is wholly owned by Hershon.
CFC is a Delaware corporation with its principal place of business in Washington, D.C. Formed in 1999, CFC was originally named IBF Special Purpose Corporation VII ("Fund VII"). Fund VII initially sought to raise $25 million through the issuance of unsecured subordinated notes under a private placement memorandum dated May 10, 1999. It increased the offering to $50 million under an amended private placement memorandum dated August 29, 2000, and it further increased the offering to $100 million under a supplemental private placement memorandum dated June 27, 2001. In October 2001, Fund VII merged with two smaller IBF Funds and changed its name to CFC. At that time, CFC increased the total offering amount to $200 million under a supplemental private placement memorandum dated October 1, 2001. In January 2002, CFC merged with a fourth IBF Fund, which had itself issued about $50 million in subordinated notes in private placements. As a consequence of the mergers, CFC now carries $182 million in investor notes on its books.
Fund VI is a Delaware corporation formed in 1999, having its principal place of business in Washington, D.C. In August 2000, it began offering $50 million in current and accretion subordinated bonds in a public offering. The bonds mature on a rolling basis and bear interest at rates of between 8 and 10.75 percent per annum. Fund VI has raised about $7.2 million through the public offering.
The Complaint charges that all defendants committed fraud in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and Sections 17(a)(1), (2) and (3) of the Securities Act of 1933. It also charges defendants CFC and Fund VI with violations of Section 7 of the ICA.
The Complaint seeks preliminary and permanent injunctions against all defendants barring further violations of the securities laws; an order appointing a trustee to take possession of the assets of CFC and Fund VI; disgorgement of all offering proceeds obtained by CFC and Fund VI; and civil penalties against Hershon and IBF for their violations of the antifraud provisions of the securities laws.
The action is pending in the United States District Court for the Southern District of New York.