CHICAGO - The $37 million Chicago Housing Authority pension fund lost at least a third of its assets in a fraudulent investment scheme, becoming the first employee benefit investor to fall victim to a proliferating sham involving so-called "prime bank instruments" the Securities and Exchange Commission has been investigating.
The case is only the most recent the SEC has investigated in the phantom securities schemes that reportedly have cost investors some $100 million in the past two years, said William McLucas, director-division of enforcement in Washington.
"We have brought suits in at least a half-dozen or more of these cases, and we have a lot more we are investigating," he said.
In October, the SEC issued an official warning about prime bank instruments. That was followed the same month by a separate advisory jointly issued by five federal agencies that regulate banks and other financial institutions, including the Federal Reserve Board and the Office of the Comptroller of the Currency.
The two-page SEC alert to investors and investment firms it regulates notes "(c)ommon targets of these schemes included both institutional and individual investors."
The alert warns of the fraudulent schemes involving the issuance or trading of "so-called 'prime' bank, 'prime' European bank or 'prime' world bank financial instruments."
The schemes use the word "prime," not in the sense of prime rate of interest, but rather to mean the "top 50 world banks," or other top banks to convey that the instruments are issued by "financial institutions of purportedly high repute and financial soundness," the alert notes.
The phantom instruments, which in fact don't involve any of the leading international banks, "typically take the form of notes, debentures, letters of credit, and guarantees," the alert said. The instruments promise or guarantee unrealistic rates of return.
The schemes, while they promote investments in similar-sounding prime bank instruments, involve different perpetrators.
The SEC last week filed a civil suit in the CHA case, naming as defendants, among others, John D. Lauer, CHA director of risk management and benefits, and Clifton Capital Investors L.P., an Illinois partnership he helped form, which received $25,000 in commissions from the CHA for making the fraudulent investments.
"(T)here is no evidence that a market exists for" such prime bank instrument," documents filed by the SEC in the suit note.
Mr. Lauer was a general partner with Kenneth Senffner in Clifton Capital. Mr. Senffner, who wasn't named as a defendant, wasn't further identified in the suit.
CHA officials were unaware of the fraud or the pension fund losses until the SEC informed them the day before filing the suit June 21, said Kristin Anderson, CHA director-external affairs.
The SEC investigation, led by Stanley B. Whitten, assistant regional director for enforcement in the SEC's Chicago office, discovered the CHA fund invested at least $12.5 million in a scheme it calls the Konex Roll Program, court papers show.
None of the money has been recovered from the investments, which Mr. Lauer made between March and May 1993.
Konex Holding Corp. is one of the four other defendants named in the suit. Konex, a Nevada corporation with an office in Lexington, Ky., had its "registration," apparently meaning its incorporation, revoked in May 1993, the suit noted.
Nevertheless, it claimed to offer "international financial investments" and the Roll Program.
According to the suit, Lyle E. Neal, chairman, chief executive office and sole shareholder of Konex, described the program to Mr. Lauer. It purported to purchase and trade instruments issued by the "top European prime banks."
Mr. Neal told Mr. Lauer "your funds ... are 100% protected at all times" and "are never removed from your direct control," the suit noted.
Mr. Lauer made the CHA fund's first of several investments in the Konex program on March 29, 1993, when he transferred $10 million from the pension fund's account at CIGNA Insurance and ultimately to the account of Copol Investments Ltd. at Kreditbank S.A., Luxembourg. Further details about the CHA's relationship with CIGNA were unavailable.
The other defendants named in the SEC's suit involving the CHA are Copol Investments, Joseph Polichemi and Mr. Neal. Copol, an entity based in St. Peter Port, Guernsey, and incorporated - the suit was unclear - either in the Channel Islands or British Virgin Islands, purportedly buys and trades prime bank instruments for Konex and others. Mr. Polichemi is Copol's chairman.
Mr. Neal purportedly was a Copol officer. He was convicted previously of a felony in connection with coal tax-shelter limited partnerships, for which he served nine months in federal prison.
Upon learning of the losses in the SEC suit, CHA officials suspended Mr. Lauer with pay from his job pending the investigation, Ms. Anderson said.
Mr. Lauer "made all investment decisions for the assets" in the CHA pension fund, according to the suit.
Mr. Lauer, who is 29, has a journalism degree and is a certified financial planner, according to the suit. Information about what organization certified him was unavailable.
The Chicago authority's susceptibility to the fraud appears to stem in part from the lack of the internal and external controls of the pension fund or normal due diligence of professional investment management and oversight by trustees.
F. Willis Caruso, the CHA's general counsel, who is chairman of the board of trustees overseeing the pension fund, refused to take phone calls.
Mr. Lauer and his department were under the CHA legal department, which Mr. Caruso heads. Ms. Anderson said Mr. Caruso was now taking over for Mr. Lauer to oversee investments of the remaining assets.
The CHA fund, unlike nearly all of the more than 500 public pension funds in the state, doesn't have to file an annual audit with the Illinois Department of Insurance, said Tom Jones, manager of department's pension division.
Ms. Anderson had no information available who the trustees of the CHA pension fund are or how it was managed or custodied. But she said the fund apparently had no external discretionary investment advisers.
She said no audits of the fund were available.
She said Mr. Lauer, had sole authority to decide investments but was to report his decisions to the board. She said he didn't report the prime bank investments.
The CHA receives all of its money from the federal government and, like other municipal housing agencies around the country, formulates its own guidelines on managing its pension funds, said Judy Wojciechowski, a team member in the regional office of the Department of Housing and Urban Development. She didn't know if HUD audits the fund, or if the CHA fund submits audits on the fund to HUD. HUD wasn't involved in the SEC's investigation.
Ms. Anderson said the loss did not endanger the fund financially because it was overfunded and such losses are fully insured by Housing Authority Risk Retention Group. But neither of her statements could be confirmed.
From the SEC suit, it appears the pension plan is underfunded. As the suit noted, "Because of a shortfall in Benefit Plan assets created by early retirements, Lauer concluded that higher returns were required to eliminate this deficit." The suit noted Mr. Lauer considered the Konex Roll Program "as a possible means to cover the Plan's deficit."
The Housing Authority Risk Retention Group is part of Housing Authority Insurance Inc., Cheshire, Conn., which Jim Dibble, an official with the HAII, described as a captive mutual insurance company formed by federally funded housing authorities around the country.
Mr. Dibble confirmed the CHA has some insurance through it, but doesn't know if HAII insures pensions.