The Securities and Exchange Commission told a top Maryland pension official that Nathan A. Chapman Jr. violated federal law when he permitted money managers he supervised to invest state pension funds in his own companies, newly released documents show.
Carol Boykin, the pension system's chief investment officer, wrote in a March 19 memo that the SEC regards the purchases of Chapman stock as breaking a securities law, the Investment Advisers Act.
"I was told by the SEC that these transactions were a violation of fiduciary duty according to section 206 (an anti-fraud provision) of the 1940 Act," Boykin wrote to pension system executive director Peter Vaughn.
In her memo, Boykin also disclosed that Chapman had told her as far back as August 2001 that a money manager he selected had invested in a Chapman-controlled company.
She didn't act on that information, she said, because she thought Chapman meant the manager had invested personal funds, not state pension money - a misinterpretation Chapman yesterday called "incredible."
"What else could I have been talking about?" Chapman said. Boykin declined to comment for this article.
The disclosures came in documents obtained by The Sun under Maryland's public records act. Chapman, chairman of the state university system's Board of Regents and a friend of Gov. Parris N. Glendening, is also under investigation by the U.S. attorney in Baltimore.
The SEC would not comment on Boykin's memo. "It is the commission's policy to neither confirm nor deny the existence or nonexistence of an investigation or inquiry," said Carol Patterson, a commission spokeswoman. "It's also our policy to never comment on a specific company or individual."
Chapman declined to comment on the SEC investigation, saying he "would prefer not to discuss any regulatory matters."
Section 206 of the Investment Advisers Act is policed by the SEC and, in part, prohibits transactions by registered investment advisers, such as Chapman, that conflict with the best interests of their clients, such as the state pension system.
Bruce L. Lieb, a partner in the corporate law practice of the New York-based firm Proskauer Rose, said the provision most relevant to the Chapman case prohibits an investment adviser from selling a security in which he has an interest to a client without first obtaining consent.
Investment advisers found to have violated this section face civil penalties including fines, compensation to wronged clients, suspensions or even permanent disbarment from the securities business, Lieb said.
Conflict of interest
The pension fund lost an estimated $5.4 million as a result of purchases by two Chapman-selected managers of stock in companies he controlled - Chapman Holdings Inc. and eChapman.com. Investment experts consulted by The Sun have described the transactions as a clear conflict of interest.
Until he was fired in January, Chapman worked for the Maryland pension system as a money manager who, in effect, hired "sub-managers" to invest hundreds of millions of dollars in state pension funds. The pension system provides retirement benefits to state employees and public school teachers.
The bulk of the purchases in Chapman stock were made by Albriond Capital Management, a now-defunct firm that was run by Alan B. Bond, who has since been convicted of federal fraud charges in another case.
Stock worth pennies
Bond invested $560,000 of state pension money in the 1998 initial public offering of Chapman Holdings, then poured another $5.1 million into the 2000 IPO of eChapman.com.
Albriond and another Chapman sub-manager, Zevenbergen Capital, paid $13 a share for the eChapman.com stock - which never traded higher than $9 on the open market. By the time the pension system disposed of the stock, it was worth pennies.
Chapman, who owns two-thirds of the company, had the most to gain if the stock had taken off with the help of pension fund money.
The documents released yesterday - copies of which have also gone to the U.S. attorney - shed new light on the $27 billion pension system's failed oversight of Chapman.
According to the documents, Boykin met with Chapman in August 2001 after Bond, who was already facing criminal charges brought in 1999, was indicted for a second time - an event that prompted Chapman to fire Albriond.
Internal reports and e-mails show that Chapman told the pension system's Boykin that Bond had bought stock in Chapman-controlled companies. But Boykin failed to take action or notify the state pension board for more than four months.
In her memo to Vaughn, the pension system's executive director, Boykin said she did not realize that Chapman was talking about the use of state pension funds.
"I thought that he meant Bond personally owned eChapman.com. I did not realize that he meant that Bond had purchased the stock with funds from our account," Boykin wrote.
She said she did not learn that pension system money was involved until January, when staff attorneys learned that the SEC was probing the purchases of Chapman stock.
Boykin wrote in the memo that when the she received a report from Chapman on Oct. 11, detailing the investments made by his sub-managers, she delegated the job of analyzing it to her staff. She said she didn't follow up because she was instructed not to continue looking into Chapman's dealings with Bond because the SEC was investigating the matter.
Joseph M. Coale, the pension system's spokesman, said the instruction to Boykin to curb her investigation came from Vaughn, but was misinterpreted. Coale said Vaughn did not intend to limit Boykin's inquiries into the use of state pension funds.
Meanwhile, Boykin's contention that she didn't learn until January about Bond's use of pension funds to invest in Chapman's company was contradicted by one of her employees.
In an e-mail Feb. 28, Boykin subordinate Art Lynch told her he noticed Bond's purchases of eChapman.com stock when Chapman's report arrived the previous October. He insisted that he discussed the matter with Boykin at that time.
"I do not have any recollection of this," Boykin wrote in her memo to Vaughn.
Chapman was incredulous when told of Boykin's claim that she thought he was talking about a personal investment by Bond. He said Boykin asked him if Bond had invested in eChapman.com's IPO - a question Chapman says he took as a reference to state pension money.
"That's incredible," Chapman said of Boykin's statement. "I wasn't talking about Bond's personal portfolio. I have no knowledge of that."
If Boykin had taken action when Chapman spoke to her in August 2001, the pension system still would have absorbed a large loss. By then, stock in his company was trading at about $2 a share, and the state would have been constrained from selling it before making a public announcement that likely would have driven down the price even further.
But more timely action might have cut the state's losses by hundreds of thousands of dollars.
Coale admitted the record does not reflect well on the pension system's performance.
"Our internal communications should have been better and must improve," he said. "Fortunately the funds involved have not been significant in the context of the fund's total assets."