An Ohio fund manager used brokerage accounts at Baltimore's Ferris Baker Watts to engage in a stock manipulation scheme, borrowing millions of dollars from the firm to finance trades even as his activities raised concerns, according to a criminal complaint filed yesterday.
David A. Dadante used at least four sham trading techniques to artificially bid up shares in Innotrac, a small and lightly traded Duluth, Ga., order processing firm in which he accumulated a roughly 34 percent stake, the complaint against him says. At one point, the value of Dadante's account at Ferris reached $18.4 million.
On one occasion, when Dadante needed to quickly raise money to cover debts to another brokerage firm, his Ferris broker bought more than $600,000 worth of his Innotrac shares, using other Ferris clients' accounts without their knowledge, the complaint says. The Innotrac shares were later placed in those investors' accounts.
After Ferris placed restrictions on his activities, Dadante was able to continue trading in Innotrac shares through a second Ferris account opened under a different name with the same broker as the first, the complaint says.
Dadante's arrest yesterday, after the complaint was filed by the FBI in federal court in Cleveland, provided further insight into the nature of continuing probes by the Securities and Exchange Commission and the Justice Department into Ferris' relationship with Dadante.
The criminal complaint is centered on Dadante; it does not accuse Ferris of wrongdoing or suggest anyone at the firm deliberately aided illegal activity. Ferris officials declined to comment on the details of the complaint.
"First of all, the matter is in litigation," said Robin Oegerle, a Ferris spokeswoman, in an e-mailed statement. "Second, neither Ferris Baker Watts, nor any of its employees are a party to the litigation. FBW is cooperating fully with the U.S. Attorney's office and the SEC in the continuing investigation. In view of these circumstances it would be inappropriate for us to comment further."
Legal experts say details in the criminal complaint raise fundamental questions about Ferris' internal controls. Brokerages face intense regulatory oversight and are required by law to police the trading activity of their brokers and traders to prevent fraud and ensure fairness in the market.
Ferris has hired outside counsel to conduct its own investigation. This month, the firm disclosed that it had placed six traders and top executives in Baltimore and Hunt Valley on leave while the investigation took place. Ted Urban, the firm's executive vice president and general counsel, went on leave in November and subsequently took early retirement. Horace Usry, director of institutional sales, resigned. The firm's directors of retail sales and the private client group remain on paid leave. Two traders were allowed to return to work this week.
"I would say that based on what's alleged, it certainly does raise the stakes for the firm to determine quickly whether anyone else knew about this activity," said Kathleen M. Hamm, a former SEC enforcement official who heads the securities practice group of Promontory Financial Group in Washington. "And also, generally, under these types of allegations, if the facts are true, one would want a firm to evaluate their internal controls and their surveillance processes to determine why these transactions were not identified more quickly."
The criminal complaint says Dadante bilked about 100 investors out of nearly $50 million in a Ponzi scheme, in which money from new investors is used to pay returns to old investors. Some of the funds were diverted for Dadante's family, for gambling junkets and to purchase the Innotrac shares. At least $27.6 million is missing, court documents say.
The criminal complaint says Dadante's trades boosted the price of Innotrac shares from $2.19 in October 2002 to approximately $12 per share by March 2004. To do it, Dadante employed a variety of techniques that compliance measures are designed to protect against.
One method outlined in the complaint involved buying a small number of shares - sometimes as few as 100 - at elevated prices just minutes before the market's 4 p.m. close. Called "marking the close" or "painting the tape," the practice has the effect of artificially boosting that day's closing price.
In another, Dadante made small trades in Innotrac throughout the day, boosting the price at each turn and giving the appearance of active trading. The appearance of liquidity can be important to investors, who often shy away from lightly traded stocks for fear they won't be able to find buyers when it comes time to sell.
The criminal complaint and SEC filings show that Dadante traded in Innotrac stock almost daily over the course of years, often paying slightly more than the prevailing market price. A spokesman for Innotrac did not return two phone messages left this week.
"It is counter-intuitive that an individual would place bids for a stock at a higher price than the current market price," the complaint says. "Therefore, there is no legitimate reason for such a transaction other than to manipulate the market."
Dadante's trades went straight to Ferris' trading floor without the involvement of his broker, whom the complaint identifies as someone who left the brokerage firm Advest in January 2003 and joined Ferris shortly thereafter. That broker has been identified as Stephen J. Glantz, who left the firm in 2005 and has told The Sun he did nothing wrong. Broker records from the National Association of Securities Dealers confirm that Glantz, who has confirmed he was Dadante's broker, left Advest and joined Ferris in January 2003. Glantz has said that Dadante was allowed to place orders directly with Ferris traders, and the complaint backs that statement.
Ferris traders interviewed by the FBI said Dadante refused their offers to help him get the best price on his trades.
At other times, the complaint says, Dadante engaged in "wash sales," selling shares from one account and buying them in another account. Wash trades have the effect of sending signals to the market that the stock is more heavily traded - or liquid - than it truly is.
In August 2003, the complaint says, Ferris restricted Dadante's trading in Innotrac stock. To get around the restrictions, he opened a second Ferris account under a different name, using the same broker. That same month, Dadante bought 64,600 shares of Innotrac in the second account and later sold them to the restricted account. The complaint alleges that such a transaction has no economic benefit other than to increase the price by making it seem that the stock was trading heavily, to reduce the balance in one's account or to generate broker commissions.
In a later example, the complaint describes how Dadante faced a margin call - a requirement to quickly provide more money or securities to cover losses - on his account at Advest in December 2004. In response, the complaint alleges, he sold 77,000 Innotrac shares held in his Advest account for $8.75 per share. The shares were held briefly in Ferris's inventory and later purchased by Glantz at $8.90 per share on behalf of three Ferris clients who claimed to have no knowledge of the trades.
The complaint concludes there is probable cause to charge Dadante with two counts of securities fraud with maximum penalties of 20 years in jail and fines of up to $5 million.
paul.adams@baltsun.com