Trades raised flags at Ferris

The Baltimore Sun

Ferris Baker Watts employees expressed concerns to top executives in 2003 about an Ohio fund manager's stock trades, yet the firm let him keep trading for much of the next year and maintained the account until the fund was shut down amid fraud allegations in late 2005, according to documents and interviews.

The allegations against fund manager David A. Dadante, which led to a criminal complaint last month, have caused federal officials to probe his trades through the conservative Baltimore brokerage whose history in the city spans a century. Federal investigators say in a criminal complaint that Dadante used the trading desk at Ferris and other firms in a stock manipulation scheme that didn't stop until a group of investors uncovered it on their own.

The alleged fraud was occurring even as Ferris' internal watchdogs were flagging problems in Dadante's account and asking the firm's chief executive and general counsel for guidance on how to proceed, according to a company memo from May 2003.

The document shows that Ferris' compliance department believed that Dadante's trading through the firm had caused the share price of Atlanta-based Innotrac Corp. to increase and that he had potentially violated securities laws by not making required regulatory filings. The memo also questioned whether Ferris was adequately supervising Dadante's account and whether it knew enough about the source of his money and the nature of his nearly $50 million investment fund, known as the IPOF Fund.

Dadante, who was arrested last month, faces federal charges of securities fraud in Cleveland. The criminal complaint alleges that he artificially boosted the price of Innotrac's stock and looted the IPOF Fund to finance gambling junkets to Las Vegas and a luxury home in Gates Mills, Ohio.

$28 million lost

More than 100 investors lost about $28 million in what authorities say was a Ponzi scheme, in which money from new investors is used to pay phony returns to earlier investors.

Ferris has said that officials from the Securities and Exchange Commission and Justice Department are investigating Dadante's trades through his accounts at the firm.

Documents suggest that the firm took certain steps to monitor the account and correct some of the problems noted in the memo. Ferris executives restricted Dadante's trading at several points to address concerns about the millions of dollars he was borrowing from the firm to buy stock. Records also show that in June 2003, shortly after the memo was distributed, Dadante made required regulatory filings to correct a violation alluded to in the memo.

But he subsequently continued trading Innotrac stock almost daily through Ferris and other firms, according to court records and SEC filings.

In a February 2004 memo to one of the firm's traders, Ferris Chief Executive Roger Calvert instructed that Dadante could continue buying Innotrac shares as long as he paid for them in cash.

It's unclear what steps Ferris took to address the 2003 memo's concerns about Dadante's trading patterns and their influence on Innotrac's stock price. The memo was addressed to Calvert, general counsel Ted Urban and other top officers of the privately held brokerage. The firm, which has said that neither it nor Ferris clients lost money in Dadante's transactions, declined to make executives available for interviews last week or to answer oral and written questions.

Documents and interviews indicate that Dadante preferred to buy most of his shares with money borrowed from Ferris and other firms, a common practice known as buying on margin. Calvert's restriction came at a time when Dadante's debt had reached $18.4 million.

Ferris spokeswoman Robin Oegerle said the firm has already addressed issues raised in its own internal probe and is cooperating with federal investigators: "Because this matter is under investigation, it is not appropriate for us to comment further."

Four top executives and two traders took temporary leave during Ferris' internal investigation.

Urban has since retired, and Horace Usry, its head of institutional sales, has resigned. Two traders and the head of retail sales have returned to work, but Louis Akers, Ferris' vice chairman and former chief executive, remains on leave.

An attorney for Calvert did not respond to phone messages last week. An attorney for Urban said his client's departure from the firm was amicable. He declined to comment on the memo, saying his client, as former general counsel for Ferris, remains bound by attorney-client privilege restrictions.

The authenticity of the 2003 memo was confirmed by multiple sources.

Investment firms are required by law to police the trading activity of their brokers, traders and customers such as Dadante to prevent fraud and ensure fairness in the market. The SEC and Justice Department declined to comment on the matter.

The criminal case is pending before the U.S. District Court in the Northern District of Ohio.

Court records show that Dadante began buying thinly traded Innotrac stock in August 2002 through a broker at Advest Inc. who has been identified through public documents and interviews as Stephen J. Glantz. Shortly after Ferris hired Glantz in January 2003, Dadante transferred his 570,000 shares of Innotrac to a new account at the firm.

Innotrac is an Internet order processing and logistics company with about 1,300 employees and a history of financial losses. Anyone who has ordered something from a major online retailer might have used the company's services, but few in the investment community trade in its shares.

The criminal complaint says Dadante used a combination of four illegal trading techniques to manipulate the price of Innotrac's stock as he accumulated millions of shares through multiple accounts at Ferris, Advest and several other firms.

So-called "penny" stocks - stocks that sell for a few dollars per share - are vulnerable to manipulation because so few people buy them, making it easy for one buyer to influence their price.

The 2003 memo suggests that Ferris' compliance department had early indications of trouble. It noted Dadante's heavy trading in the stock and unusual habit of buying in small lots.

At that time, the memo said, Dadante owned about 1.7 million shares of Innotrac. His margin account debt with the firm had grown from $2.3 million in January to nearly $9.4 million in May, potentially putting Ferris at risk of financial losses if the stock suddenly lost value and Dadante failed to cover the losses, documents show.

The memo doesn't say whether Ferris officials suspected Dadante of illegally manipulating the stock, but it shows that compliance officials believed Dadante's near-daily purchases of the shares in small lots were largely responsible for driving the price higher. And the criminal complaint alleges that illegal trading took place in the months before and after the staff document was written.

Innotrac's price climbed from $2.68 per share about the time Dadante opened his account at Ferris to $5.97 by May 21, a 123 percent increase in five months. Leading up to that period, Innotrac had reported a $4.4 million loss for 2002 and an $892,000 loss in the first three months of 2003.

Buying practices

Court documents say Dadante often bought small numbers of Innotrac shares several times throughout the day, incrementally raising the price at each turn. He refused help from Ferris stock traders to obtain the best price for his shares, as traders typically do. Instead, he requested they use his own schedule of increasingly higher bids.

In addition, Dadante would sometimes call Ferris' trading desk minutes before the close of markets and buy small amounts of Innotrac stock at slightly more than the previously recorded bid price, the criminal complaint says. Called "marking the close," the tactic has the effect of artificially boosting the closing price of the shares.

The complaint said there is no reason for such transactions other than to manipulate the market.

The company's shares climbed from $2.19 per share in October 2002 to a high of approximately $12 per share by March 2004. The increase occurred as Dadante amassed about 4.2 million shares in multiple accounts at Ferris and other firms. The complaint says most of the manipulation was done through Ferris and Advest accounts.

Dadante's trades often went straight to Ferris' trading floor without first going through Glantz, the criminal complaint states. But on one occasion, the complaint alleges, the Ferris broker helped his client pay a debt at another firm by buying more than $600,000 worth of Innotrac shares from Dadante's Advest account and placing them into the accounts of three other Ferris clients.

The clients were unaware that Glantz had purchased Innotrac shares on their behalf, and it's not clear from the complaint whether they had given him authority to initiate such trades in their accounts.

Glantz also was the registered broker on a second account that Dadante opened at Ferris in August 2003 under a different name, according to documents. That account was opened a few months after the compliance department memo. The criminal complaint says Dadante used the new account to circumvent restrictions that Ferris placed on his trading. It's unclear from the complaint what those restrictions are or who ordered them, although sources said they were related to Dadante's ability to continue borrowing from Ferris.

The complaint says Dadante continued to buy Innotrac through Ferris accounts through the rest of the year.

Glantz, who left the firm in 2005, has told The Sun he did nothing wrong. An attorney for Dadante declined to answer questions about the investigation.

A 'break-down'

The 2003 compliance memo indicates that staff members had questioned Glantz and others about Dadante and were not satisfied with the answers they received about the structure of the IPOF Fund, its investors and the source of Dadante's money. The memo also complained of a "break-down" in supervision of the account, which was overseen by managers in both the institutional and retail sides of the business.

Compliance officials had discussed whether the account should be shut down until the firm had a more accurate and complete record, the memo says.

The compliance memo also noted that Dadante owned more than 15 percent of Innotrac's outstanding shares. Securities laws require investors to disclose their holdings and declare their intentions - such as whether they plan a hostile takeover - after purchasing more than 5 percent of a company's shares.

SEC filings show Dadante didn't make such a filing until late June, about a month after the memo was distributed. Shortly thereafter, Innotrac's board of directors notified Dadante that he owned enough shares to trigger a so-called "poison pill" anti-takeover provision.

Triggering that provision could have effectively forced Dadante to stop buying shares. But Innotrac's board decided the violation was "inadvertent" and twice amended the company's bylaws to allow Dadante to buy up to 40 percent of its shares, securities filings show. An Innotrac spokeswoman declined to comment, saying that the matter was part of a continuing investigation.

The fund manager eventually accumulated nearly 35 percent of Innotrac's shares and ran up an $18.4 million margin debt with Ferris by the time Calvert's 2004 memo ordered a halt to further lending.

Innotrac stock hit its peak the next month, but it declined sharply soon thereafter. By April the shares had lost more than a third of their value before staging a modest comeback later that year.

During this time, Dadante's investors were unaware they were major stakeholders in Innotrac. The criminal complaint says Dadante presented them with false statements indicating that they were invested in high-quality, blue-chip stocks.

The criminal complaint says the alleged fraud unraveled when IPOF investors started asking questions about the fund's Innotrac holdings and Dadante admitted his strategy to manipulate the stock. The revelations led to an angry confrontation and a flurry of investor lawsuits, which in one case lists Ferris and other brokerage firms that Dadante used as third-party defendants. A federal judge in Cleveland froze IPOF's assets, including the Innotrac shares, and appointed a receiver to oversee the fund.

A judge has ordered that none of the shares be sold until the legal process plays out.

The shares closed Friday at $2.77, less than a quarter of the high they touched during the time Dadante was trading.


1999: Investors start joining David A. Dadante's IPOF Fund.

Aug. 12, 2002: IPOF Fund begins buying shares of Innotrac through a brokerage account at Advest Inc. Innotrac stock ends the day at $2.25 per share.

Jan. 1, 2003: Ferris Baker Watts hires Dadante's broker, Stephen J. Glantz, away from Advest; Dadante moves IPOF funds and 570,000 shares of Innotrac to a new account at Ferris. He keeps an account open at Advest, too.

February-April 2003: Dadante, according to a criminal complaint, engages in stock manipulation through the IPOF account at Ferris.

May 23, 2003: Ferris compliance officials send a memo to top executives raising concerns about Dadante's account and trading. Innotrac stock ends day at $6.04 per share. Dadante owns more than 15 percent of the company's outstanding shares at this point, but he hasn't filed required regulatory documents indicating his ownership status, according to Securities and Exchange Commission filings.

June 2003: Dadante makes SEC filings disclosing his Innotrac holdings.

July 2003: Innotrac board notifies Dadante that he owns enough shares to trigger a "poison pill." Later, it amends corporate bylaws to allow him to buy up to 25 percent of the company's shares.

August 2003: Ferris places restrictions on the IPOF account. Dadante, according to the criminal complaint, then opens a second account under a different name to circumvent those restrictions. Glantz is the registered broker for both accounts.

November 2003: Innotrac board amends its bylaws a second time, this time allowing Dadante to buy up to a 40 percent stake.

February 2004: Ferris chief executive orders a trader not to allow Dadante to buy any more shares of Innotrac unless he pays for them in cash.

March 1, 2004: Innotrac price touches a high of $12 per share.

November 2005: IPOF Fund investors confront Dadante about heavy ownership of Innotrac. Criminal complaint alleges that Dadante claimed that he could control the price of the stock, keeping it above $8 per share. Investors subsequently file suit. A federal judge in Cleveland appoints a court receiver to oversee the fund. More than $28 million is said to be missing.

April 18, 2006: SEC files a civil lawsuit against Dadante.

March 15, 2007: Dadante is arrested on federal securities fraud charges in Cleveland, later posts bond. Innotrac closes day at $2.11 per share.

Sources: Company memos, SEC documents, federal criminal complaint and other public records

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