Ferris, Baker Watts is negotiating a settlement with the Securities and Exchange Commission that could result in a civil fine of $1.2 million or more and lead to additional penalties against current and former employees, according to regulatory documents filed yesterday.
The negotiations stem from a lengthy federal investigation of the Baltimore brokerage's supervision of a former broker and client who used Ferris accounts to engage in illegal stock trading. The documents say that an SEC and Justice Department probe of the matter helped spur the century-old firm's decision in February to sell itself to Minneapolis-based RBC Dain Rauscher, a division of Royal Bank of Canada.
"Given the size of Ferris and that it's a regional firm, I would regard that as a significant and substantial fine," said Ross A. Albert, a partner with Morris, Manning & Martin in Atlanta and a former SEC enforcement lawyer.
Ferris had previously said the federal probe was focused on the activities of a former broker and his client, both now in prison, and had not disclosed that current employees are also being investigated.
The deal will result in multimillion- dollar payouts to top Ferris executives who were at the helm while the stock manipulation fraud was being conducted through the firm's trading desk.
RBC is buying Ferris for $230 million in stock, subject to last-minute adjustments, according to the documents, which for the first time disclosed financial terms of the deal as well as the circumstances that led to it. The range of values that the deal places on Ferris stock is mostly above the shares' appraised value as of last August.
George Ferris, the firm's chairman and owner of about one-fourth of its shares, would have RBC stock worth $50.6 million if the transaction values Ferris, Baker Watts shares at the approximate midpoint of the price RBC could ultimately pay at closing, the filing shows. The shares, which are all owned by employees, were appraised at $202.56 apiece last year.
Roger Calvert, president and chief executive, would receive $4.5 million in RBC shares for his stock and options, and a change-of-control payment of $2.54 million.
Patrick Vaughan, one of six employees put on temporary leave last year while the firm investigated the stock fraud, has stock worth about $1.4 million under terms of the deal. He would also get payments totaling about $4.1 million if, as expected, he stays with Dain Rauscher as its senior vice president and regional director for at least four years.
The deal also creates a $97 million pool of money to keep brokers from leaving. Ferris has about 850 employees and 42 retail branches in the Mid-Atlantic, Michigan and Ohio.
A spokeswoman for Ferris declined to comment on the filing, and a Dain Rauscher spokesman did not return a phone message yesterday. The SEC also declined to comment.
Ferris has suffered financially in the past year as its trading revenue shrank while legal expenses have grown, the regulatory filing shows. The firm reported a net loss of $10.6 million in the fiscal year ended Feb. 29, compared with a profit of $16 million in the previous year, according to newly completed audited financial statements.
Ferris had long been rumored to be on the auction block, but pressure to sell accelerated after it came under increased scrutiny by federal regulators last year. The firm's board met in August to discuss options, and after hiring consultants to conduct a strategic review, concluded it was time to sell, the filing states. It approached six potential buyers, eventually leading to two bids and a decision in February to go with RBC. The other bidder was not identified.
The troubles date to 2003, when Ferris hired Ohio broker Stephen J. Glantz, who brought with him a client, David A. Dadante, who managed a $47 million investment fund based in Ohio. The fund turned out to be a Ponzi scheme, in which money from new investors is used to pay phony returns to earlier investors.
Dadante used a combination of investor money and millions borrowed from Ferris to purchase a 35 percent stake in Duluth, Ga.-based Innotrac Corp. With assistance from Glantz, he placed trades that artificially inflated Innotrac's share price.
The fraud occurred even as Ferris' internal watchdogs were raising concerns. In a May 2003 memo, Ferris' compliance department said it believed Dadante's unusual trading had caused Innotrac's shares to rise and questioned whether the firm was adequately supervising the account and Glantz, The Sun reported last year. Securities firms are required by law to police their brokers and clients to protect the integrity of financial markets.
The memo was distributed to Calvert and other top executives, but the firm allowed Dadante to continue trading into 2004. It wasn't until executives became concerned about Dadante's $18 million debt to the firm that Calvert wrote a memo placing severe restrictions on his trading in Innotrac stock. The fraud wasn't uncovered until late 2005, when investors in Dadante's fund discovered it on their own.
The fund is under court receivership. Its investors lost $28 million.
Dadante pleaded guilty to securities fraud charges and is serving a 13-year sentence in federal prison. Glantz also pleaded guilty and is serving 33 months. Three former Ferris executives, including general counsel Ted Urban and Vice Chairman Lou Akers, either retired or left the firm last year amid fallout from the federal investigation.
In an interview with The Sun before entering prison, Dadante said Ferris employees didn't try to stop him until his debt to the firm grabbed the attention of top executives. An attorney for one of the Ferris traders who placed Dadante's orders recently told The Sun that his client spoke to superiors about Dadante's activities. He said the traders had no knowledge that Dadante was doing anything illegal.
In addition to the fine, Ferris faces more legal fees to settle the matter, the documents say. The firm estimated those costs at $200,000 to $400,000. It also would have to defend any current and former employees who face SEC civil action stemming from the Dadante fraud. Ferris estimated those costs at $100,000 to $250,000 for each person affected.
While not admitting fault, Ferris has agreed to pay roughly 100 investors in Dadante's fund $7.2 million in cash to settle lawsuits. The firm would also relinquish its claim to about 3 million shares of Innotrac stock, worth about $11 million at yesterday's closing price, that are still held in Dadante's accounts at Ferris. A federal judge in Cleveland must approve the settlement.
The merger with Dain Rauscher requires Ferris to set aside money to pay any settlement costs and legal fees associated with the Dadante matter. Ferris said in the filing that it believes it has already established sufficient reserves.
Valuing the sale for executives
Royal Bank of Canada's $230 million deal to buy Ferris, Baker Watts Inc. outlines various change-of-control agreement payments (commonly known as golden parachutes), stock values and options to certain executives at the Baltimore-based brokerage. They include:
George Ferris, chairman
Value of stock in the company: $50.59 million Accelerated stock options: $67,584 Stock option cancellations: $26,303
Roger L. Calvert, president and chief executive officer
Value of stock in the company: $4.47 million Change-of-control payment: $2.54 million Accelerated stock options: $690,736 Stock option cancellations: $257,989
Patrick Vaughan, executive vice president
Value of stock in the company: $1.37 million Change-of-control payment: $1.89 million Accelerated stock options: $147,076 Stock option cancellations: $87,212
Vaughan also has an employment agreement with Royal Bank's Minneapolis-based money manager RBC Dain Rauscher Inc., which could be worth at least $4.1 million if he stays with the firm for at least four years.
Among the compensation under that deal, which includes the change-of-control payment:
$850,000 in base salary and bonus annually for the first two years
$325,000 loan that will be forgiven after three years if he remains at the firm
$325,000 contribution to a company "wealth accumulation plan" that vests after four years * Stock values, which include options, are based on number of shares owned and priced at $223.85 each. That's the approximate midrange value outlined in the deal. If it is approved, Ferris shareholders would exchange their privately held stock for shares of Royal Bank of Canada.
[Source: SEC documents]