You Can't Cheat an Honest Man - James Walsh [143]
Overstating receivables resulted in a reported $25.5 million in shareholders’ equity in 1992; in reality, equity was negative $242.4 million. Reinforcing the illusion of prosperity were slickly produced annual reports. People believed the lies.
Hoffenberg lived in a Long Island mansion—complete with a pool, tennis court and private beach. For weekends, he kept a home in Boca Raton. When he needed to drive somewhere, he hopped in one of three Mercedes. In 1993, he tried to buy the New York Post. But trouble was looming. When SEC investigators learned about Hoffenberg’s efforts to buy the Post, they accelerated their inquiry.
In early 1993, bondholder trustee Shawmut Bank began making noises. It had just received the company’s fiscal 1992 annual report (six months after the end of the fiscal year) and found what seemed to be indications that Towers had violated the terms of its various loans. Worse still, Towers wasn’t forthcoming about whether the “possible events of default had been cured.”
Shawmut declared the health care bonds in default and refused to release any more of the bond-issue proceeds for lending to health care providers. That created a huge problem for Towers: It had already sent money to health care providers after purchasing the receivables backing the bond proceeds at Shawmut.
Once the money from Towers stopped coming, many providers simply kept the insurance payments. As a result, Towers Financial’s cash flow slowed to a trickle. Realizing his time was running out, Hoffenberg tried to cover his tracks. One attorney would later discover a $6,400 claim against Towers from the Mobile Shredding Corp. of New York that covered work during the last months of 1992. Mobile had shredded ten tons of Towers documents.
In February 1993, the SEC filed a lawsuit in New York federal court, charging Hoffenberg with securities fraud and demanding the appointment of an SEC trustee to run the company. Towers filed for bankruptcy protection a few days later.
In March 1993, Alan Cohen—a New York-based workout consultant—was appointed trustee. When he arrived at Towers Financial’s offices, Cohen found Hoffenberg there, still trying to hang on to his control of the company. “I suggested to him that it would probably be better if he didn’t come around anymore,” said Cohen.
The federal lawsuit charged that Hoffenberg never intended to do anything with money taken from gullible investors except “apply it to [his] own purposes and use it for the payment of interest owing to other investors.” According the U.S. attorney, “Unbeknownst to the investors, the source of the interest they received on the Notes was the principal paid by later Note investors.”
That’s as succinct a definition of Ponzi scheme as any.
During its heyday, Towers had referred skeptical investors to Duff & Phelps, a financial credit rating agency which “would provide independent verification and corroboration regarding the creditworthiness of [Towers Financial] and... confirm the positive statements [it] had made.” Duff & Phelps claimed it used what it called a “shadow rating” of Towers Financial. Its staff told a number of investors that it “had conducted extensive due diligence investigations prior to assigning ratings to the bonds.”
Burned investors eventually sued Duff & Phelps, claiming that it had known that the false information would be used in investment decisions. They said: “At all times Duff & Phelps knew that the false assurances and information it was providing would be... used by the brokers and their clients... to evaluate whether to purchase and/or maintain investments in [Towers Financial].”
The January 1996 federal court decision Shain v. Duff & Phelps Credit Rating Company considered the complaints against the rating company. The case