Remember, back in 2009, when Phil Falcone’s personal accountants realized that the hedge fund manager owed the government more than $100 million in state and federal taxes? And he decided to come up with the cash by “loaning” himself $113 million from a gated investor fund? It’s one of our favorite Falcone stories and we bring it up today because it’s one of the reasons, among many, that the Harbinger Capital founder just agreed to pay the Securities and Exchange Commission $18 million, admit wrongdoing, and take a five year involuntary break from the securities industry. For those who need a refresh, here’s how the idea for Falcone to help himself to the money came about, courtesy of the SEC:
1. After figuring out Falcone was in the hole for over one hundred mill, Phil’s accountants informed Harbinger’s COO, Peter Jenson, of the problem.
2. Jenson made some calls and let his boss know that “no bank would accept Falcone’s hedge fund interests as collateral.”
3. Jenson suggested that Falcone “proceed with appraisals of Falcone’s two Manhattan townhouses and artwork, and raised the possibility of borrowing against other assets, including Falcone’s interest in a National Hockey League team and an estate on the island of St. Barts.”
4. Falcone said nothing but quietly stewed. Borrow against his interest in the Minnesota Wild? He couldn’t believe Jenson had the balls to even mention it. Especially when all that investor money was just sitting there, practically begging to be used…
5. On September 15, 2009, Falcone responded to Jenson’s proposal about a bank loan using Falcone’s hard assets as collateral by saying “lets discuss later this week if you have some free time.”
6. Although the proposed bank loan, combined with Falcone’s available cash, provided a potential avenue for Falcone to pay his personal tax obligation, Falcone did not pursue this option. Instead, Falcone directed Jenson to pursue a loan from SSF, an option Jenson presented to Falcone following discussions with another outside law firm, Sidley Austin LLP (“Sidley”). On September 15, 2009, Jenson emailed Sidley regarding the loan proposal, stating “[P]hil [Falcone] loves the idea . . . Need a term sheet asap.”
7. On October 8, 2009, Jenson emailed a 14-page PowerPoint presentation to Falcone prepared by Sidley, and asked Falcone to take a “careful read” of it. The next day, Jenson and Harbinger’s in-house counsel reviewed a revised version of the PowerPoint with Falcone in a brief meeting.
8. The PowerPoint that Falcone reviewed at the October 9 meeting, which stated the “[g]eneral [r]ule” of “[n]o borrowings by any ‘insider’ from any fund” contained numerous incorrect assumptions – based on information that the law firm had been provided by Harbinger personnel – that should have demonstrated to Falcone that Sidley’s legal advice could not be relied upon. For example, the PowerPoint represented: (a) that the loan “must only be made as a ‘last resort,’” when Falcone knew that he had other potential options; and (b) that the loan would be “in the best interests of the lender,” when Falcone knew that SSF did not have separate representation to protect SSF’s interests.
9. Despite these red flags in the PowerPoint, Falcone asked no questions during the October 9 meeting and gave final approval for the loan transaction.
Which you have to love him for (“Do I reject this loan for myself? No. In fact, I’m going to be a co-signer”) although investors– at least the ones who read the footnotes in their Harbinger correspondences– didn’t.
17. Five months after the loan, Falcone and Harbinger disclosed the transaction for the first time in a footnote to SSF’s audited financial statements dated March 12, 2010. At that time, Falcone still owed a principal balance of approximately $98 million.
18. On May 12, 2010, Falcone wrote to SSF investors regarding a restructuring proposal. Falcone reported that greater than 80 percent of SSF investors chose to receive distributions rather than merge with HCP Fund I. Falcone further stated that “[a]s a consequence of this vote, we are beginning the process of an orderly reduction to cash” of the SSF portfolio and that Harbinger was “assessing other sources of liquidity” for SSF. The 5028 Harbinger Defendants, however, failed to accelerate the repayment of the loan.
19. In addition, in an email dated September 29, 2010, Falcone told an investor representative that, among other things, the loan “was collateralized by all my holdings, essentially 14x.” In actuality, the pledged collateral for the loan was limited to Falcone’s interest in SSF, which was less than two times the principal amount of the loan.
20. In the same e-mail, Falcone stated that the “[o]utside counsel structured the [loan] as an investment for the fund with terms advantageous to the fund like any other investment.” However, the 5028 Harbinger Defendants did not treat the loan as a fund investment and did not disclose it to investors in monthly portfolio holdings reports for approximately five months.
21. Falcone made his final loan repayment in March 2011, after becoming aware of the SEC’s investigation.
That was smart. Unfortunately, the SEC was not ready to let bygones be bygones re: the loan or overlook a few other possibly less than kosher actions on Phil and Harbs’ part and now this is happening:
The Securities and Exchange Commission today announced that New York-based hedge fund adviser Philip A. Falcone and his advisory firm Harbinger Capital Partners have agreed to a settlement in which they must pay more than $18 million and admit wrongdoing. Falcone also agreed to be barred from the securities industry for at least five years.
The SEC filed enforcement actions in June 2012 alleging that Falcone improperly used $113 million in fund assets to pay his personal taxes, secretly favored certain customer redemption requests at the expense of other investors, and conducted an improper “short squeeze” in bonds issued by a Canadian manufacturing company. In the settlement papers filed in court today, Falcone and Harbinger admit to multiple acts of misconduct that harmed investors and interfered with the normal functioning of the securities markets.
“Falcone and Harbinger engaged in serious misconduct that harmed investors, and their admissions leave no doubt that they violated the federal securities laws,” said Andrew Ceresney, Co-Director of the SEC’s Division of Enforcement. “Falcone must now pay a heavy price for his misconduct by surrendering millions of dollars and being barred from the hedge fund industry.”
While some hedge fund managers might see this as a setback, for Phil its an opportunity. The truth of the matter is, his heart hasn’t been in money managing for a long time. Now that he’s free of distractions, he can focus on his one true passion project. Without having to worry about this little Harbinger side gig, his life is streamlined. The SEC actually did him a favor. In fact, we have it on good authority that upon hearing 5 years he said, “Screw your 5, make it 10.” (They told him they weren’t here to make things easier for him, that’d the ban would be remain at 5, and to get out of their offices.)