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Regulation and Compliance > Federal Regulation > SEC

Guggenheim, the SEC and Milken's Shadow

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Monday Guggenheim Partners agreed to pay a $20 million penalty to the Securities and Exchange Commission for what looks like some pretty minor stuff. The SEC says that Guggenheim overcharged one client by $6.5 million over several years, but then it figured out the mistake on its own and gave the money back. (Guggenheim didn’t admit or deny wrongdoing.)

It had a compliance policy that seems to have forbidden flying on clients’ private jets, but sometimes its employees flew on clients’ private jets. And it “breached its fiduciary duty by failing to disclose a $50 million loan that one of its senior executives received from an advisory client”:

A senior Guggenheim executive obtained the loan in July 2010 so he could fund his personal investment in a corporate acquisition led by Guggenheim’s parent company. In August 2010, Guggenheim invested certain of its advisory clients in two transactions in which the client who made the loan also had invested, but on different terms. The Guggenheim executive and the client who made the loan discussed the two transactions and the Guggenheim executive played a role in structuring them. 

Well that seems, you know, baddish? Medium-bad? Obviously if one client — the SEC order calls him “Client A” — gave a Guggenheim executive a sweetheart loan, and Guggenheim then gave him preferential treatment at the expense of its other unwitting clients, that would not be great. But if that had happened you might expect the SEC to say so, and it didn’t.

The loan doesn’t seem to have been an especially sweet deal, insofar as the executive “refinanced the loan with a different lender” just over 14 months after taking it out. One of the transactions — Client A had some investments in a private company (“Company 1″), didn’t like them and ended up swapping them for more senior interests, giving the Guggenheim clients more junior interests — seems to have been negotiated mostly before the Client A loan, and not by the executive who had the loan. 

The other seems to have involved basically warehousing some private company warrants in five Guggenheim accounts for a couple of months until their issuer worked out a deal with Client A; ultimately Client A bought the warrants from the Guggenheim clients at the price they’d paid, plus interest. That is a little fishy — normally when you invest in private company warrants you expect more than a fixed-income return — but doesn’t seem to have done anyone much harm.

“There is no allegation by the SEC that any Guggenheim client was financially harmed,” says Guggenheim, which calls the whole thing “a potential conflict of interest related to a loan to an executive in GPIM” (Guggenheim Partners Investment Management, and emphasis added). The SEC doesn’t really seem to disagree. 

So why was the fine so big? The mystery might get cleared up a bit if you figure out who Client A is. Last week Charlie Gasparino reported that Guggenheim was “scrambling to put together a civil settlement with the Securities and Exchange Commission that would end a probe that originated with a regulatory investigation into the firm’s dealings with one of its most prominent clients—former junk bond king Michael Milken.”

When that investigation first came to light in February 2013, Bloomberg reported that it was about “whether Milken, an investor in the $170 billion asset-management firm, has in effect managed other clients’ money by playing an active advisory role to the firm.” Milken was banned from the securities industry a while back, but he remains rich and, you know, good at securities things. If he is investing alongside other Guggenheim clients in private investments, that’s fine. If he’s involved in structuring those investments, as a client negotiating with his advisers, that’s … fine? But if he’s involved in structuring those investments as an adviser to the other clients – if, for instance, he’s getting paid for his expertise — then it’s not. As Fortune reported in February 2013:

The SEC is looking at whether Milken is violating that ban by effectively acting as a manager of Guggenheim investments beyond his own, according to sources familiar with the investigation. The question is: Has Milken provided advice in exchange for some form of compensation?

But that is itself a vague question not susceptible to clear answers. Guggenheim in the past has said that “Mr. Milken, while a valued client, does not have an ownership or managerial role in the firm in any way, shape or form.”

The obvious guess here would be that Client A is Milken. Spokespeople for Guggenheim, the SEC and Milken all declined to comment, and the SEC order is written with more than the usual attention to vaguing up the anonymous parties. But there are enough clues that I at least am satisfied that Client A is Milken. One company mentioned in the SEC order (“Company 2″) did a bond deal underwritten by Guggenheim in 2010, and a subsequent warrants-for-preferred-and-common-stock swap on February 18, 2011. Diamond Resorts seems to be the only company that matches that description. The

SEC says it sold that preferred and common stock “to Client A”; Diamond says it sold it to four entities whose address and manager are the address and treasurer of Milken entities. If you’re interested in more detail, you know where to go.

So take the Company 1 transaction:

In or around late 2009, Client A sought to exit his Company 1-related investments. Client A expressed his “fatigue” with the sustained poor performance of Company 1 to the GPIM Executive. GPIM, on the other hand, held a view – endorsed by the GPIM Executive – that despite the sustained prior negative performance, Company 1’s performance would soon improve and generate positive returns for its investors.

In January 2010, Client A and GPIM began negotiating a transaction to restructure Client A’s and the GPIM clients’ investments in Company 1. In August 2010, approximately three weeks after the GPIM Executive’s receipt of the loan from Client A, Client A and nine other GPIM clients (through discretionary accounts managed by GPIM) restructured their existing investments in Company 1 by contributing their respective Company 1-related investments to a newly-formed limited liability company (the “LLC”) organized by Client A’s representatives. Company 1 did not participate in the transaction, and the funding of the LLC did not change Company 1’s capital structure.

The LLC then issued senior notes to Client A and junior notes to the GPIM clients. Overall, the effect of this transaction gave Client A less potential upside gain on Company 1 investments and greater protection against losses on those investments. GPIM’s clients received the converse position.

Why is that bad? One theory could be that the Guggenheim clients were treated unfairly, getting a worse deal because a Guggenheim executive was trying to curry favor with Client A, whom he owed money

But no one says that. The SEC’s actual theory – ”As fiduciaries, investment advisors must be vigilant about disclosing all material facts to their clients, including actual and potential conflicts of interest” — is sort of meh. It’s true enough, but a $20 million fine?

But if Client A was Milken — if Guggenheim put its investors into a structured private transaction instigated by Milken, in which Milken got a senior stake — then doesn’t that look a little like Milken was structuring the transaction for those investors, and getting paid for that structuring in better economic terms?

It obviously doesn’t look enough like that for the SEC to prove that Milken is acting as an investment adviser, or to fine Milken, or even to name him in its order against Guggenheim. But it might look suspicious enough for the SEC to get curious, and spend two-plus years investigating and fine Guggenheim $20 million as a consolation prize when the original investigation didn’t work out.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

  1. Per paragraph 29 of the SEC order, “Between 2009 and 2012, at least 7 GPIM employees took at least 44 unreported flights on the private planes of GPIM clients.” Only one was reported to compliance.

  2. That’s from paragraphs 2 and 3 of the SEC order. Paragraph 3 also says that the loan was secured by assets and that he “was at all times current on the payments under the note.” (Also, to be fair, it was only a 2-year loan.) Guggenheim adds: “There is no allegation in the settlement that the loan itself was illegal.”

  3. It is more complicated than that, but not in an especially interesting way. More in footnote 7.

  4. As far as I can tell – from paragraphs 19 and 21 of the order — the clients paid $10 million in mid-December and got paid $10.15 million in mid-February, for about a 1.5 percent return in a bit over two months. Not a bad fixed-income return.

  5. Not legal advice! Not that he’s taking advice from me.

  6. Though it does refer to Client A as “he,” a man rather than an entity.

  7. Here you go:

    • The SEC order describes a deal involving “Company 2.”
    • Paragraph 13 of the SEC order: “In August 2010, Company 2 refinanced its debt through a secured note offering that was co-underwritten by Guggenheim Securities, LLC.”
    • Bloomberg’s league tables show only one corporate bond offering underwritten by Guggenheim Securities in 2010: for Diamond Resorts International on August 10.
    • That was a private offering, but here is the Form S-4 for the public exchange offer for those bonds done a few months later.
    • The SEC order goes on to describe a “warrant ‘swap’” where, in essence, Company 2 agreed to buy back about $10 million worth of warrants from some Guggenheim clients, and Client A agreed to buy about $10 million of common and preferred equity from Company 2 to fund the warrant buyback.
    • Paragraph 21: “The transactions closed on February 18, 2011, when Company 2 repurchased the warrants from the GPIM clients for $10,150,951, which reflected a return of the GPIM clients’ cost basis in the warrants plus interest. Simultaneously, Company 2 issued $10 million of par preferred equity and a 2.25% share of common equity to Client A for $10,150,951.”
    • Pages F-56 and F-57 of the Diamond Resorts S-4 describe what are obviously the same transactions: “On February 18, 2011, DRP entered into various agreements with four new equity investors to issue an aggregate of 25.1 common units and 133.33 preferred units in exchange for $10.1 million,” and “Also on February 18, 2011, DRP entered into a warrant purchase agreement to purchase certain warrants issued by Diamond Resorts Corporation from various holders of the warrants.” (DRP is the Guggenheim entity that owned 24.2 percent of Diamond Resorts.)
    • In May 2011, Diamond Resorts filed an amended S-4 including the purchase agreement and shareholders’ agreement for that February 18 transaction. 
    • The buyers of the common and preferred — which the SEC calls Client A — are four entities named Silver Rock Financial LLC, IN-FPI LLC, BDIF LLC, and CM-NP LLC. All are signed for by Ralph Finerman as manager. Their addresses (in the Notices provision of the shareholders agreement) are all 1250 Fourth Street, Santa Monica, CA 90401.
    • Ralph Finerman is the treasurer of the Milken Family Foundation. 1250 Fourth Street is the address of the Milken Institute. (It has also been reported that Silver Rock Financial is a Milken entity.) 

To contact the author on this story: Matt Levine at [email protected]. To contact the editor on this story: Zara Kessler at [email protected].


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