A "Pump and Dump" Stock Scheme and a University's "Incredible Gift"

Here is a new twist on how respected academic institutions have gained from less than respectable donors.  As reported by the Palm Beach (FL) Post,

John David Mazzuto and a colleague stole more than $60 million from his former company and its investors, New York prosecutors said Tuesday afternoon.

... the Manhattan District Attorney said today that, while he was in bankruptcy from 2002 to 2009, he siphoned more than $15 million from Industrial Enterprises, and used the money to support 'a lavish lifestyle using millions of company dollars for homes, travel, and personal expenses.'

They included Mazzuto's 7,715-square foot house at 11503 Green Bayberry Drive. Palm Beach County records show a corporation managed by him bought it for $2.6 million in 2007. No mortgage was recorded, suggesting the company bought it outright.

New York prosecutors said Mazzuto also bought a $3 million home in the exclusive Long Island community of Southampton and spent more than $500,000 to fly on private jets.

Palm Beach Gardens police arrested Mazzuto Thursday and investigators from New York were in a Palm Beach County court Monday to collect him.

The New York indictment alleges Mazzuto and Cleveland, Ohio, attorney James W. Margulies, the corporation's general counsel, illegally issued millions of shares of stock and used fraud to inflate its value and deceive investors.

Mazzuto and Margulies are charged with grand larceny, scheme to defraud, conspiracy, falsifying business records, and violations of New York State's securities fraud law.

The district attorney said the two illegally issued millions of shares to family, friends, and associates.

'The defendants stole from the corporation and legitimate investors, and engaged in a variety of fraudulent accounting and securities practices to disguise the theft and pump up the value of the stock,' the release said. It said one outside investor lost more than $20 million.

'This was the wholesale looting of a public company,' Manhattan District Attorney Cyrus R. Vance, Jr., said in a statement.

A 2007 class-action lawsuit filed by investors alleged Mazzuto had a long history of unscrupulous business practices.

It also alleged Mazzuto used more than $100,000 from insider trading to buy a Porsche for his girlfriend.

The suit said the federal Securities and Exchange Commission was investigating Industrial Enterprises for insider trading and accounting fraud during Mazzuto's tenure. The SEC has declined to comment.

Mazzuto and Industrial Enterprises, saying the accounting mistakes were unintentional, agreed in April to settle the lawsuit for $3.8 million, records show. The settlement still is awaiting the court's approval.

Industrial Enterprises has been negotiating since October for Yale to return a gift that paid for a head coach and a new all-weather baseball practice facility.

Lawsuits alleged the bequest included improperly issued stock worth $1.7 million.

The New York Times added some detail about Mezzuto's dontation to Yale:

The news release called John D. Mazzuto one of the 'greatest supporters' of the Yale University baseball team.

Mr. Mazzuto, a 1970 Yale graduate who played shortstop for the team, had donated to the baseball program about $1.5 million worth of shares in a company he owned. The university rewarded him by naming a new practice facility after him and his wife — the John and Theresa Mazzuto Field — and by adding his family name to the baseball coach’s official title: the Mazzuto Family Head Coach of Baseball.

'John has bestowed upon Yale baseball an incredible gift,' John Stuper, the baseball coach at Yale, said in the release, dated April 17, 2009. 'His support of our program has been absolutely phenomenal.'

Manhattan prosecutors said Tuesday that Mr. Mazzuto’s support of his alma mater was illegal.

Mr. Mazzuto, 61, was indicted on charges of fraudulently inflating the value of a company he owned to mislead investors into buying worthless shares. He gave shares of the company, Industrial Enterprises of America, to family and friends and to companies he controlled, and they sold them on the open market, giving some of the profits to Industrial Enterprises, prosecutors said.

Those profits made Industrial Enterprises seem as though it was in better financial health than it actually was, raising its stock’s value, prosecutors said.

'It’s a new twist on a pump-and-dump,' said Garrett A. Lynch, the assistant district attorney handling the case.

Mr. Mazzuto also gave shares of the stock to Yale, prosecutors said. The university sold its shares before their value plummeted and earned about $1.5 million, prosecutors said.

Yale officials did not know that Mr. Mazzuto was issuing stocks illegally, prosecutors said, although some of the recipients of the shares did conspire with him.

A report in the Wall Street Journal added:

Industrial Enterprises, which was based in New York at one point, sought Chapter 11 bankruptcy protection in May 2009. [a month after Yale announced the donation - Editor]

A shareholder lawsuit, filed in federal court in Manhattan in 2007, alleged the company engaged in accounting fraud by 'materially overstating' its revenue between December 2006 to November 2007. The company announced in November 2007 it had overstated revenue by millions of dollars for two quarters that year.

For the sake of fairness, I must emphasize that the allegations against Mr Mezzuto and Mr Margulies are just that. However, there ought to be considerable suspicion that something unethical was going on, at least based on the company's admission of over-stated earnings, Mr Mezzuto's provision of the gift while he apparently was in personal bankruptcy, and (at least in retrospect), the company's filing for bankruptcy weeks after the gift of its stock was announced . Thus, Yale's acceptance of the gift, and its effusive accolades to its donor at best suggest an attitude of "what, me worry."

At best, it seems that our once unimpeachable academic institutions have become so eager to raise money that the provenance of donations is no longer of interest to them.  Furthermore, it seems that anyone who provides a big donation becomes a local hero, regardless of the source of the donation.  Embracing donations arising out of questionably ethical situations implies a tacit endorsement of the means used to provide them.  Our universities ought to remember that their mission is teaching, research, and for academic medical institutions (as Yale is), patient care.  It may be true that if there is no margin, there is no mission, but if margin comes first, regardless of where it comes from, there soon will be no mission. 

Leaders of Discredited Financial Rating Agencies as Leaders of Health Care

This is the latest in our informal series on the cross-linkages between the thinking and leadership that lead to the global financial collapse/ great recession and that current in health care.  Last month, a US Senate sub-committee held hearings on the role of the rating agencies, actually for-profit corporations that evaluated securities, including derivatives, in the collapse. 

The Fundamentally Conflicted Rating Agencies

To briefly provide some background, these agencies were hired by the firms that created these securities to evaluate them.  Because the securities were complex, they were hard for investors to evaluate.  Investors had become used to using the rating agencies' evaluations as benchmarks for the quality and riskiness of complex securities.  Many did not seem to realize that the agencies themselves were for-profit corporations, or subsidiaries thereof, which made more money the more securities they rated.  The rating agencies gave many of their highest ratings (AAA) to securities that later failed.  (See an informal video discussion by corporate governance expert Robert A G Monks here.)

Some key quotes from the news coverage follow.

Former credit rating agency officials said on Friday that the quest for market share fueled a drive for short-term profits, sacrificing credit quality in the process.

Eric Kolchinsky, who was in charge of the Moody's (MCO.N) unit that rated subprime CDOs, or collateralized debt obligations, said that people 'across the financial food chain, from the mortgage broker to the CDO banker, were compensated based on quantity rather than quality,' according to testimony prepared for a Senate panel.

'The situation was no different at the rating agencies.'

from Reuters

Former Moody’s Investors Service and Standard & Poor’s employees said they were excluded from assessing mortgage bonds if they questioned Wall Street’s conclusions and that credit-rating companies focused on protecting business at the expense of accurate grading.

Richard Michalek, a former managing director in Moody’s structured products derivatives group, told the Senate Permanent Subcommittee on Investigations at a hearing today that managers said he was 'not welcome on deals' involving certain banks.

Eric Kolchinsky, who led the Moody’s group that rated collateralized debt obligations made up of mortgage bonds, said he was berated by his boss when the company lost business after implementing more conservative ratings.

S&P wrongly concluded that its increasing profits amid an inflated U.S. housing market was based on 'superior management skill and insight,' said Frank Raiter, a former managing director at the company. In reality, regulators had made the firm part of 'an oligopoly' by requiring investors to hold assets it rated, Raiter said.

per Bloomberg

The documents show, sometimes in excruciating detail, the conflicts of interest that many claim lie at the heart of the ratings business model and the concerns of employees about what was happening inside the companies well before the crisis broke.

One employee at Standard & Poor's, the world's largest rating agency, said its handling of awkward questions in the summer of 2007 made it 'sound like the Nixon White House'.

And,

As one Moody's managing director wrote to his superiors in 2007, the company's errors, made it look 'either incompetent at credit analysis, or like we sold our soul to the devil for revenue, or a little bit of both'.

per the Financial Times

The two companies targeted by these hearings were Moodys, and Standard & Poors (a subsidiary of McGraw-Hill Inc).

Overlaps with Health Care Leadership: Moody's Corporation

Perusal of the roster of the Moody's board of directors in 2008, per that year's proxy statement, reveals the following overlaps with health care leadership, of its 8 directors.

Connie Mack - is also on the boards of EXACT Sciences Corporation (a biotechnology company), and Genzyme.  He is the chair of the H. Lee Moffitt Cancer Center.

Henry A McKinnell Jr - was chairman of the board and CEO from 2001-06 of Pfizer Inc.

Basil L Anderson - is a member of the board of directors of Becton Dickinson.

Overlaps with Health Care Leadership: McGraw-Hill Inc

Via the company's 2008 proxy statement, of 12 directors:

Sir Winfried Bischoff - is a director of Eli Lilly and Company.

Linda Koch Lorimer - is Vice President and Secretary of Yale University, and a Director of Yale-New Haven Hospital.

Kurt L Schmoke - is a Trustee of the Howard Hughes Medical Institute

Sidney Taurel - was chairman and CEO of Eli Lilly and Company.

Summary

So, in summary, the 20 board members of one for-profit "ratings agency," and of the corporation of which the other major "ratings agency" was a subsidiary, served on the boards of 2 biotechnology corporations (EXACT Sciences Corporation and Genzyme), one medical device company (Becton-Dickinson), one pharmaceutical company (Eli Lilly) , 2 major academic medical centers (Moffitt Cancer Center and Yale-New Haven), and one medical research institution (Howard Hughes).  Two were recent former CEOs and chairmen of the boards of 2 of the world's largest pharmaceutical companies (Pfizer and Eli Lilly). 

Most of these health care organizations have been involved with cases we have discussed on Health Care Renewal (see links above).

Given the serious concerns about the conflicts of interest that became the core of these corporations' business models, and their central role in the global financial collapse, one has to wonder why so many of the directors who presided over them still have such influential positions in health care organizations?

As we have pointed out, as the world economy was driven to near ruin by "masters of the universe," some of the same also became leaders of academia and academic medicine in their spare time. Maybe this made sense 10 or 20 years ago, but why does it still make sense? On the other hand, now that we understand how bad the leadership of finance really was, it is a little easier to understand why the leadership of health care has become so bad. It seems reasonable to hypothesize that some of the problems of academia, and particularly the problems of medical academia, may have been at least enabled by leadership more used to working in an increasingly amoral marketplace than to upholding the academic mission. The failures of the leadership and governance of finance thus suggest we need to re-examine the leadership of health care.