It could be months, or even years, before we fully understand all the system failures surrounding Aequitas Capital Management, but the ultimate takeaway already looks like a familiar tale of ignored warning signs in pursuit of something that looked too good to be true.
A once-obscure provider of private equity, credit and merchant-banking services, Aequitas apparently decided to start pushing the envelope over the past few years. Now the company, established in the early 1990s, is fighting for survival and faces a major liquidity shortage related to more than $300 million worth of private investment notes that it sold mostly through financial advisers.
The story is as complex as it is tragic, but the short version is that a relatively-predictable model for selling unregistered, high-paying debt instruments through financial advisers was somehow allowed to spin out of control.
So far, the most vocal player in a story that leaves hundreds of investors holding millions of dollars' worth of potentially useless paper, is financial adviser Chris Bean of Private Advisory Group in Redmond, Wash.
For more than six years, Mr. Bean had been buying the Aequitas private notes that had maturities of two-to-four years and paid yields of between 8% and 11%.
That fact that the 10-year Treasury bond is currently yielding 1.75% should serve as context to the kind of risk embedded into what Aequitas was selling. But Mr. Bean said it kept adding up and his clients kept getting paid, until they stopped getting paid about a month ago.
Mr. Bean is now having uncomfortable conversations with hundreds of clients, including his own mother, regarding their portfolios that held up to 10% in Aequitas private notes.
“In hindsight, I wished we hadn't done the notes, or had gotten out sooner,” Mr. Bean said. “But we have been upfront with our clients from the minute we found something out, and we've tried to paint a conservatively bleak picture, which will hopefully turn out better than expected.”
While he is now warning clients not to expect a full recovery on their investments through the multi-year liquidation process, Mr. Bean acknowledged a cushion from the ride that was.
“Most of these clients have been getting 11% returns on the notes for two or three years, or longer,” he said. “So even if they don't get full recovery, they're still out ahead.”
Since acknowledging in early February its inability to make good on many of the private notes it sold, Aequitas has gone into full crisis mode. In a carefully worded statement on Monday, the company cited cost-cutting measures and the hiring of an outside consultant to oversee the liquidation of assets and investment funds, which is expected to take at least two years.
Aequitas has already trimmed its workforce down to fewer than 40 from around 120 employees at the end of 2015, but the unraveling is only just beginning.
Lawsuits are being filed. Regulators, including the Securities and Exchange Commission and the Consumer Financial Protection Bureau, are reportedly already circling, and the Aequitas statement said the company is cooperating.
This is all a very long way from the model that Aequitas executives were talking about in November 2014, which might have been the start of the envelope-pushing period.
At that time, Aequitas was trying to launch a merchant banking type of platform for financial advisory firms that would involve Aequitas' providing equity and debt capital in exchange for commitments to invest at least $10 million on the Aequitas platform.
That never got off the ground, primarily because it isn't legal or ethical for advisory firms to enter into such hard-dollar relationships.
However, Aequitas did manage, through its multiple business ventures, to acquire pieces of advisory businesses, including a 23% stake in Mr. Bean's firm.
The Dallas-based turnkey asset management platform Summit Advisor Solutions also confirmed that it is 21.5% owned by an Aequitas venture, the Aequitas Capital Opportunity Fund.
The basic concept that advisers like Mr. Bean got on board with, involved buying hard-to-collect debt from businesses like hospitals and at least one college. Aequitas would buy the debt for about 70 cents on the dollar, then collect as much as it could to register a profit for investors through the private notes.
One sign of trouble cropped up in early 2014 when a federal judge ordered Aequitas to set aside $2.48 million ahead of a lawsuit related to commissions charged on a portfolio of student loans.
According to people familiar with the situation, Aequitas was counting as receivables on its balance sheet student-loan debt from Corinthian Colleges Inc., which went out of business in April 2015.
Aequitas, which is only commenting through its PR firm, was reportedly still putting on a positive face as recently as October when the company hosted a “Fall Summit” in Oregon's wine country for about 200 people. And the company was still taking in investor money as recently as January.
Mr. Bean believes Aequitas was overstating its assets and somehow cross-collateralizing some of the receivables, and then used the proceeds of the loans to lend money to Aequitas' expanding web of enterprises, many of which were “hemorrhaging money,” he said.
Time will certainly tell. But until then, we're left with another reminder of the importance of due diligence, especially when delving into the world of unregistered private investments offering returns that look too good to be true.