Two money managers selected by Baltimore investment banker Nathan A. Chapman Jr. to invest funds for the state pension board used that money to buy $5.1 million worth of shares at $13 each in a Chapman-controlled company - stock that is now worth 17 cents a share.
Unless the company's stock stages a remarkable recovery from a price lower than that of the bankrupt Enron Corp., the fund is in danger of losing more than $4 million on that investment.
Chapman, chairman of the University System of Maryland's Board of Regents and an ally of Gov. Parris N. Glendening's, said he didn't receive a dime as a result of the purchases - though his company did. But he acknowledged that the transactions are under investigation by the federal Securities and Exchange Commission - as The Sun reported last month.
The state pension board fired Chapman as a fund manager in January after learning about the investigation.
The eChapman.com investment represents a tiny fraction of the pension system's $27 billion in assets, but it raises questions about Chapman's actions and the retirement fund's oversight of its money managers.
Experts in securities law said these transactions were at least troublesome and at most, a blatant conflict of interest.
"It definitely sounds problematic," said Professor Lisa Fairfax, who teaches securities law at the University of Maryland. "Whenever the SEC's investigating, that actually suggests that [a company's] disclosures weren't adequate."
Business law Professor Ronald Gilson defined the transaction more bluntly.
"It's a massive conflict of interest," said Gilson, a professor of law and business at Columbia and Stanford law schools. "If this had been a mutual fund regulated under the Investment Company Act, it would have been a prohibited transaction.
"A simple way of understanding it," he said, "is that all regulation of investment professionals contains prohibitions against self-dealing."
In his first public comment on the matter, Chapman said this week that managers he hired - including one who is under indictment - had been investing Maryland pension money in the shares of his companies since 1998.
Chapman said he disclosed the transactions, and pension system officials should have been aware of them. If officials were aware, he said, it wasn't a conflict of interest.
"I discussed the position with clients at various times - including the state of Maryland retirement system - and no client ever had an issue with it," Chapman said.
Even so, Chapman concedes, "in retrospect, I would have avoided it."
SEC spokesman John Hein declined to comment on the matter, saying the federal agency does not confirm or deny whether an investigation exists.
Comptroller William Donald Schaefer, chairman of the pension system, said the transactions trouble him.
"I don't like it, don't think it's right. It opens us up to a lot of criticism," he said. "In a retirement system, when you're affecting the welfare of thousands of employees, it has to not only look right but to be right."
Schaefer, who emphasized that the state fund remains strong, said the pension system is examining every trade Chapman carried out since he began managing money for the system. He said the inquiry will also review the staff's oversight of Chapman, an early financial backer of Glendening's 1994 campaign for governor.
Chapman Capital Management was one of about two dozen companies hired by the pension board to invest billions of dollars in stocks. Chapman, in turn, employed from 12 to 15 submanagers to invest the state money apportioned to him - a fluctuating amount that was about $175 million when he was terminated.
State records, obtained by The Sun under the Freedom of Information Act, show the managers hired by Chapman to invest state money paid $13 a share to buy 395,000 shares of eChapman.com when the company first sold its shares to outside investors, a process known in market parlance as an initial public offering, or IPO. The shares started trading in the market about five days later.
The size of the purchase made the pension fund one of the largest outside holders of eChapman.com stock - by acquiring about a third of the 1.26 million shares put on the market. The IPO raised $16.4 million for the company.
If the pension fund investments and others who bought into the IPO had given the stock price a boost, Chapman would have been the single largest beneficiary. SEC filings show that he owned from 64 percent to 65 percent of eChapman.com just before the public stock sale.
In an IPO, a privately held company sells a percentage of itself to outside investors. These stock sales allow an entrepreneur to be rewarded for starting the company and give companies a way to retire debt or generate working capital for growth.
When an IPO in a promising company comes during a healthy stock market, there's often a huge appetite for the newly minted shares - which can sometimes double or triple in price in their initial day of trading.