Manager of fund accused in scheme

Ferris accounts allegedly used in stock manipulation

March 16, 2007|By Paul Adams | Paul Adams,sun reporter

An Ohio fund manager used brokerage accounts at Baltimore's Ferris Baker Watts to engage in a stock manipulation scheme, borrowing millions of dollars from the firm to finance trades even as his activities raised concerns, according to a criminal complaint filed yesterday.

David A. Dadante used at least four sham trading techniques to artificially bid up shares in Innotrac, a small and lightly traded Duluth, Ga., order processing firm in which he accumulated a roughly 34 percent stake, the complaint against him says. At one point, the value of Dadante's account at Ferris reached $18.4 million.

On one occasion, when Dadante needed to quickly raise money to cover debts to another brokerage firm, his Ferris broker bought more than $600,000 worth of his Innotrac shares, using other Ferris clients' accounts without their knowledge, the complaint says. The Innotrac shares were later placed in those investors' accounts.

After Ferris placed restrictions on his activities, Dadante was able to continue trading in Innotrac shares through a second Ferris account opened under a different name with the same broker as the first, the complaint says.

Dadante's arrest yesterday, after the complaint was filed by the FBI in federal court in Cleveland, provided further insight into the nature of continuing probes by the Securities and Exchange Commission and the Justice Department into Ferris' relationship with Dadante.

The criminal complaint is centered on Dadante; it does not accuse Ferris of wrongdoing or suggest anyone at the firm deliberately aided illegal activity. Ferris officials declined to comment on the details of the complaint.

"First of all, the matter is in litigation," said Robin Oegerle, a Ferris spokeswoman, in an e-mailed statement. "Second, neither Ferris Baker Watts, nor any of its employees are a party to the litigation. FBW is cooperating fully with the U.S. Attorney's office and the SEC in the continuing investigation. In view of these circumstances it would be inappropriate for us to comment further."

Legal experts say details in the criminal complaint raise fundamental questions about Ferris' internal controls. Brokerages face intense regulatory oversight and are required by law to police the trading activity of their brokers and traders to prevent fraud and ensure fairness in the market.

Ferris has hired outside counsel to conduct its own investigation. This month, the firm disclosed that it had placed six traders and top executives in Baltimore and Hunt Valley on leave while the investigation took place. Ted Urban, the firm's executive vice president and general counsel, went on leave in November and subsequently took early retirement. Horace Usry, director of institutional sales, resigned. The firm's directors of retail sales and the private client group remain on paid leave. Two traders were allowed to return to work this week.

"I would say that based on what's alleged, it certainly does raise the stakes for the firm to determine quickly whether anyone else knew about this activity," said Kathleen M. Hamm, a former SEC enforcement official who heads the securities practice group of Promontory Financial Group in Washington. "And also, generally, under these types of allegations, if the facts are true, one would want a firm to evaluate their internal controls and their surveillance processes to determine why these transactions were not identified more quickly."

The criminal complaint says Dadante bilked about 100 investors out of nearly $50 million in a Ponzi scheme, in which money from new investors is used to pay returns to old investors. Some of the funds were diverted for Dadante's family, for gambling junkets and to purchase the Innotrac shares. At least $27.6 million is missing, court documents say.

The criminal complaint says Dadante's trades boosted the price of Innotrac shares from $2.19 in October 2002 to approximately $12 per share by March 2004. To do it, Dadante employed a variety of techniques that compliance measures are designed to protect against.

One method outlined in the complaint involved buying a small number of shares - sometimes as few as 100 - at elevated prices just minutes before the market's 4 p.m. close. Called "marking the close" or "painting the tape," the practice has the effect of artificially boosting that day's closing price.

In another, Dadante made small trades in Innotrac throughout the day, boosting the price at each turn and giving the appearance of active trading. The appearance of liquidity can be important to investors, who often shy away from lightly traded stocks for fear they won't be able to find buyers when it comes time to sell.

The criminal complaint and SEC filings show that Dadante traded in Innotrac stock almost daily over the course of years, often paying slightly more than the prevailing market price. A spokesman for Innotrac did not return two phone messages left this week.

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