Banks and Investment Losses and Investing and Banking & Finance and Loans and Law

State going after underwriter of $5M Estridge offering

October 20, 2012

State securities regulators are seeking more than $1 million from the owner of an Indianapolis investment firm that raised $5 million for homebuilder Paul Estridge Jr. just as the housing market was collapsing in 2007.

The Indiana Secretary of State’s Securities Division filed an administrative complaint this month against Frank Neese, owner of Indiana Securities of Indianapolis, which served as underwriter of the offering.

The regulatory action is an outgrowth of a falling-out between Neese and Indianapolis-based Bank of Indiana, which lost its entire $1 million investment when The Estridge Cos. collapsed. The once-mighty homebuilder—which raised at least $15 million through offerings in its final years—now is part of Houston-based David Weekley Homes.

Neese was chairman of Bank of Indiana when the institution invested, putting him on both sides of a transaction board members later questioned. Indiana Securities ended up earning $375,000 in commissions on the sale of the $5 million in notes, which were supposed to pay 11 percent interest and be paid off in 2010.

“It’s easy to second-guess, but one has to wonder how Mr. Neese thought this was a suitable investment for a national banking institution,” said Mark Waterfill, a partner in the Indianapolis office of Benesch Friedlander Coplan & Aronoff who represents Bank of Indiana.

“You are basically buying junk bonds in a homebuilder.”

Confidential settlement

The state complaint takes issue with what occurred after the board’s relationship with Neese began unraveling in late 2009. In February 2010, Neese signed a confidential settlement agreement under which he resigned from the board and agreed to serve as guarantor on the notes if Estridge didn’t pay. Under the guarantee, he would cancel Bank of Indiana notes sold to him and his wife that were scheduled to be paid off in 2015.

Neese violated securities laws both by failing to report the settlement to securities regulators and by entering into an agreement guaranteeing repayment of an investment, according to the administrative complaint.

Jeff Bailey, a Bose McKinney & Evans partner representing Neese, 74, declined to respond to the complaint in detail because the case is pending but said, “We intend to contest it.”

The soured bet on Estridge was one of a number of transactions that left Bank of Indiana on the ropes following the financial crisis. The bank, which has just $103 million in assets, lost $2 million in a single loan issued by its Lafayette division, and in 2009 it was upbraided by the Office of the Comptroller of the Currency for “unsafe or unsound practices … related to credit administration.”

The board later appointed new management and launched a turnaround strategy. The institution’s performance has improved this year after a stretch of harrowing losses.

Falling-out

Waterfill said board members had been unhappy with Neese for a host of reasons, including his conversion of a house he owned at 17th and Meridian streets into the bank’s headquarters. Directors believed Neese’s ownership was a conflict of interest, Waterfill said, and they didn’t think the space befit a national bank.

Some board members also contended that, because of a series of amendments, they had been unaware of key aspects of the Estridge offering, including the amount of commissions Indiana Securities earned, Waterfill said. In addition, “there were new board members by the time of the default, and some of those wondered, ‘Why did we get into this in the first place?’”

Board members also asserted that Neese violated the terms of the settlement agreement by telling Estridge about the existence of his guarantee, a disclosure that reduced Estridge’s incentive to pay off the bank when the notes came due in June 2010.

The terms of that guarantee were far less favorable to the bank than outright repayment by Estridge, Waterfill said.

“It would be the difference between getting a million in 2010, or not having to repay someone five years later,” he said.

The bank sued Neese for securities fraud in 2010 but dismissed the claims last year in an effort to resolve the matter out of court and limit attorney’s fees. As that lawsuit was playing out, the bank contacted securities regulators, triggering the investigation that led to the filing of the complaint.

The complaint accuses Neese and Indiana Securities of dishonest and unethical practices and seeks a $1 million civil penalty, which would go to Bank of Indiana if collected. It also seeks an order that Neese and Indiana Securities pay the costs of the investigation along with a $10,000 fine for each violation of securities law.

Representatives of the Securities Division declined to comment.•

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