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The $700 Million Mystery


Finance: DERIVATIVES

THE $700 MILLION MYSTERY

It was one of the biggest disasters in the history of Wall Street. David J. Askin's $700 million array of mortgage-backed derivative funds crumbled in March, 1994, dragging down an illustrious roster of investors and triggering a collapse in the market for collateralized mortgage obligations (CMOs). Askin's funds are long dead, but the legal morass continues to this day--and some crucial questions remain unanswered:

Did some of Wall Street's biggest brokerages--notably Kidder, Peabody & Co.--help Askin mislead investors? Did Kidder and other firms, such as Bear, Stearns & Co. and Donaldson, Lufkin & Jenrette Securities Corp., improperly force his demise? Do they share in the potentially enormous liability--investor losses that exceed $400 million? Did Bear Stearns deliberately destroy tape recordings of trading-desk conversations, in defiance of a court order?

The answers to those questions are becoming clear--and troublesome. Documents and internal brokerage tape-recording transcripts, made public in Askin-related court proceedings and examined by BUSINESS WEEK, seem to support the contention that Street firms enjoyed a symbiotic relationship with Askin, helping him inflate returns to investors when mortgages turned sour early in 1994. The alleged quid pro quo was that Askin was a leading buyer of the Street's "nuclear waste"--the junkiest grades of mortgage-backed derivatives--benefiting the firms and their salespeople, who would get much higher commissions than on ordinary bonds. But when the CMO market fell precipitously in March, 1994, the brokerages were no longer Askin supporters. They moved hard and fast--and shut him down.

COZY. Such accusations, made by creditor lawyers in court filings in the Chapter 11 bankruptcy of the Askin funds, are vigorously denied by Kidder, now a unit of PaineWebber Inc., as well as by Bear Stearns, DLJ, and Askin's lawyer, Andrew J. Levander. "The notion of a conspiracy or collusive arrangement with Askin is ludicrous," sniffs Kidder General Counsel John Lifton.

Still, the documents leave little doubt that Askin had a close relationship with Kidder, the former mortgage-securities powerhouse. Kidder commonly sold, swapped, or engaged in repo transactions in which Askin received entire series, or "tranches," of low-grade mortgage-backed derivatives. At its peak, the Askin portfolios owned some $2.2 billion in CMOs. Kidder's top salesman went so far as to confide his firm was "in bed" with Askin (box). The comment, made in a taped conversation, was one of a series of recordings obtained by a court-appointed trustee, Harrison J. Goldin, who is investigating the Askin funds. Excerpts from the tape transcripts were recently placed in the court record by Edward S. Weisfelner, a lawyer for Askin-fund investors who last month obtained court approval for his own probe.

Levander maintains Askin's pricing policies were perfectly proper, and that he might still be in business if brokerages hadn't seized his portfolios when he couldn't meet margin calls. Brokerage executives say Askin failed to hedge, became too bullish, and was creamed by a merciless CMO market.

It was an unlikely end for the scholarly, soft-spoken, egotistical Askin. Whenhetookoverthe Granitehedge fundsin1990, healready was a highly regarded CMO expert who cut his teeth at Drexel Burnham Lambert Inc. Granite at the time was owned by Whitehead/Sterling Advisors, a white-shoe money management firm headed by biomedical magnate Edwin Whitehead. Granite was sold to Askin after Whitehead's death, and various Whitehead-related charities, and the Whitehead estate, became investors in--and now bankruptcy-court creditors of--the Askin funds.

"WEIRD STUFF." Court documents shed a rare light on the investor rolls and internal workings of the Askin funds, which were private hedge funds that usually kept their operations and investor lists a close secret. Among the investors in Askin funds were Nicholas J. Nicholas Jr., former president and co-chief executive officer of Time Warner Inc. Nicholas sank $500,000 into Askin's Granite Partners at an inopportune time--Jan. 1, 1994, three months before the fund collapsed. Another former Nicholas colleague at Time Warner also appears on the list of hapless Askin investors: James L. Gray, former president of Warner Cable Communications Inc. Playboy Enterprises Chief Financial Officer David I. Chemerow was an Askin investor, as was a partnership headed by Isidore Pines, chairman of National Foods, the Hebrew National kosher food magnate. A handful of money managers and other hedge funds also got caught in the Askin bankruptcy, notably fund-of-funds manager Collins Associates. Minnesota Power & Light invested and lost $10.8 million, and the 3M Employee Retirement Income Plan lost $20 million.

All told, investors are believed to have lost over $400 million in the Askin collapse. Kidder, by contrast, claims a loss of $17 million. Kidder and the other brokerages have had a much higher profile in the bankruptcy than the investors--much of it spent fighting efforts by Goldin, and by attorneys for the investors, to obtain information about their ties with Askin. Goldin notes that the brokers were slow to respond to requests for information, often provided "unhelpful or unreadable" records, and at one point cooperated only after Goldin threatened to sue. The firms maintain they have fully cooperated with the inquiry.

The result was a mountain of tapes and documentation, only a fraction of which has been made public. What has come into the public domain so far paints Askin as both victim and perpetrator. In the tapes, brokerage-house salesmen refer to the low-grade tranches sold to Askin disparagingly--as "nuclear waste" and "weird stuff" that sometimes was too complex to be hedged. According to a court ruling in one Askin-related lawsuit, Kidder was so vigorous in its sale of the "nuclear waste" that it allegedly told Askin that certain securities were bearish--that is, they would rise when interest rates rose--when they were far more complex than that. The claim was made at a time in early 1994 when Askin was trying to hedge his portfolio, which was heavily bullish as bonds tanked.

Tape transcripts, only recently made public, present a troubling picture of the Askin-Kidder pas de deux. While their meaning is far from crystal clear, they can be interpreted as indicating Kidder provided misleadingly high "marks"--marks to market, or prices--for the funds, thereby artificially boosting their investment returns. When the brokerages needed to price the securities kept as collateral for unpaid margin debt, the tapes support the view that the firms exchanged bogus prices.

Will this dour view of the tapes, and the court record, be borne out? Much depends on Goldin's report, which he expects to release early in 1996--delayed, he says, by brokers' slowness to cooperate. Goldin has been criticized by Weisfelner and his clients for not pressing hard enough on the brokerages' dealings with Askin, and he seems intent on demonstrating his independence. Goldin, a workout specialist and former New York City comptroller, says he is taking a sharp look at possible "actionable conduct" and he expects that there are likely to be "viable claims" pursued--perhaps against the brokerages.

At the top of the agenda of both Goldin and Weisfelner is the destruction of Bear Stearns's trading-desk tape recordings after a court order to preserve them. According to an affidavit recently filed with the court by Bear Stearns, the tapes were recorded-over by a junior employee unaware of the court order. Bear says that was in August, 1994--four months after the order was issued--while the responsible Bear Stearns official was on vacation. No one heard the original tapes "to the best of Bear Stearns's knowledge," says the affidavit.

Even without tapes from Bear Stearns, the evidence that already has come to light hardly casts a favorable light on Wall Street's dealings with Askin. Goldin says he will move to make public the final report of his investigation, in contrast to a preliminary Goldin report that was placed under court seal. Unless it is a ringing victory for the brokers, which hardly seems likely, Goldin's report will doubtless encourage an army of lawyers to descend on the only available deep pockets--the brokerages. For Wall Street, which made him and then smashed him to smithereens, it is a fitting epitaph to the legacy of David J. Askin.By Gary Weiss in New York


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