Department of Can't Say We Didn't Warn Ya: Dicey Investment Offer Advertised in Chronicle Goes Bad

News headlines Monday suggest our warning was valid. Advanta Corp., a bank holding company specializing in small business credit cards announced today it was filing for bankruptcy, throwing into question whether the company would pay in-full investment notes advertised in the Chronicle's business section less than four months ago.

On July 12 of this year,  Advanta, bought an advertisement on page D-2 of the Chronicle's business section, surrounded by ads touting ordinary bank certificates of deposit, announcing: "You can now earn: 1 year -- 11.00 percent."

The announcement seemed unbelievable, given bank interest rates at the time topped out at about 2 percent. It apparently was. Investors now seem doomed to receive pennies on the dollar.

On July 17, and in a print column July 27, we quoted ex-bank examiner Richard Newsom, who in the 1980s helped bring down savings and loan villian Charles Keating, as saying,
"This is an example of the old standard rule, that if it looks too good to be true -- run."

It was Newsom who originally spotted the ad. He told SF Weekly, as well as investigators at the Securities and Exchange Commission, that Advanta's balance sheet suggested the floundering company was in no position to pay back the investment notes, and that it was giving investors faulty information that glossed over the foundering company's true situation.
In Newsom's words, the company was operating a Ponzi scheme.

Now, investors who responded to the offer must now get in line with creditors grubbing for the $100 million in cash the bank holding company has to pay off obligations. According to Reuters and AP stories reporting on the bankruptcy announcement, Advanta had $138 million in investment notes outstanding. Given that bankruptcy will entail mountains of attorneys and other fees, a best-case scenario suggests investors will have lost more than a quarter of their principal investment in less than four months. The Chronicle ad, in other words, should have offered negative annualized interest.

The worst part about the whole affair, according to Newsom and former banking regulator William Black, is that the U.S. government should have known enough four months ago to shut Advanta down. Instead, it took Newsom's tip to the SEC's enforcement arm to stop the company from selling investments based on faulty information. By the time the SF Weekly story came out, regulators had halted the sale of Advanta investments advertised in the Chronicle.

A Nov. 9 recording on the company's investor and press information line, however, was still offering to mail investment packets to callers on request.

"This is not unlike the Lincoln Savings and Loan scandal 20 years ago, in which they sold investment notes to widows right up to the day they closed," said Newsom. "We probably saved a few million dollars for some people. But you feel sad about any of the people who were sucked into this Ponzi scheme. This was the classic scenario: They went after older people. And as an older person [of 62], I'm particularly offended by people who swindle older people."

For Black, a former federal regulator during the S&L crisis and a professor of economics and law at the University of Missouri-Kansas City, Advanta's Chronicle investment offer -- and subsequent bankruptcy -- highlight critical flaws in the financial regulatory system.

The Federal Deposit Insurance Corporation (FDIC) should have been in a position to spot Advanta's apparent hail-Mary attempt to bolster capital by luring unsophisticated investors. What's more, he said, the agency should be much quicker to shut down  failing banks whose dire straights might tempt executives to use unscrupulous methods to right the ship.

"Insolvent zombie banks rarely get better," Black said. "Their incentives are perverse, they're run by crooks frequently, and they not only get worse, they're likely to get dramatically worse. In bankers' jargon, they have 'maximum moral hazard.'"

In other words, for an institution that's sliding toward bankruptcy such as Advanta, there's little incentive not to offer investors sky-high interest returns, because there's slim chance of ever paying investors back in full.

"They knew they were in desperate trouble. They knew they couldn't have sold it to sophisticated investors. So they sold it to people who are vulnerable to this kind of offer," Black said.

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