What happened at Custom House Capital? Part 1

I was hoping to fit this blog on Custom House Capital into just one blog post but even with leaving out large chunks, there is just too much to fit in one post, so I will be publishing this over two weeks.

It was reported in the news last week, that Bank of Ireland are pursuing clients of Custom House Capital who took out loans to invest with the fallen company. What really went on in Custom House Capital? There was a report to the High Court by Court Appointed Inspectors issued on 19 October 2011. This is what they reported:

How it all started

Custom House Capital  started promoting property investments to clients around 2004. After some success, they committed to more, bigger projects and as the CEO, Harry Cassidy said, acquired a good reputation around Europe. They way that Custom House Capital would do these deals was to commit to the projects and place deposits before securing the required equity from investors. When the property crash happened in 2007, they found themselves committed to a number of projects and were struggling to find investors. Not wanting to have to pull out and lose their deposit, they looked to cover the shortfall through products like a Mezzanine Bond and then through the misuse of clients money.

As well as losing their deposit, there was also significant fees at risk. For example, on a property valued at €50m, they would typically raise equity of €15m and borrow €35m. They would charge a commission of 5% on the full property value i.e. €2.5m. They would also receive ongoing management fees of 5% of rental income and they would charge annual management fees on the pension plans that wrapped the investment.

Scale of the misappropriation

  1. Evidence suggests that at least €56m of clients monies was inappropriately transferred from cash or equity investments without their knowledge or consent.
  2. The valuation of the Destiny PRSA Cash Fund on 14 July 2011 was €10,412,139, held on behalf of 485 clients. Of this amount, it appears that €9,930,999 was transferred or made available to Custom House Capital  promoted property investments.
  3. The valuation of the Destiny Select II Cash Fund on 15 July 2011 was €3,860,836, held on behalf of 58 clients. Of this amount, it appears that €3,674,803 was transferred or made available to Custom House Capital  promoted property investments.
  4. The valuation of the Destiny PRSA Equity Fund on 11 July 2011 was  €8,918,591, held on behalf of 154 clients. Of this amount, it appears that €6,801,813 was transferred or made available to Custom House Capital  promoted property investments.
  5. The valuation of the Destiny Equity Fund on 22 June 2011 was €11,833,043, held on behalf of 120 clients. Of this amount, €10,071,297 was transferred or made available to Custom House Capital  promoted property investments.

John Whyte, Executive Director, Investment & Head of Private Clients, confirmed that from 2007 onwards that shortfalls in property transactions were taken from clients cash funds and from the end of 2010 onwards from the equity funds

The Excuse

Harry Cassidy argued that the investment manager was given discretion to invest in equities on behalf of clients and the investments made were into the equity of the SPV’s (Special Purpose Vehicle) “so not specifically directly into the property”

John Whyte said money transferred across to two of the banks were called the Valovis bank bond and the Saarslandes Bank bond. These are the names of the lending banks for property deals but no bond certificates were ever issued for bonds in these banks. The money was paid over against the strength of the property value.

€3.315m was transferred to Valovis bank. It has been confirmed by Custom House Capital staff that none of the payments to this bank or any of the banks related to investments in bonds.

How Custom House Capital was run

The financial services industry is a heavily regulated industry, with an enormous amount of paperwork required. Detailed notes should always be maintained on conversations held with clients and clients should always sign off on any investments that they make.

Pooled Property accounts

When buying a property for your pension, it is usually set up as a separate unit trust, with your own bank account, from which rent is received and expenses paid out.

In the case of Custom House Capital , they used pooled accounts for the various property unit trusts they held. Payments were made without checking whether the individual unit trust had enough funds to cover the transaction. An example given by Harry Cassidy was if the loan repayments were taken a few days before the rent was received. The repayment money would be taken from another, completely separate property owners funds and then repaid when the rent came in.

Payments were recorded as loans from other unit trusts and money was transferred from one unit trust to another. When the recession hit Ireland, some people stopped making pension contributions to cover mortgage repayments, meaning some of these loans would never be recovered.

Client Valuations

Under legislation, valuations must be issued for PRSA’s every 6 months. When it came to running valuation for Custom House Capital clients with misappropriated funds, there was a note on their internal system to contact one of senior management before issuing the valuation.. The Finance department would then back out the property investment and show it as cash or whatever the client thought they were invested in. The valuation report would be issued and the next day the property investment would be shown up again.

Client Loan

A building client of Custom House Capital ’s was trying to establish himself in the Middle East. Under local law there they had to prove that the company had a certain net worth at a period of time. So he asked Custom House Capital  to make a lodgement into his company account in the Middle East so he could show his contacts there that his company had the required net worth. The money was only there for a few days. According to the report, €2.5m was paid to this client’s company bank account. This was paid out of other clients funds without their knowledge. Harry Cassidy charged the client €25,000 for this favour and the money was paid to him personally.

The Commodity Fund

The Custom House Capital Commodity Fund was a established in November 2009 on their internal system to reflect cash received from Barclays Capital. Over the following month, this money was used to meet client redemption requests, the client loan and into various European property funds and €5.6m was transferred to the German private bank, Hauck & Aufhauser.

Example of how properties were purchased

The Custom House Capital  Prime Property Fund raised €55,528,900 from 166 investors. The normal procedure for making investments into a collective investment scheme is to pay the subscription proceeds into a bank account with an appointed custodian, Bank of America in this case. Shares would be issued to the investors or to Custom House Capital as the nominee. Property would then be bought by the fund and Bank of America would take custody of these assets.

Custom House Capital  did not pay the subscription proceeds to Bank of America. Instead, they used the money to buy 5 European properties through SPV structures, saying the properties could not be bought by the fund due to tax and legal issues. The fund was then formally launched by way of an in specie transfer of 4 of the properties into the fund. The 5th property did not transfer in due to unfavourable tax treatment of rental income.

Of the money raised, €2m was retained by Custom House Capital for the payment of  marketing fees. A payment of €1.3m was also paid to Custom House Capital out of the proceeds from the sale of one of the properties. This is 5% of the original purchase price of €26.5m. The prospectus states that this fee is on the value of the property when it is acquired by the fund. However, when the fund acquired the property, it was only worth €19.7m, so €985,000 should have been taken as fees.

Next week, I will post part 2 of the findings of the report on Custom House Capital.

If you have any questions, please contact me directly at steven@bluewaterfp.ie