Portland Business Journal -

Date: Thursday, November 11, 2010, 4:52pm PST

http://www.bizjournals.com/portland/print-edition/2010/11/12/conviction-didnt-slow-financier-berg.html

Despite his criminal past involving bank fraud, Mercer Island financier Frederick Darren Berg was able to freely operate what federal authorities now charge was an elaborate Ponzi scheme that bilked 1,000 Seattle-area investors out of at least $100 million.

That’s because Berg set up his Meridian Group investment funds as “private offerings” — a category supposedly reserved for experienced investors rather than the general public — which guaranteed virtually no federal or state oversight over his actions or protection for the buyers.

The recent crash of Berg’s and other investment schemes is casting light on the loosely regulated world of private investment funds. Scandals such as Berg’s and the fraud conviction of Bernie Madoff show how a system designed to allow capital to flow freely and build wealth can sometimes backfire on individuals and the economy.

While Congress recently tightened the rules surrounding private investment instruments as part of financial reform, those changes in federal law — whose implementation is still largely being worked out — bring no relief to Berg’s alleged victims.

Berg, by listing himself as a seller of private offerings under Securities and Exchange Commission Rule 506 of Regulation D, was required only to fill out a form declaring that his investors met certain income and net worth thresholds.

He did not have to disclose to the SEC or to investors that he’d been convicted in 1989 in Oregon in connection with stealing $30, ...

Despite his criminal past involving bank fraud, Mercer Island financier Frederick Darren Berg was able to freely operate what federal authorities now charge was an elaborate Ponzi scheme that bilked 1,000 Seattle-area investors out of at least $100 million.

That’s because Berg set up his Meridian Group investment funds as “private offerings” — a category supposedly reserved for experienced investors rather than the general public — which guaranteed virtually no federal or state oversight over his actions or protection for the buyers.

The recent crash of Berg’s and other investment schemes is casting light on the loosely regulated world of private investment funds. Scandals such as Berg’s and the fraud conviction of Bernie Madoff show how a system designed to allow capital to flow freely and build wealth can sometimes backfire on individuals and the economy.

While Congress recently tightened the rules surrounding private investment instruments as part of financial reform, those changes in federal law — whose implementation is still largely being worked out — bring no relief to Berg’s alleged victims.

Berg, by listing himself as a seller of private offerings under Securities and Exchange Commission Rule 506 of Regulation D, was required only to fill out a form declaring that his investors met certain income and net worth thresholds.

He did not have to disclose to the SEC or to investors that he’d been convicted in 1989 in Oregon in connection with stealing $30,000 in a check-kiting scheme, according to federal authorities.

Although Rule 506 prohibits the solicitation or advertising of private securities, Berg and his associates set up a website to promote the fund to a wide network of investors, according to the Washington state Department of Financial Institutions.

“Just because someone files a document doesn’t necessarily mean, No. 1, it’s a great investment, or No. 2, that there couldn’t be something nefarious going on,” said Bill Beatty, securities administrator for the department.

Federal prosecutors contend Berg’s Meridian Group funds were “elaborate Ponzi schemes,” according to court documents charging Berg with nine counts of wire fraud and one count of money laundering. Berg, who was arrested Oct. 21, also is charged with hiding funds from a bankruptcy trustee.

Authorities contend that after filing for personal and business bankruptcy, Berg attempted to conceal $400,000 in bank accounts and set up a shell company and offshore trust in Belize, in Central America. He is being detained by federal officials, who consider him a flight risk.

For most kinds of securities and investments, regulators are expected to scrutinize the prospectus and provide a level of protection for investors. But under Rule 506, Berg could sidestep any state oversight by declaring that he was selling to “accredited” investors. By accredited, the SEC means investors with an annual income of $200,000 ($300,000 for couples). Investors with a net worth of $1 million or more also are accredited.

Rule 506 does allow up to 35 nonaccredited investors to invest in a private offering, but sets no limit on the number of accredited investors — on the assumption that such investors have the means and investment experience to evaluate the merits and risks of the private offerings.

The DFI’s Beatty said Rule 506 assumes that sophisticated investors don’t need the same level of protection as “the proverbial widows and orphans.”

The state Department of Financial Institutions receives notice of Rule 506 offerings, but the agency’s only role is to investigate complaints. The state received five complaints about Berg’s Meridian funds, dating back to June, and in September and October issued three cease-and-desist orders against Berg and his funds. But by then it was too late.

The Dodd–Frank Wall Street Reform and Consumer Protection Act passed by Congress earlier this year sought to at least tweak Rule 506. The SEC no longer counts the value of a person’s primary residence in determining net worth. The legislation also calls for the SEC to enact a “disqualification provision,” which would keep people with bank fraud convictions or other crimes from selling private investments.

Seattle attorney William Carleton, who represents startup clients who use private security offerings, said Rule 506 is designed to help small companies avoid the cost and regulatory burden of raising capital.

It cuts out the middleman, brokerage fees, finder fees and legal fees, and allows entrepreneurs to raise capital from private investors who know what they are doing and can bear any potential loss, Carleton said.

“For me, 506 is sacrosanct, not for people who are raising funds and making a living off of managing money,” said Carleton. “It makes it possible for a small company to raise $200,000, $300,000 or $400,000 without having to pay $100,000 in legal fees.”