By Emily Thornton Not all the hedge-fund scandals of late have involved complicated transactions and big players like Wood River (see BW Online, 10/13/05, "Another Fishy Hedge Fund") and Refco (see BW Online, 10/17/05, "Refco's Painful Lesson for Investors"). The Securities & Exchange Commission has charged an Ohio stock broker with collecting millions of dollars for an apparently bogus hedge fund -- and then allegedly pouring those investors' money into his coffee shop and a local community center, where his wife worked.
From 2001 until 2005, Gregory Applegate, 46, of Ashland, Ohio, persuaded about 140 investors to give him at least $5.8 million to invest in a hedge fund he claimed was made up of tax-exempt securities, according to the SEC complaint filed Oct. 7. But Applegate used some of the money to prop up Friendzy's Coffee Shop, which he owned, according to FBI documents filed in the case. The shop was losing money, according to the same documents.
An additional $76,000 of investors' money went as a 2003 donation to the Ashland Community Art Center, where Applegate's wife served as the executive director, the SEC charges. Some new investors' funds were also used to pay off earlier investors, according to the complaint. At the SEC's urging, a federal judge has frozen Applegate's assets pending resolution of the case.
UNSETTLING REMINDER. Applegate's attorney, Dennis Bartek, told BusinessWeek Online he intends to file a response on Applegate's behalf to the SEC complaint. Bartek said his client has cooperated fully with investigators from both the SEC and the FBI. The Justice Dept., through the office of the U.S. Attorney for the Northern District of Ohio, may bring criminal charges against Applegate, Bartek added.
Whatever the ultimate outcome, the case serves as a reminder about the riskiness of hedge funds for ordinary investors -- one of the securities industry's last largely unregulated areas. Once only for those with large sums to play with, these funds are increasingly being pitched to less sophisticated investors, with the promise of returns that can be far better than market indices or mutual funds.
But hedge funds don't come with the disclosure and transparency requirements of other funds. And that makes the field fertile for scams, reform advocates warn.
UNDER WRAPS. If it is true that, as the SEC charges, Applegate was able to take people's money and put it into something as different from a stock or bond as a coffee shop, it could buttress arguments that hedge funds may need greater government oversight. "This is an unfortunate example of why the industry needs more regulation," says Laurence Allen, managing member of NYPPE, a Greenwich (Conn.)-based firm that trades interest in private partnerships such as hedge funds.
According to the SEC complaint, Applegate was able to gain investors' trust, in part because he showed them business cards from Westerville, Ohio-based, Regis Securities, a brokerage where he had been working since January. Applegate told investors that he was running a hedge fund for Regis called Applegate Investments, and produced false monthly client statements for them, the SEC alleges.
Contacted by Business Week Online, Regis Securities' president, Robert Cargin, said that Applegate's alleged scheme had been going on for years, beginning at another brokerage. "He had this program basically concealed when he joined our firm," Cargin said.
RETURNS GUARANTEED. Cargin says Applegate enjoyed a reputation as a trustworthy community leader with "eclectic" interests. In addition to being a patron of the arts, he wore colorful ties, kept cats that roamed around his brokerage office, and led a program to rescue abandoned and homeless dogs, according to Cargin. "He did a lot of good things," Cargin adds. "A lot of people still just don't believe he did anything wrong."
According to the SEC, Applegate orally promised investors returns as high as 8%. He also claimed that he would manage the money without taking a commission. Instead, Applegate said he would keep returns above the guaranteed rate for himself. And if the fund underperformed that rate, he told investors he would make up the difference "out of his own pocket," the complaint says.
Investors started to smell the coffee in August, according to the SEC complaint. One client's financial adviser informed Cargin that he had discovered the share price on one of the financial statements for Applegate's supposed hedge fund was not the actual market price. When Applegate refused to cooperate with an audit of his supposed hedge fund, Cargin dismissed him, according to a declaration made by FBI agent Joseph Williamson in court documents filed in the case. Cargin confirmed Williamson's account to BusinessWeek Online.
CONFLICTING TALLIES. In September, Applegate began to liquidate investors' accounts and write them checks. One check, submitted as an exhibit by the SEC, was for $167,000 and said "just cash it" on the bottom as a reason for the individual's refund.
On Sept. 14, Applegate admitted to the FBI at the Ashland Police Dept. that he had been running an "illegal and unethical investment scheme" as a "side business," according to FBI agent Williamson's declaration.
Applegate turned over his bank records, and consented to a search of his office and home. At that time, Applegate told the FBI he had $90,000 left in his E-Trade account and about $10,000 in his two bank accounts. But a week earlier, on September 8, an SEC accountant who was part of the agency's investigation found a total of more than $4 million, according to the accountant's statement filed with the court.
SOMETHING BACK? And what of Friendzy's coffee shop? Applegate's attorney is requesting that the court permit him to sell it. "Mr. Applegate currently has several offers," a filing by Bartek explained to the court.
Just one problem: With his assets frozen, some of his former investors have filed to force him into bankruptcy. "They would like to get their money back," says Attorney Diana Thimmig, who represents some of them. Or at least get back what's left of that money.
Thornton is an associate editor for BusinessWeek