Federal authorities are investigating the activities of two executives at Vicis Capital LLC, a New York hedge fund operator that began last year with nearly $5 billion under management.
Vicis is the biggest investor in a pair of small public companies that have been implicated in an insurance fraud scheme. The FBI and a grand jury have been examining what role, if any, representatives of the hedge fund played in that scheme.
The investigation has focused attention on the close relationship between Vicis and Midtown Partners & Co. LLC, a Florida-based investment bank that has paired Vicis with 20 companies whose shares trade mainly on the Over the Counter Market or Pink Sheets.
Sharesleuth learned of the probe while conducting its own investigation into Vicis. Our analysis of Securities and Exchange Commission filings shows that Vicis ultimately put more than $150 million into those companies, in return for stock, warrants, and notes convertible into shares.
Midtown Partners has collected at least $5 million in cash fees in connection with those transactions. It also has received blocks of stock and warrants that were worth millions more at the time they were issued.
The shares of many of the companies have plunged in value. Even the investments showing gains for Vicis are relatively illiquid, and the purported profits may exist only on paper.
Vicis and Midtown Partners did not respond to written questions submitted by Sharesleuth. The FBI declined to comment.
AN INSURANCE FRAUD CASE
The federal investigation involves two of Vicis’ portfolio companies — Medical Solutions Management Inc. (Pink Sheets: MSMT.PK), of Marlborough, Mass., and MDwerks Inc. (OTCBB: MDWK.OB), of Deerfield Beach, Fla. Over the past five years, the hedge fund has provided roughly $30 million in equity and debt financing to those companies.
A federal grand jury in New Hampshire has been hearing evidence in the fraud case, which revolves around falsified receivables for benefits covered by workers’ compensation plans.
Medical Solutions Management spent roughly $8 million to buy insurance receivables at a discount, under a deal signed in 2007. MDwerks took over the claims processing the following year.
Authorities believe that one or both companies learned that some of the receivables were bogus. But instead of reporting the problem, MDwerks continued collecting on them.
People familiar with the investigation told Sharesleuth that certain participants in the scheme have already been charged under sealed indictments.
The Vicis executive who has been implicated in the case is Christopher D. Phillips, who has been a managing director for nearly two years. He previously headed the parent company of Midtown Partners, which is based in Tampa and has been acting as a middleman for Vicis in equity and debt placements since 2005.
Partly because of its relationship with Vicis, the company ranks among the most active firms in the country in raising capital through so-called PIPE (Private Investment in Public Equity) deals.
Phillips was the point person for dealings between Vicis and Medical Solutions Management. He also sat on MDwerk’s board of directors. Shad L. Stastney, one of the hedge fund’s three founding partners, was a director of both companies.
Medical Solutions Management’s stock ended the year at 1.5 cents a share, down from a high of $10 in the second quarter of 2006. MDWerk’s stock is trading for 0.5 cents a share. It peaked at $1.55 in July 2007.
In September, Vicis barred investors from withdrawing money after being deluged with $550 million in redemption requests. News reports at the time said that Vicis’ main fund was down 12 percent through the first eight months of the year, after posting a 14 percent gain in 2008.
It is unclear what value Vicis places on its investments in the companies that were brought to it by Midtown Partners. The quarterly SEC summaries did not list any of those shares or notes.
Although hedge fund investments are typically reserved for the wealthy, the Vicis investigation has implications for the general public, because a number of pension funds have invested money with Vicis.
The West Virginia Investment Management Board had $37.8 million in assets with Vicis at the end of November. The Fort Worth Employees’ Retirement Fund, in Texas, said in August that it planned to increase its investment to $10 million, from $8 million.
(Disclosure: No one associated with Sharesleuth has any investment position, short or long, in the companies mentioned in this story.)
DEALS BETWEEN COMPANIES
Sharesleuth noted that some of the small public companies in Vicis’ portfolio have entered into daisy-chain deals with one another, often generating additional shares and warrants for Vicis and additional fees and warrants for Midtown Partners.
We also noted that some of the companies sold Vicis millions of warrants – in a few cases, tens of millions of warrants — that were exercisable at prices well below the prevailing market price of the shares. They also repriced existing, out-of-the-money warrants so that the hedge fund still could exercise them at a profit.
It’s possible that some of those transactions created temporary gains that boosted Vicis’ overall returns, making its funds more attractive to investors than they otherwise would be.
It’s also possible that those gains boosted the profit payouts for the hedge fund’s managers. Hedge fund operators typically charge a 2 percent annual management fee, and get 20 percent of any profits their funds generate.