A securities fraud case in Connecticut has opened a window into how Petroleos de Venezuela SA’s pension fund apparently speculates in Venezuelan currency transactions — a business that is illegal in Venezuela. The U.S. Securities and Exchange Commission has interrupted the scheme, along with some allegedly improper private equity investments, in a way that may end up making PDVSA into a major investor in a U.S. nuclear power company.
Updated: Changed fifth paragraph to say that Illarramendi’s registration status with the SEC may have been OK.
The case, Securities & Exchange Commission v. Illarramendi et al, has been underway in Connecticut since Jan. 14, with barely a peep from the English-language press. Noticias Candela had part of the story as long ago as Jan. 19. El Mundo wrote an unsympathetic profile of the accused, as did Venepiramides. The U.S. press reprinted the SEC press release from Jan. 28 (sometimes rewriting a little), and local press in South Carolina and Oregon have covered some of the companies wrapped up in the situation. But nobody has pulled it all together.
So here’s the story: According to the SEC’s complaint, Short Term Liquidity Fund I Ltd., an unregistered hedge fund, had about $540 million, 90 percent of it from PDVSA pension money.
Short Term Liquidity Fund I’s directors, Octavio Calvo, Ronald G. Percival and Odo G. Habeck, are all established Latin America bond players. The fund was managed and administered by Michael Kenwood Capital Management, where former Credit Suisse banker Francisco Illarramendi, along with Percival and Habeck, were principals, according to a prospectus filed in the case.
The SEC complaint says “Illaramendi is not registered with the Commission in any capacity.” This may have been OK — I spoke to an SEC official who made it clear he wasn’t charged with being an unregistered investment adviser. A lot of advisers don’t need to register, the official said. Michael Kenwood lawyers Thomas D. Goldberg and Adam J. Reinhart didn’t immediately return calls for comment. Illaramendi doesn’t currently have a lawyer listed on the court docket. Illaramendi’s former lawyer, Seth Stratton, didn’t immediately return a call for comment.
It sounds like the PDVSA pension fund didn’t have strict standards for its investment advisers. El Mundo, the Caracas business daily, quoted oil union leaders in Caracas who said the pension fund is still the same black box as it was when Hugo Chavez criticized it in his first presidential campaign, in 1998. Here’s the article at the union website. PDVSA Insurance lawyers Jerome S. Fortinsky and Lindi Beaudreault didn’t immediately return calls for comment. A communications official at PDVSA headquarters in Caracas didn’t immediately return a call.
The prospectus outlines the fund’s goals:
its primary investment strategy seeks to take advantage of products offered in the global fixed income and derivatives markets to generate gains through short-term (under one year) investments in sovereign securities, particularly those subject to currency arbitrage opportunities in their country of issuance, due to a particular country’s exchange rate policy. The Fund may, from time to time, also invest in G-20 government securities and derivatives referencing such securities, as well as selected short-term instruments issued by international financial institutions and other business entities.
In addition, the Fund may, from time to time, take a transactional approach to the trading of fixed income securities, by taking advantage of inefficiencies in the currency markets of the securities in which it invests to generate arbitrage gains.
(My emphasis.) Allow me to translate:
We are going to run a currency exchange house for Venezuelan bolivars. We’re allowed to buy U.S. treasuries. But if you ever see us do so, please shoot us.
As site pal Otto might say, “Ponche crema served, the end.”
I realize this I am interpreting, but I’m not the only person who thinks that’s what the prospectus meant. The SEC talked with two individual investors in the fund, and one “stated that his understanding was that his funds would be used solely for short term currency transactions involving Venezuelan bonds.”
Venezuela currency transactions are a field that Illarramendi knows well. Industry sources say he invented the permuta market back in 2003. That is, he was the one who told the government how it could, on the one hand, peg the bolivar exchange rate to the dollar, while also giving the rich and importers an escape valve. While most people muddled along with the benefits and hassles of currency controls, the rich would be able to get additional foreign currency for imports (or capital flight) by buying bonds in bolivars and selling them in dollars. His bio, from the prospectus:
Mr. Illarramendi is one of the founding members of Highview Point Partners, LLC, which was formed in June 2005 and acts as the investment manager of an emerging markets fixed income hedge fund…he was a Director in the Emerging Markets Coverage Group of CSFB from 1994 until May 2004, when he left the firm to accept a temporary position as Senior Advisor to PDV USA, Inc., the international financial advisory arm of Petróleos de Venezuela, S.A. (“PDVSA”), where he served as a special financial advisor to PDVSA and its worldwide affiliates in connection with its ongoing restructuring of operations and its liability management program until February 2005…Mr. Illarramendi was a leading member of the teams that helped restructure both Argentina’s and Venezuela’s debt profiles…”
Now, running a bolivar-dollar exchange house from the USA (and from some offshore accounts in Panama and the Caymans) is tricky. I talked to a banker, who said that his first concern would be that wiring all those dollars around, one could run afoul of U.S. money laundering laws. Second, you end up with a whole heap of bolivars in your Venezuelan bank account — and you can only eat so many arepas. What happened to the bolivars? The SEC doesn’t say.
My guess is that the bolivars go back into the PDVSA pension fund, where they can be converted to dollars at the official rate. And the dollars sold for bolivars at the black-market rate, and the bolivars converted to dollars at the official rate. And so on, and so on, and so on. Please note: this is speculation. I have no way of knowing whether this was happening. If it was, it was another “financial centrifuge,” spinning off profits for the funds (and reducing Venezuela’s supply of hard currency) every time money was run through it. It’s a nice idea — and it would have complied with the pension’s duty to its pensioners, if not to the rest of the pueblo. In any case, I have no idea if it was happening.
What’s not speculation is that the transactions continued long after May. That was the month when Venezuela banned currency swaps (law in Spanish here), shut down all the exchange houses and threw bankers in jail for having done swaps even back when they were legal. The fund owed customers dollars as recently as last month, according to this memo from the fund’s lawyers, which the SEC filed in court.
…STLF [the hedge fund] has been conducting two Venezuelan currency transactions….STLF purchased bolivars from non-U.S. participants at an agreed exchange rate, to be paid in dollars at this point in the transaction….MKG [the fund manager] has stated that bolivar providers need to be paid, in no small part to assure that they will be willing to participate in future transactions requiring bolivars. From STLF’s perspective, these are pure foreign-exchange transactions.
It says that about $15 million in dollars need to be paid out, and a $5 million loan between funds needs to be repaid. So at least $15 million in bolivar-dollar “pure foreign-exchange transactions” — with Venezuelans — for the benefit of PDVSA?
Well, this may all be newsworthy — in Venezuela. Currency exchange isn’t restricted in the U.S, unless there was some sort of money laundering. Which has not been alleged.
In any case, the SEC says it detected a fraud. It’s pretty funny, really — one of their issues is that the funds were NOT being used for currency swaps, in violation of the fund prospectus. Over the course of 2010, people with access to the fund — including Illarramendi, or someone forging his signature — started wiring money out and buying stock in various small, start-up companies. The SEC says that the stock wasn’t put into the Short Term Liquidity Fund I, but rather into separate entities controlled by Illarramendi.
Now, it’s possible that this can all be explained in some other ways. And frankly, a hedge fund using its funds for investments not described in the prospectus? Zzzzzzzzzzzzzzz. Misappropriation of funds? Yes, interesting, and nobody should steal $53 million, but the evidence is pretty fuzzy. PDVSA said it knew the fund was making private equity investments. It’s quite possible that the funds could have made investors whole when the time came. For me, the juicy parts are elsewhere. First of all, why didn’t he register as an investment advisor? Second, how does PDVSA end up giving a half-billion dollars to someone who doesn’t have that most basic qualification? Third, what is PDVSA’s pension fund doing speculating on the bolivar, when Venezuelan law explicitly bans any currency exchange outside of the Central Bank system?
And now, there’s the legal but Fox News-ready post-script that has unfolded since the SEC started poking its nose around.
The SEC won a court order Jan. 28 freezing funds controlled by Illarramendi or Michael Kenwood Capital Management LLC. That meant that they couldn’t come through with cash that they had promised to startup companies as private equity investments. One of these was Golden, Colorado-based Proterra Inc. GreenvilleOnline.com, the news website for the South Carolina city that houses Proterra’s manufacturing plant, covered the story Feb. 10:
Proterra executives said they were counting on getting another $8 million from a Connecticut investment company…
After learning it wouldn’t be getting another $8 million from MK Energy and Infrastructure, Proterra scrambled to negotiate with PDVSA, and the Venezuelan company agreed to provide Proterra with a $5 million loan, which “should enable us to catch up,” Granato said….
Gottschalk said PDVSA has been “completely supportive and rational” in all of its dealings with Proterra.
“There’s no suggestion that there’s any desire or request or demand that the money that’s been put into Proterra be somehow disgorged,” Gottschalk said. “Everybody is treating this as the investment’s been made and now we just need to act rationally to figure out how to deal with the mess that’s been created.”
Gottschalk and Granato didn’t immediately return calls for comment.
The mess was even bigger at NuScale Power Inc., a Corvallis, Oregon-based developer of small nuclear reactors. Michael Kenwood Group’s lawyer wrote to the SEC Jan. 4 to say that NuScale needed $5 million in January and $5 million in February to make payroll. The judge in the case has allowed the funds to provide NuScale some money — but nothing like $10 million. The Corvallis Gazette-Times reported Feb. 3 that the company would receive $1.1 million.
Although welcome, the additional money won’t be enough to bring back any of the 30 workers furloughed early this week by NuScale or reverse any of the other austerity measures the company has taken to weather its financial crisis.
“It only allows us to continue operating at current levels,” said Bruce Landrey, NuScale’s chief marketing officer….
The fresh influx of cash should allow NuScale to keep its doors open until March 15 as it continues to work toward submitting its novel nuclear reactor design to federal regulators for approval.
In the meantime, the company is doing the same as Proterra — it’s going to the source and seeking investment straight from PDVSA, The Oregonian reported Feb. 4.
PDVSA, Venezuela’s state-owned oil company, is in talks to loan NuScale Power $5 million to keep the Corvallis company afloat while it seeks new investment….
PDVSA had invested with the Kenwood Group, according to NuScale chief marketing officer Bruce Landrey. He said the federal judge hearing the SEC’s complaint agreed Wednesday to allow NuScale to continue using funds on hand and to receive up to $5 million from PDVSA, funneled through an existing Kenwood investment fund.
“It extends our runway so we can put together long-term financing,” Landrey said.
It will take a few days to finalize the loan, however. And Landrey said that even if NuScale receives the funds, it won’t be able to bring back its laid-off employees until it finds some long-term funding.
Landrey didn’t immediately return a phone call and text message seeking comment.
So how about that for a punchline. Regardless of the motivations for the case (The blind pursuit of justice? Politically motivated harassment of PDVSA and its pals? Who knows?), the result is clear: Venezuela, the most anti-U.S. government in South America, a vigorous proponent of a large public sector and a major oil exporter, ends up funding U.S. private sector nuclear research. Go figure!