Bill Bartmann Points to Lawyer as Source of Problems

Bill Bartmann, founder of CFS in Tulsa, OK, who is facing investor accusations of fraud, is pointing the finger at his lawyer, according to a recent report in the Wall Street Journal. “I trusted him. In hindsight, I think we got terribly bad advice,” Mr. Bartmann says. Bondholders, meanwhile, are suing the law firm, alleging securities fraud.

No one blames Jason H.P. Kravitt, the lawyer in question, for the business behavior that led to a debacle in the world of low-end debt — behavior that recently brought a felony guilty plea by a former Bartmann partner. But should the lawyer have recognized a flaw in the business model and helped keep investors from falling victim to it? Bond buyers contend the legal advice Mr. Kravitt gave at a key juncture kept them in the dark and caused them to have losses of more than $1 billion. Mr. Bartmann, who denies any wrongdoing on his part, contends that the same lawyer’s advice doomed his business to a premature death. Yet he and the bondholders have different takes on what the lawyer should have done differently. The dispute offers a rare look inside a financial scandal where the normally secret details of the lawyer’s conduct and advice come to light.

In 1995, Mr. Bartmann, along with partner Jay L. Jones, decided to enter the fledgling field of bad credit-card debt purchasing. Doing so took a lot of funding, and he hired Mr. Kravitt to help structure a way to “securitize” the bad debt — to repackage and sell it as rated bonds. A Harvard Law grad and the author of a textbook on securitization, Mr. Kravitt had turned his arcane practice into a big revenue generator for Mayer Brown. He helped devise a structure that let CFS sell investment-grade bonds on unsecured bad debt — 15 bond issues in all. The company’s growth exploded. Mr. Bartmann says estimates of the value of his stake in privately held CFS ranged as high as $7 billion.

On May 28, 1997, Mr. Bartmann phoned his lawyer with alarming news: His chief executive of just five months was threatening to quit. The CEO, Mitchell Vernick, had concluded the company’s program for collecting delinquent debt would never match the projections it was giving to bond buyers. He noted that CFS was making up the shortfalls by selling off some loans on which it managed to collect, but he said this practice dug the company into an ever-deeper hole, by depriving it of future collections. Mr. Kravitt immediately went to meet with Mr. Vernick. One day later, Mr. Vernick officially resigned.

After the resignation, Mr. Kravitt had to decide how to advise Mr. Bartmann on future bond offerings. With the next one scheduled three months later, he had to decide quickly. Ultimately, all parties agreed to go ahead with future bond offerings, with carefully worded acknowledgment of Mr. Vernick?s departure in the offering letters. The departure did not scare rating agencies or investors as CFS sold additional bonds valued at $1.2 billion in the 13 months. At the end of those 13 months, an anonymous letter would bring the whole thing to a grinding halt.

On Sept. 30, 1998, bond-rating agencies received an anonymous letter about CFS. The letter claimed that ?around 20% of all collections on the securitizations are coming from asset sales.” CFS launched an internal investigation and acknowledged to the rating agencies that there was some basis for the allegations in the letter. The raters began to downgrade CFS?s bonds and finally stopped rating them altogether. Within 10 weeks, Mr. Bartmann had stepped down, CFS declared bankruptcy, and the company defaulted on more than $1.6 billion in bonds.

The letter led to the discovery that many of the assets sales had been to a fictional company called Dimat, Inc. Under this mounting pressure, Mr. Jones pled guilty six weeks ago to conspiracy to commit fraud and money laundering. He confirmed his role in setting up Dimat and named Mr. Bartmann as a co-conspirator. Mr. Bartmann denies all accusations. He claims he did know of Dimat, Inc. and was aware that the company was purchasing CFS?s debt. But he says he had no idea of the link between Dimat, Mr. Jones and CFS.

There is no claim that Mr. Kravitt or his law firm knew about the sham transactions. Mr. Vernick, the unhappy CEO, didn’t allege any fraud when he met with Mayer Brown lawyers, says Mr. Villa, the law firm’s attorney. Mr. Bartmann contends that Mr. Kravitt gave bad advice in deciding to continue with the bond offerings. But Mr. Kravitt?s law firm faces allegations of malpractice and “negligent misrepresentation” by CFS, which is suing in Tulsa County state court and is being liquidated by a trustee. Mayer Brown also faces fraud suits from bondholders, filed in federal court in Tulsa. One fraud suit — noting that Mr. Kravitt met with a CEO who found CFS’s business plan wanting — asserts that the law firm knew CFS was “a house of cards about to fall down” but helped conceal this fragility from investors so that bond sales could continue. It is now a matter for the courts to decide.