Friday, March 09, 2001

'Opportunity' led to Donahue's downfall




By Amy Higgins
The Cincinnati Enquirer

        Stephen G. Donahue is a man who knows a good business opportunity when he sees it.

        His acumen allowed him to sell for Prudential Insurance; to get in on the ground floor of a new financial planning and pension administration industry; and to build a network of companies that eventually managed $9 billion.

Donahue
Donahue
        But the ability to see an opportunity to use $6 million in clients' funds ultimately became his downfall, securities officials charge. The former president of S.G. Donahue & Co. and Donahue Securities stands accused of illegally using that money for personal and business expenses.

        His brokerage is facing liquidation; the financial planning firm is on the auction block; and creditors are lining up in court looking to take what's left over.

        Mr. Donahue would not speak to the Enquirer for this article. He did not return repeated phone calls, nor would he answer the door when a reporter visited his home.

        This is the story of how a boy who grew up in Price Hill rose to the top of the local financial services industry — and how his success came crashing down around him.
       

Seizing opportunity
        In 1981, Mr. Donahue spotted an underserved market and seized the opportunity to serve it. He founded S.G. Donahue & Co. that year in half of his two-car garage off Gaines Road in Green Township to provide financial services to employees of hospitals, schools and other nonprofit institutions.

        Mr. Donahue already had some success selling for Prudential Insurance since 1970. Those who have met him personally and professionally call him a born salesman: charming, confident, a good listener.

        “I never knew anyone to not like him,” said Ralph E. Dickman, a classmate in the 1967 Elder High School graduating class.

        Mr. Dickman said Mr. Donahue wasn't a great student or especially popular, but he was someone everyone liked. Still, he kept a low profile in the community and financial services industry. Few people in the local industry contacted by the Enquirer remember ever meeting him.

        But to Elder grads, he came to be someone they would talk about with pride, someone who had made good.

        His success came in large part because financial planning was a young industry, with few advisers working with nonprofit employees. He got in on the ground floor of an industry that would explode during the next 20 years.

        He also got in with some of the largest employers in town, such as University of Cincinnati, the Health Alliance, Children's Hospital and Cincinnati Public Schools. Those institutions alone employ about 25,000 people.

        Employees at such schools and tax-exempt organizations can save for retirement through so-called 403(b) accounts — named for a section of the tax code that defines them. The accounts allow such employees to invest pretax money in annuities or mutual funds and have that money grow tax-deferred.

        By the late 1970s, however, few employees were taking advantage of their investment opportunities. By 1981, Mr. Donahue saw a chance to enter the fresh field and provide a needed service.

        It's also a lucrative service. Critics of 403(b)s often point out that 403(b) plans can generate higher commissions and expenses than other types of retirement plans. Annuities, in particular, can carry hefty fees and charges compared to no-load mutual funds common to other kinds of retirement accounts.

        Like their 401(k) brethren for corporate employees, 403(b) accounts are funded through payroll deductions. Employers withhold money from paychecks, then submit the money to a company like S.G. Donahue. Acting as a third-party administrator, that company then divvies the money among individual annuity or mutual fund accounts operated by investment companies such as Putnam, Fidelity or Kemper.

        Those accounts typically are set up with the help of a financial planner. Such representatives from a company like S.G. Donahue sometimes aren't employed by the firm, but work as independent contractors. The Donahue companies had as many as 300 such representatives before closing operations this week.

        Therefore, No funds are actually held by the representatives or third-party administrator (also called a common remitter), but they collect commissions and fees along the way.

        Mr. Donahue was known for selling Kemper annuities to clients in his early years. By 1983, Mr. Donahue had moved his offices to Dixie Terminal, downtown, and was still operating as a small firm. But growth was on the way.
       

Becoming a broker-dealer
        In 1989, Mr. Donahue founded his own broker-dealer firm, Donahue Securities, to streamline and expand his business — and to save some money.

        Without an in-house broker-dealer, companies like S.G. Donahue need to send client orders through another company to be executed. That other company also takes a cut of the commission.

        But by setting up as a broker-dealer — accredited with the U.S. Securities and Exchange Commission (SEC) and the National Association of Securities Dealers (NASD) — Mr. Donahue was able to keep all of his commissions in-house.

        He also was able to set up individual brokerage accounts, holding and moving money without that extra layer of oversight that an outside broker-dealer would give.

        Neither Mr. Donahue nor his companies ever had been subject to regulators' disciplinary actions before. But some people who have dealt with his firms say they observed questionable business practices.

        No one would talk about specific situations for this article because of their relationships with the companies. But one example they cited was the failure to provide prospectuses to all clients, violation of a federal regulation. Another, they said, was the way in which the firm collected commissions — sometimes trying to collect twice for one investment.

        A third example that some people point to is churning. That's a practice in which a planner advises a client to sell and rebuy securities in order to rack up commissions and fees.

        In 1995, in an article on one such allegation published in the Wall Street Journal, Mr. Donahue denied that the company churned accounts.

        Mr. Donahue was quoted as saying his firm was trying to inform clients of their options and to do “the best for our clients.”
       

Crossing the line
        Mr. Donahue crossed the line, according to the SEC civil complaint against him, when he began to use client money for his personal and business use.

        He had the opportunity to use client funds when he started his broker-dealer operation, Donahue Securities Inc., in 1989.

        With the retirement operations, the firm is a third-party administrator, with money leaving its grasp almost as soon as it enters. But as a brokerage, Donahue Securities can hold money for clients.

        If clients didn't know where they wanted to invest all of their money, Mr. Donahue agreed to hold a portion until a decision was made. Such an arrangement is not unusual.

        What crossed the line, however, is that Mr. Donahue put the money into his own account at PNC Bank for storage, the SEC says. Such commingling of funds is illegal.

        Eventually, the maneuver snowballed. What started as temporary storage turned into using the money for his own expenses — and telling investors that their money was actually invested in money market funds or tax-free bond funds, the SEC says. At times, he would repay some investors the principal, plus reasonable interest, with money from other clients.

        Industry insiders say the lies were easy to perpetuate because he was the president of the company, with hardly any oversight from either an outside broker-dealer or an inside superior.

        Also, the company didn't regularly generate consolidated account statements. Instead, investors would get separate statements from each of the investment companies where they had mutual funds or other accounts.

        When a consolidated statement was generated, most of the information had to be entered manually — including information about nonexistent money market or tax-free bond funds.

        The SEC says Mr. Donahue also generated such false statements for its examiners in last month's investigation.

        During the 12 years that the SEC says he has admitted to using client money, Mr. Donahue put the money into the company for working capital, paid $50,000 for a down payment on a Naples, Fla., condo and bought a $275,000 nine-acre lot in Clermont County to build a $1 million dream home.

        Court records show that in 1993, he also paid $68,482 in unpaid state income taxes that had been accruing since 1985. The state had issued liens against Mr. Donahue's property because of the unpaid taxes.

        The SEC says much of the rest of the money is unaccounted for, but investigators are continuing to track it.

        In the meantime, all of his assets have been frozen. Federal courts have appointed trustees to oversee the liquidation or sale of his companies to pay back the 123 personal clients that Mr. Donahue is accused of stealing from.

        Industry insiders say, however, that it's unlikely that the companies will sell for much — if at all. The value in financial firms such as Donahue Securities and S.G. Donahue lies in its client relationships. However, the accounts are owned by the independent representatives, not the company. Instead of the $5 million to $6 million officials had hoped a sale would bring, they received an offer of only $485,000. Other offers are pending.

        In the meantime, however, Mr. Donahue still faces personal financial problems. Provident Bank has sued him and his wife, Linda, for $664,000 in unpaid loans. There are liens against their Clermont County land and garnishments against their personal brokerage accounts.

        The FBI and federal prosecutors are a part of the Donahue investigation, but no criminal charges have been filed. Mr. Donahue is barred from making money from his companies.

        Despite the prominence of his companies and working with some of the largest employers in Cincinnati, hardly anyone in the local industry knew him well or had even personally met him.

        Until Mr. Donahue finds another opportunity, his outcome will be what many people had called the man himself: a mystery.

       



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