More than a decade ago, a Michigan man raised millions of dollars to build a company that sold computer equipment — except they were phony machines with blinking lights.
Although the products weren't real, the mess that the man and his company left behind remain very real to Columbus-based Huntington Bancshares, which continues to battle in the courts over a judgment against it that, with interest, has grown to $81 million.
Huntington was the lead institution that lent money to Barton Watson of Grand Rapids, Michigan, to help continue his fraudulent venture, Cyberco.
The bank should have been aware of the company's illegal activity, given all the red flags Cyberco was creating, a federal court has ruled in a case arising from the company's eventual bankruptcy.
Huntington has contended that it was not aware of what the company was doing as Cyberco continued to try to collect on the line of credit Huntington had extended until just before the fraud blew up.
"There was clearly a fraud. We are a victim as well," said Steve Steinour, the bank's chairman, president and CEO, said last fall when the bank recorded a $38.2 million charge to bolster reserves set aside to cover the verdict. "We're not settling this."
The massive fraud behind the judgment against Huntington was built on a web of made-up customer lists, phony computer servers and false financial documents meant to create the appearance of a strong, rapidly growing company. Cyberco managed to get a $17 million line of credit from Huntington based on money that Cyberco said it was owed by customers. Financial documents that Cyberco submitted to Huntington were meant to give the appearance of a real company.
The fraud unraveled in 2004 — not long after Huntington had collected its debt from the company — when federal authorities raided Cyberco's corporate offices in Grand Rapids. Watson, 44, who was not arrested during the raid, shot and killed himself a week later in an upstairs bedroom of his million-dollar estate.
Cyberco and Teleservices, another company tied to the scam, each filed for bankruptcy weeks later, sticking creditors with tens of million of dollars in unpaid bills and loans.
Those creditors have claimed that Huntington could have limited their losses by putting a stop to the fraud long before the FBI and IRS raided Cyberco. Huntington disagrees and says it is as much a victim of Watson's fraud as anyone else.
Assessing blame
Huntington has asked the 6th U.S. Circuit Court of Appeals in Cincinnati to review a September ruling by a federal judge in Grand Rapids ordering Huntington to pay $71.8 million plus interest. The ruling followed a 2012 decision by a bankruptcy-court judge who found that Huntington, which earned $693 million last year, was responsible for the losses suffered by other banks and finance companies. The bankruptcy-court order was subject to an independent review by a federal judge.
Cyberco did business with Huntington from September 2002 to October 2004.
James Horton, a former Cyberco president who spent several years in prison for his role in the fraud, testified during a bankruptcy hearing six years ago, saying: "I believed then, and I believe now, that had Huntington called their loan and insisted to be repaid, or called their loan and showed up at our offices to seize their collateral, the whole scheme would have fallen apart almost instantly."
The judgment hasn’t raised alarm bells among analysts who cover the bank.
"It is not an anomaly for someone like Huntington to have this type of litigation," said Mark Nolan, vice president of rating agency DBRS. "Where the concern is, is the magnitude of the judgment. Is there enough to have an impact on the capital or earnings to make us dig a lot deeper."
Nolan said that such a fraud typically doesn't get exposed until the end.
"It's one of the harder things for the bank to detect unless you're right there," he said.
Still, banks do get held accountable when they hold the money for those committing the fraud. JPMorgan Chase & Co. paid $2.6 billion in 2014 to the federal government and victims of Ponzi schemer Bernie Madoff to settle allegations that the bank failed to tell authorities about the scam.
"Most Ponzi schemes cannot exist without a bank or a financial institution. ... Typically, that's where all the money flows," said David Meyer, a Columbus lawyer who has built a practice on representing victims of financial scams.
Meyer said banks have far more tools to detect fraud than a typical consumer does.
Also, they might have a conflict of interest because if they report the fraud, they stand to lose money, he said.
"They may look the other way or turn a blind eye when they see these red flags," Meyer said.
One of those flags might have been Cyberco's actions in 2003 and 2004. Bankruptcy-court documents show that Huntington told Cyberco in January 2004 that the company would need to find a new bank because of its actions in the previous the year that included bouncing two checks for more than $1 million each.
On hearing the news, Cyberco began to pay down its loan to the bank, partly by continuing the fraud by getting money from other banks.
Horton, the former Cyberco president, acknowledged that Cyberco lied to Huntington and gave the bank false information about its finances and customers.
"What didn't make sense to me was that Huntington kept asking questions and never really went into the answers and never really pressed us for anything," he said during his testimony in bankruptcy court. "As soon as we ... pressed back at Huntington, they rolled over and didn't pursue things."
"There were over 20 red flags that something was not right," said Douglas Donnell, the Grand Rapids attorney representing creditors of Cyberco and Teleservices, including more than a dozen banks and finance companies. "This was not a legitimate customer."
Securing support
Cyberco also would secure money from banks and other financial institutions that was meant to buy servers and related computer equipment for customers. The vendor for those products and services was Teleservices.
Early in Cyberco's days, it did provide legitimate computer services for clients, but it morphed into a criminal enterprise, Donnell said.
In 2004, the FBI investigation determined that Watson and other Cyberco officials weren't buying computer equipment but using the money to finance a lavish lifestyle of fancy homes, sports cars and expensive wines.
Cyberco was able to extend the fraud by using its relationship with Huntington to get loans from other banks or get companies to extend it credit, Donnell said.
If Huntington had acted then, it would have been out no more than $17 million, the amount of the full line of credit that had been extended to Cyberco, Donnell said.
"They made it infinitely worse, vastly worse," he said.
Horton said Cyberco used its relationship with Huntington to hoodwink other banks to get more money by showing its relationship with a legitimate bank.
"Well, the story that we told the banks was that, you know, we were a large and growing company with operations internationally, financially very strong and healthy, managerially very strong with a very favorable relationship with our primary bank, which was Huntington," he said.
"And a 'X' million-dollar line of credit and some term loans with Huntington. And we were able to access Huntington's West Michigan operations at the highest level because of our good relationship with them."
In spring 2004, Huntington began to press Cyberco to repay the line of credit, Donnell said.
"The bank figured out there was some kind of fraud," he said. "Whether they were aware of all the details, there could be some debate there."
The creditors were able to show that the bank repeatedly violated its internal rules and guidance, Donnell said.
He said he had figured the bank would be eager to settle, given its behavior.
"You would use this as an example of what not to do," Donnell said. "It is surprising that the bank has been unwilling to really engage in what I think are realistic settlement discussions."
mawilliams@dispatch.com
@BizMarkWilliams
There is no statutory exemption of alimony or child support receipts. However, Florida courts have not allowed judgment creditors to garnish the debtor’s alimony payments. Garnishment is permitted only where the garnishee (alimony payer) and the debtor have a debtor-creditor relationship. A Florida court many years ago held that alimony was not a “debt” in the traditional sense, and that alimony therefor could not be subject to garnishment. The court also held that public policy prohibited the garnishment of alimony from one ex-spouse to the other. No court has disagreed. The same court also found that alimony is not a form of wages which could be exempt under Florida’s protection of head-of-household earnings.
