How 15,000 investors were swept over the Rubicon

Highwire mezzanine loans and extraordinarily high fees cost unwitting investors dearly, writes Michael West.

Highwire mezzanine loans and extraordinarily high fees cost unwitting investors dearly, writes Michael West.

When David Coe and his fellow directors made the fateful decision to buy Rubicon they quickened the demise of their Allco Finance Group. Rubicon was the Trojan Horse which brought Allco unstuck.

Besides the wreck of Allco though there were also 15,000 unwitting retail investors hit by the collapse of Rubicon's three ASX-listed property trusts, and a handful of fund managers who failed to do their homework.

The mastermind behind Rubicon, investment banker Gordon Fell, has seen no action from regulators or investors - neither have the perpetrators of the Babcock and Allco debacles either, for that matter.

But Rubicon was the slickest and quickest financial engineering ploy of the lot, brilliantly orchestrated on the edges of the sharemarket disclosure regime.

Fell and Coe built a $5 billion business from scratch, flicked it in into Allco - where they were also directors - and Fell emerged in little over three years with a $30 million house on Sydney Harbour and a truckload of cash.

This story and the extra online coverage on Monday examines how he did it, and in particular, how he pulled off the most aggressive ploy of all, switching unwitting shareholders in his flagship Rubicon America Trust into highwire mezzanine loans. They would implode the minute the financial crisis hit. Sources who have analysed the wash-up of Rubicon conclude the fees on this deal, even though it was a disaster for investors, were extraordinary. The disclosures were hardly adequate and the transactions were actually funded by a margin loan from an associated investment bank which effectively dumped its toxic assets into Rubicon America Trust unit-holders, taking fees for the pleasure.

The Rubicon operation was blessed by the imprimatur of a host of blue-bloods: Credit Suisse, PwC, KPMG, AMP, Grant Samuel and UBS among them.

Last week it finally got to court. Paul Billingham, the liquidator of the Rubicon America Trust, brought an examination of KPMG in the Supreme Court of NSW.

KPMG was the "independent expert" appointed by Fell to rubber-stamp the sale of the toxic mezzanine loans, from another company he controlled, into his flagship Rubicon America Trust.

Later, another "independent expert" Grant Thornton was to deliver its approval too, this time for the Allco proposal to buy Rubicon for $260 million at the very peak of the boom.

Yet Gordon Fell's fateful move came in late 2006, deadly from the perspective of his investors that is, when he raised the risk stakes and steered Rubicon America Trust into mezzanine loans.

The outstanding feature of a property trust is its stable income from the underlying real estate with its secure tenancy. The central feature however of mezzanine loans is extreme risk, and Rubicon was moving headlong up the risk spectrum at a time when savvy investors, sensing the credit and property markets were too hot, were beginning to "short-sell" CDOs (collateralised debt obligations).

Rubicon America Trust went the other way: it was a big buyer. In November 2006 it notified the stock exchange that it would be launching Rubicon Finance America to provide "financing solutions". It would be wholly owned by Rubicon America Trust and would invest in high-yielding mezzanine loans.

Its first foray was to buy a bunch of loans from Ruspif, which was a unit trust managed by David Coe (who died in late January) and Gordon Fell's head company, Rubicon. Another lot of loans would be acquired from Rubicon Capital, owned by the Rubicon Group. For Fell and Coe, the beauty of these transactions was that they were all with related parties, that is, the financiers were able to make fees on both sides of the deal but they could use their investors' money in Rubicon America Trust to buy the high-risk assets.

The justification for the deal was to create a new growth engine for Rubicon America Trust. There was a reference in Rubicon America Trust's disclosures to its real estate financing expertise in the US and its origination capabilities, which would prove to be absurd claims.

The source of the Rubicon Capital loans was never disclosed but probably came from an investment banking contact of Fell's. The Ruspif loans were sourced from the asset manager Terra Capital partners and proved a most excellent opportunity for Simon Milde and Bruce Batkin, a couple of gun New York property financiers, to get some hairy assets off the books and at a full price paid by Rubicon America Trust unit-holders.

It is clear now, if not to the Rubicon asset managers at the time, that the New Yorkers played Rubicon likely a finely tuned Stradivarius. Terra had seen the credit market cratering and got out of the mezzanine loan business in mid-2007 - a time Australians will recall for the spectacular timing of John Kinghorn, who sold his RAMS mortgage business onto the sharemarket just weeks before the financing house imploded.

While Fell and his cohorts at Rubicon were claiming "expertise" in the mezzanine loan business, Terra was selling to them. With exquisite timing, when the entire Rubicon stable was in the hands of liquidators in 2009, Terra got back into the business.

Besides the lack of expertise, there were no synergies in managing the US loans and managing the unrelated US properties. All the deal did was to shove Rubicon America Trust's unwitting investors up the risk curve when they had invested in the first place to get exposure to steady commercial real estate returns.

The first part of the deal was to buy 27 mezzanine loans for $82.2 million from Ruspif (Rubicon US Property Income Fund). Ruspif was another fund managed by Fell. Its other owners were Rubicon group and some fund management connections.

The second part of the deal, also a related party transaction, was to buy five mezzanine loans for $73 million from Rubicon Capital Pty Ltd, a wholly owned subsidiary of the Rubicon Group.

The fees were predatory: $22.8 million in costs on top of the face value of the loans. The premium paid to Ruspif was $6.6 million and there were $16.2 million in other costs including Rubicon's fees.

Notwithstanding the exorbitant price paid for these loans, Rubicon needed a "fair and reasonable" opinion from an independent expert to take the deal to unit-holders. The meeting was held on December 21, 2006.

Thanks to the humungous fees raked out by the Rubicon group and others the yield to Rubicon America Trust minorities was 8.86 per cent. Without the feeding frenzy on the fee-front it would have been 10.88 per cent.

This epitomises the Rubicon modus operandi in that, one: the assets were poor and, two: fees were astronomical. Needless to say, none of this was spelt out in the experts' reports, either by Grant Samuel or KPMG.

After the initial mezzanine deal was done Rubicon America Trust revealed to the ASX that the senior lenders behind the loans were the likes of Credit Suisse, the soon to be defunct Bear Stearns and Morgan Stanley.

The investment bankers had shifted their risk, or to call a spade a spade, dumped their toxic loans onto Rubicon America Trust's small unit-holders.

The icing on this cake for Credit Suisse was a $350 million warehouse loan facility, effectively a three-year margin loan subject to margin loan covenants and conditions.

This was never disclosed yet it left Rubicon America Trust having to top up if the value if the loans had problems.

In the 2007 Rubicon America Trust annual report it was disclosed that the Asset Management Contract for the loans had been "restructured". Rubicon had evidently bought the contract from Terra Capital but the effect for Rubicon America Trust unit-holders was a trebling in fees charged by Rubicon.

Again, this was not clearly disclosed and if there were any benefits to Rubicon America Trust minorities they were never revealed. Given Terra's demonstrable expertise in the area and Rubicon group's lack of track record, the fee rise is weird at best.

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