Copyright 1998 by Journal of Business


Empire Securities Inc. of Washington, a Spokane brokerage firm, is under fire.


A retired Spokane optometrist and his wife have filed suit in U.S. District Court here claiming that Empire Securities and three allegedly related companies misled them into making more than $580,000 in investments that they now fear may be in jeopardy.


Meanwhile, a sister company of Empire has been placed into receivership here and another affiliated company was expected to be placed in receivership this week. Also, the Securities Division of the Washington state Department of Financial Institutions is investigating Empire Securities based on complaints it has received from investors.


The federal lawsuit, filed by John H. and Kathleen C. Smith, names as defendants Empire Securities; its parent, Empire Financial Group Inc.; two allegedly related investment companies named RTC No. 3 Investment Group LLC and Claremont Management Inc.; and 10 investment executives and advisers who the suit says have worked with the companies.


David Taisey, president of both Empire Securities and its parent, declined to comment for this story, citing the advice of the companies attorney. The attorney, James B. King, could not be reached for comment. However, a Spokane attorney who has been appointed by Spokane County Superior Court to act as receiver for an Empire Financial subsidiary named Northwest Capital & Advisory Inc. says hes confident that when the assets of those two companies are liquidated, investors will be repaid at least substantial amounts. He is expected this week to be named receiver for RTC No. 3.


In their federal lawsuit, the Smiths portray what they allege is an Empire-arranged web of companies, each of which had its own set of investors, but were interconnected through a series of loans and other financial arrangements. The Smiths charge that those intercompany financial relationships were, at a minimum, undisclosed to investors and, at worst, amounted to a Ponzi scheme. In such a Ponzi scheme, funds paid by later investors are used to pay sometimes artificially high returns to the original investors, thus attracting more investors.


The Smiths say they invested $464,500 in RTC No. 3 during a three-year period beginning in August 1993, and another $117,500 in Claremont Management also during that period. They say that all of their investments were made through Empire Securities and claim that the assets in RTC No. 3 now are insufficient to repay shareholders. Similarly, the couple claims that their investment in Claremont is now worthless.


Documents filed by the couple in federal court say that RTC No. 3 was established to raise funds from investors to buy, at a discount, portions of the loan portfolios of failed savings and loan associations under the control of the federal Resolution Trust Corp. The documents say that Empire Securities raised about $4.75 million for RTC No. 3 from about 35 investors, including the Smiths. The couple claims in the documents that RTC No. 3s assets now are worth only about $2.2 million, and that their liquidation might bring as little as $1 million.


The principal asset of Claremont Management, meanwhile, is described in court documents as being a hotel property in California. Court documents dont indicate how much money Empire Securities raised for Claremont or how many investors were involved in that investment. The Smiths say that their investment in Claremont, made through Empire Securities, was in the form of two promissory notes.Alleged non-disclosureThe crux of the Smiths allegations appears to be their assertion that Empire Securities failed to disclose loans and other financial transactions between RTC No. 3 and its two predecessorsRTC No. 1 and RTC No. 2as well as between RTC No. 3 and other Empire Securities-related companies, such as Claremont, ESI Financial Partners LP, and Northwest Capital & Advisory, the second company thats now in receivership. The couple also claims that RTC No. 3 didnt disclose that it would make unsecured loans to three other companiesFour Corners Ltd., D&D Ltd., and Clearview Ltd.though its not clear from the lawsuit documents whether any of those companies are affiliated with Empire.


Specifically, the Smiths allege that when RTC No. 1 and RTC No. 2 were liquidated due to concerns by their managers that their investors might face liability from environmental or other claims, RTC No. 3 bought more than $1 million of those two companies assets, a substantial portion of which the Smiths assert were delinquent or nonperforming. RTC No. 3 also allegedly acquired assets of and made unsecured loans to Northwest Capital.


Barry Davidson, the court-appointed Spokane attorney whos acting as receiver of Northwest Capital and likely will be receiver of RTC No. 3, says that RTC No. 3 is owed about $1.8 million by Northwest Capital.


The Smiths further allege that RTC No. 3 invested about $680,000 in Claremont, the key asset of whichthe hotelis at risk of being foreclosed on by a lender with higher-priority rights to the asset.


The Smiths are asking the court to rescind their investments in RTC No. 3 and Claremont and for treble damages based on the alleged violation of a spate of federal and state securities rules. They also ask that the 10 individual defendants named in the suit be held personally responsible for the damages.


The individual defendants named in the suit are Taisey, Ronald G. Strack, Randall J. McNeice, Robert B. Clark, Robert L. Newell, Donald R. Snyder, Stan G. Covey, Michael S. Atkinson, Michael B. Lavigne; and Dale Woolhiser. Though the court documents list most of those defendants as being executives at Empire Financial and its affiliated and subsidiary companies, its not clear whether they still are with those companies. State investigationDeborah Bortner, administrator of the Securities Division of the state Department of Financial Institutions, says her agency began investigating Empire Securities last May after receiving complaints from individual investors about the Spokane brokerage.


She says she wont be able to say more about the investigation until more information is gathered by the agency. She confirmed that an audit of Empire Securities has taken place, but says such an action is routine when regulators receive complaints from investors.


Were still collecting documents, Bortner says. Were trying to find out how big this is. We dont have the answer to that yet.


Bortner wouldnt speculate on how long the investigation might take.


Determining how big the alleged investment problems at Empire are is difficult, due in part to the complicated structure of the investments and to the intercompany loans and acquisitions that the Smiths claim took place between the various companies involved.


However, more than $6 million was raised from about 80 investors for the three RTC funds alone, according to court documents.


In addition, Northwest Capital, the subsidiary of Empire that is in receivership, has liabilities of about $7 million, which are owed primarily to about 90 investors, Davidson says.


Paul Brain, the Smiths Seattle-based attorney, says he has talked with a number of people who have investments with the various companies, but its unlikely a class-action lawsuit will be filed since the best interests of investors in each company might be in conflict with those of other investors as the liquidation of the investments and court proceedings continue.


It should be noted that Northwest Capitals purpose was unlike that of the RTC funds in that it primarily made bridge loans to businesses, including short-term loans, receivables factoring, and equipment leasing.


Davidson says that companys management voluntarily decided to place it in receivership in December, after realizing that many of its loan customers were facing their own financial difficulties and would have difficulty repaying their debts.


He says the companys assets include collateral pledged by those customers, and that it could take two years or more to identify and liquidate those assets to pay investors and other creditors of the company.


It is our anticipation that well recover substantial funds, Davidson says.