Stephen M. Coleman has won his latest skirmish with Robin Carnahan, Missouri's top securities cop, over the untimely demise of the Chicken Little Growth Fund.
The mutual fund sizzled, then fizzled in 2006 and 2007. It left investors delighted over a 64 percent profit in just 17 months. But the sky fell in on Chicken Little's separate management company, and its investors lost most of their money.
This is a convoluted tale with a couple of lessons for small investors: First, read the fine print. Next, be very wary when investing in small, private companies.
A state administrative commissioner rejected last month charges that Coleman mislead people who invested in the mutual fund's management company and then lost big. The ruling was a defeat for Carnahan, the Democratic nominee for U.S. Senate, who brought the charges in her role as Missouri Secretary of State and enforcer of investment laws.
The ruling means the state can't revoke Coleman's securities license. But Carnahan's office points out that it still has two legal restraining orders in effect against Coleman, one of which includes a $38,000 fine over the Chicken Little adventure.
Coleman, of the Central West End, managed the Chicken Little Growth fund and ran its management firm. The way Coleman tells it, the venture's death is a story of bureaucrats and cops gone wild. Carnahan's enforcement officials, the U.S. Securities and Exchange Commission, the FBI and U.S. Postal Inspectors all came trooping through his office asking questions.
The SEC, FBI and postal inspectors have brought no charges. But Coleman says the SEC probe was so long that it destroyed his fund business. He complains of "being smeared and lied about."
By contrast, Carnahan's office paints Coleman as a repeated stretcher of securities laws, who misled investors and paid himself well as his investors' money drained away.
The story starts in 2005. Coleman was running a small investment firm called Daedalus Capital and planning to start a mutual fund. He named it "Chicken Little," hoping to attract people frightened by the idea of investing. It even had an unofficial motto: "When the sky is falling, buy sky." Coleman bet heavily on Apple stock just as the iPod was taking off. Eventually, 43 percent of the assets of the fund were invested in Apple and Pixar, the movie animation company that Jobs was about to sell. "It was a Steve Jobs bet," said Coleman.
Investors in the fund did spectacularly well. The 64 percent return brought mention in Kiplinger's and The Wall Street Journal. But money didn't come flowing in as expected. The fund was never bigger than $1.2 million.
Mutual fund investors pay a fee to cover management expenses, generally charged as a percent of fund assets. Chicken Little's fee was high, at 3 percent. Still, it wouldn't cover all the expenses until assets hit $5 million, says Coleman. Assets never got that high, and that was the rub. To fund the deficit, he had set up a management company, the Chicken Little Funds Group, and started seeking investors. According to Coleman, the plan was for the management company to pay the extra expenses when the fund was small, then reap a profit when the fund grew big enough to pay larger fees.
Carnahan's office says Coleman misled his investors. Caitlyn Shabel, 22, told state investigators that she thought a $22,500 investment was going into the Chicken Little mutual fund; but actually her money went to the Chicken Little management company.
Coleman also accepted a $50,000 investment in the management firm from Sharon Hall of Georgia, and promised to repay it in one month. When the deadline arrived, the company didn't pay up. "I ask that you remain patient," he wrote her in a note that was later quoted in the state's legal filings.
Coleman told the Post-Dispatch that, when he made that promise, he had a $1 million offer to buy his company from a Chicago investment firm, but the offer fell through.
Chicken Little drew the attention of the SEC in early 2006. "They asked, 'Did you have insider info? Is this a Ponzi?'" Coleman recalled. The SEC declined comment.
Running out of money
At that point he'd raised $1.2 million for his management company, $800,000 short of what he needed. "The big problem was that the SEC showed up, and my lawyer told me to stop the offer," said Coleman. He stopped raising money.
According to Coleman, the SEC kept asking questions for nearly a year. Meanwhile, fund expenses were draining the assets of the management company.
Many of those expenses went to Coleman. The management company, which Coleman ran, hired Coleman's Daedalus firm to pick investments, paying the firm $400,000 per year. Coleman himself took another $100,000 per year. In all, Coleman said, he received $150,000 and Daedalus $600,000.
Carnahan's office said the management company paid a $100,000 tax lien against Coleman and his wife, and paid for a financial plan for the couple. Coleman says that money was part of what he and Daedalus were due. "What I did with it was my business," he said.
The state claims that Coleman also failed to tell potential investors about two judgments against him for unpaid debts totaling nearly $750,000 from the 1990s.
The fund company had hired a firm in Ohio to handle the nuts-and-bolts administration of the fund. When it looked as if the expense money was running out, the Ohio firm pulled the plug on the mutual fund and sent the proceeds to the fund's investors.
Investors in the fund got to keep their fat profit. Investors in the fund management company lost their shirts.
Carnahan tried to lift Coleman's license as an investment adviser, claiming that investors were defrauded. Administrative hearing commissioner Nimrod T. Chapel rejected that case last month. He ruled that the payment arrangements for Coleman and Daedalus were spelled out in documents given to the investors before they invested, and that Coleman wasn't required to reveal the old judgments. He noted that Coleman had paid all of one judgment and most of the other.
Coleman didn't renew his license when it expired this year. He said he intended to renew it now that the case was finished.
Besides going after Coleman's securities license, Carnahan's office also sought fines against him. In the midst of that effort in 2008, Coleman got a surprise interruption at his home. "The FBI and the postal inspector were ringing the doorbell," he said.
When time came for the hearing on the fine, Coleman begged off, citing the federal investigation and potential self-incrimination. The state securities commissioner in 2009 imposed a $38,000 penalty. Carnahan's office is still trying to collect it. "Mr. Coleman is paying the price for defrauding clients and taking advantage of their trust," Carnahan said at the time.
Postal Inspector Dan Taylor said only that it was 'still an active investigation."
Coleman's latest venture is called "the Deuce." It's a contract in which Coleman's Daedalus firm promises to double an investor's money in five years.
Carnahan's office and the Missouri attorney general got a court injunction to stop it. It's illegal to promise a specific return on an investment, her office says, and Coleman failed to register the offer with the state. Registration is a protection against fraud.
It's clear that the Chicken Little deal was good for Coleman and investors in his fund, and terrible for investors in his management company. Investors who actually read the offering document would have seen the danger. It revealed the rich annual payments to Coleman and his firm. It warned that "an investor should be able to afford the complete loss of his or her investment." Investors signed papers saying they'd received the document.
This is proof positive that reading fine print is a really good idea.
Investing in small, private companies is always a leap of faith, and that's especially true for startups. Don't invest unless you can afford to lose it all. Even then, make sure you thoroughly understand the business, and check the track record of its promoters and managers.
Investors can call the Missouri Secretary of State's hot line, 800-721-7996, to check on an adviser, broker, or securities product.
