Wall Street touched by pay-to-play pension scandal

December 20, 2010, 8:05 PM UTC

A Dallas-based private equity investor will be sentenced early next year for his role in New York’s public pension kickback scandal. What won’t be mentioned, however, is how a major Wall Street bank may have helped keep him in business.

Saul Meyer is a crook. The former private equity pro has admitted to indirectly bribing public pension officials in order to secure investment contracts for his firm, Aldus Equity, which has since collapsed under the weight of scandal. In February, he’ll be sentenced by a New York judge.

In most respects, this is old news. Meyer pleaded guilty to felony securities fraud in October 2009, and Aldus  settled with New York earlier this month for $1 million in restitution and a forfeiture of interest and fees in a fund that it had managed on New York’s behalf.

Barely mentioned by prosecutors, however, is that Deutsche Bank held a 45% interest in Aldus at the time of Meyer’s arrest. Not mentioned at all are allegations by a former Aldus partner that Deutsche Bank not only was warned of Meyer’s possible wrongdoing prior to its investment, but that it effectively forced Aldus to keep Meyer on staff.

Let me explain:

In late 2006, Dallas-based Aldus Equity had a big problem.

The firm had spent several months negotiating to sell a minority equity stake to Deutsche Bank, with a bank option to acquire the remaining interest at a later date (it also had a put, which it exercised when Meyer was arrested).

The initial purchase was to be valued at approximately $28 million, including around $10 million up-front. More important, from Aldus’ perspective, was access to Deutsche clients and a bank promise to use Aldus as its exclusive platform for fund-of-funds and co-investments in the private equity space.

But Aldus was hardly a stable partnership. During the first full week of October, a majority of Aldus partners had voted to oust firm founder Saul Meyer. News of the termination hit the trade press before all clients could be informed, and a meeting with Deutsche Bank was hastily arranged for the following Tuesday.

The sit-down took place in New York’s Pierre Hotel, and was attended by a Deutsche Bank executive and two remaining Aldus principals.

One of those Aldus principals, Marcellus Taylor, tells Fortune that the bank’s representative was informed that Meyer had been fired over suspicions of illegal behavior, including possible kickbacks to a New Mexico placement agent.

According to this telling, the bank’s response came after the meeting and stunned Taylor.

“They gave us two choices,” he says. “Either reinstate Saul, or forget about the investment. And if we didn’t bring him back, Deutsche would also sue us to recoup its legal fees. We couldn’t believe it.”

Deutsche Bank acknowledges the Pierre Hotel meeting, but differs on what was said.

According to a bank spokeswoman: “At no point did the former Aldus partners indicate any concerns to Deutsche Bank about fraud, as it pertained to Saul Meyer.” Instead, she claims that Deutsche was led to believe that Meyer’s termination was related to a “business dispute” over firm control and/or economics.

Deutsche Bank would not allow Fortune to speak with its representative at the Pierre Hotel meeting.

No matter which side you believe, three things are certain: (1) Aldus chose to reinstate Meyer; (2) Deutsche Bank completed its investment in Aldus; and (3) Meyer was able to keep receiving fees related to fraudulently-obtained contracts.

It would be easiest to leave this story alone as a he-said/they-said, but I’m not quite able to do that. Something just doesn’t sit right about the Deutsche Bank version.

First, Marcellus Taylor does not seem to have anything to gain by making this story public, and he only did so after being contacted on a separate matter (Fortune obtained, and partially published, a confidential offering document recently circulated by Taylor, in which he is seeking to sell his personal stake in an Aldus co-investment vehicle).

Moreover, it would seem that he’d come off better had he either refused to reinstate Meyer, or had informed law enforcement of his suspicions (he says his inaction was due to a lack of tangible evidence against Meyer).

Second, it wasn’t exactly a big secret that Aldus seemed able to win state pension contracts it had no business winning (just ask any of its former peers). For example, a mandate from the New Mexico Education Retirement Board came over the objection of New Mexico ERB staff. One of the only other times I’ve heard of that happening came when CalPERS invested in a Hicks Muse buyout fund over staff objections. Hicks Muse’s placement agent on that fund, Alfred Villalobos, is currently under indictment in California for fraud.

Third, Deutsche Bank later retained Meyer’s “placement agent” pal in New Mexico, to help it secure a $250 million hedge fund commitment from a state pension fund. Taylor says that the introduction was made by Meyer, following Deutsche Bank’s investment.

Fourth, Deutsche Bank cannot convincingly claim that it threatened to bail on the investment because of concerns over an unstable partnership. Seems to me that Aldus was just as shaky with its founder back in the fold, given that his partners had compelled to reverse course under threat of lost investment.

To be clear, there also is circumstantial evidence in the other direction. For example, Deutsche says that “the deal documents that each of the partners signed contained explicit representations that the business was being run lawfully.”

The truth almost certainly lies somewhere in between. My best guess, however, is that it’s closer to Taylor.