Head of Cincinnati firm settles with agency

One rogue broker can do a lot of damage to investors.

That’s the moral of Stephen G. Donahue’s rise and fall as the head of Cincinnati broker-dealer Donahue Securities Inc.

About 123 investors are out $6 million because Mr. Donahue used their money to pad his lifestyle, according to a recent civil complaint by the Securities and Exchange Commission.

Mr. Donahue was charged with bilking between 200 and 250 investors, starting in 1989, the first year his company opened, according to court documents.

Such fraud can take time to surface, explains one regulator.

“This is tantamount to a Ponzi scheme,” says Tim Warren, associate regional director in Chicago with the SEC. “He sells fictitious investments and promises a rate of return. Everyone thinks it’s great.”

The scheme, in which money from new investors is used to pay returns to earlier investors, is named after Carlo Ponzi, an early 20th century con artist. It usually collapses when money owed to previous investors is greater than money that can be raised from new ones.

Mr. Donahue settled the case at the end of February without admitting or denying the charges. A future hearing with a federal judge will determine a fine.

Mr. Warren would not say what sparked the SEC’s investigation, but added that it is continuing.

high flying

During the 1990s, Mr. Donahue used his clients’ cash to live well and play the bull market, according to court documents.

He allegedly paid back taxes, bought and refurbished a condominium in Florida and purchased nine acres of land and materials to build a house in the Cincinnati area, according to the SEC’s complaint, which was filed Feb. 26 in U.S. District Court in Cincinnati.

He also allegedly opened his own brokerage account and bought mutual funds.

The Donahue business specialized in retirement planning, and Mr. Donahue was well respected in Cincinnati, says one former employee. “This absolutely came as a surprise,” says Mark Demma, an assistant director of recruiting and development with the firm.

When a team of SEC regulators arrived at the Donahue offices the week of Feb. 12 to examine its books, Mr. Donahue was far from cooperative, according to the complaint.

During that time, Mr. Donahue destroyed files detailing phony investments and created false statements to show examiners, according to the complaint. He then allegedly told employees to hide records from the examiners and delete records of fraudulent investments.

Mr. Donahue, 52, got his start in the investment business as an insurance broker with Prudential in the 1970s, according to published reports. He started his first business, S.G. Donahue Inc., at home in his garage in 1981. The company sold retirement planning to employees of hospitals, schools and other non-profit businesses.

His network of companies, which came to include a mortgage company, reportedly had 50,000 clients and controlled $9 billion in assets.

Messages were left for Mr. Donahue at the company, but he did not return calls.

Donahue Securities, with 130 brokers in Ohio, had grown steadily during the years of his alleged fraud to a network of about 200 brokers outside Ohio in 31 states.

Mr. Donahue’s own customers ultimately became his victims. The complaint detailed the following events.

In 1989, Mr. Donahue began misappropriating funds that clients gave him to invest. He deposited the money in a personal bank account, then commingled the money with accounts controlled by the firm.

He told clients, however, that he was investing their extra cash in a money market fund returning between 5% and 6%.

When the firm began to offer a legitimate money market fund in 1998, he continued diverting money, telling clients that he was investing their cash in a tax-free bond fund.

The SEC says it doesn’t know what Mr. Donahue did with most of the money. So far, it has accounted for only $1.07 million.

Regulators effectively shut down the company in February, although some brokers and planners have regained control of clients’ accounts.

A judge put the company in receivership, and parts have been sold. But the proceeds are far short of the $6 million owed investors, the SEC says.