The Sacramento Bee

The Sacramento Bee

April 21, 2002
SEC probe strands start-ups
They lose venture capital as a firm's assests are frozen.
Author: Melanie Payne
Bee Staff Writer
Edition: METRO FINAL
Section: BUSINESS
Page: D1
Article Text:
One day, near the end of January, Kurt Lohse, CEO of CouponMaker.com, received two pieces of news that would dramatically change his life.
First he found out that after trying for four years to conceive, his wife was pregnant.
He also learned that day that Larry Toshio Osaki, a venture capitalist who was funding Lohse's fledgling Santa Ana start-up company, was cutting him off.
It wasn't that Osaki no longer believed in Lohse's company. He had already given the firm $2 million and had promised an additional $1.5 million if it met certain goals.
Osaki could no longer fund Lohse's company, or the 120 other mostly high-tech companies he had invested in, because the Securities and Exchange Commission had frozen the assets of Osaki's Pasadena-based venture capital company, Citadel Capital Management Group Inc.
On Feb. 3, the SEC charged Osaki and his partner Van Y. Ichinotsubo, a Cerritos dentist, with operating a Ponzi scheme.
The SEC alleges that the two inappropriately used more than half of $230.14 million they received from the sale of unregistered promissory notes to at least 2,000 investors in California and 24 other states to fund the start-up companies.
Those investors, the SEC claims, were led to believe the money from the sale of those notes was being used to make loans to purchase the accounts receivable of a Malaysian latex glove manufacturer.
The SEC has ordered the Osaki-owned company, J.T. Wallenbrock & Associates, which shared office space and staff in Pasadena with Citadel Capital, to stop selling the notes.
Wallenbrock promised investors a quarterly return of 20 percent and compounded annual interest of 107 percent for buying the notes. Many of the investor accounts were individual retirement accounts (IRAs) that investors allowed to sit and grow instead of cashing in.
Wallenbrock submitted to the SEC an accounting of the $230 million it collected showing that approximately $103 million of the money had been withdrawn by the lenders and that $131 million had been passed on to Citadel.
Not only had Wallenbrock failed to properly register the promissory notes as securities, but the people who purchased the notes did not know that their money would be given to Citadel and used to finance risky start-up companies, the SEC alleged in its complaint.
"There's no evidence that they actually engaged in accounts receivable financing," said Jamie Davidson, deputy assistant director in the SEC's Midwest regional office in Chicago.
The SEC claims that Wallenbrock owes investors $700 million in principal and interest.
James H. Donell, the receiver appointed by the federal court to try to recover and preserve what's left of the investors' funds, is equally perplexed. "They (the investors) were thinking profits were coming from an Asian latex glove manufacturer," Donell said. But Wallenbrock and Osaki have yet to produce "proof ... that the situation exists."
Robert Rosen, the Los Angeles-based attorney for Osaki and his companies, defended his clients, describing the arrangement as "an unusual financing program." The SEC, Rosen said, "didn't take the time to understand the real nature of the business," before it started making accusations against his clients.
"Not any lender has not gotten money back," Rosen said.
Donell said that only about 95 of the 120 or more start-ups that Citadel funded are still in business. He said that he'd like to see them keep going because they are an asset that Wollenbrock investors might be able to cash in on to recover some of their money. But he can't continue to fund the companies with money that was received from investors, he said, because it wasn't meant to be used that way. Wallenbrock's account has about $3 million remaining, while Citadel has about $20,000 in its account, Donell said.
Kenneth Frasse, who owns another Osaki-Citadel-funded company, Flying Blind Technologies Inc., in Mountain View, said, "It's a shame that investors didn't know they were putting money into our (company)."
Frasse, who grew up in Sacramento, is blind. His company has developed a product that Frasse says will revolutionize the lives of blind people, increasing their employablity and bridging the gap between blind people and the sighted world. The company had already received $700,000 from Citadel and had finished the prototype for the wireless device ahead of schedule.
Frasse, his business partners and the staff who remained on their jobs without pay are working to keep the company afloat.
To make matters worse, Frasse invested $30,000 of his personal funds in the Wallenbrock promissory notes.
CouponMaker.com's Lohse laid off four of his eight staff members and cut the hours of another when Citadel's funds were frozen. Lohse is in better shape than some of the Citadel-funded companies because he has national accounts and is generating revenue. But in order to keep his staff on, he'll need to find additional funds soon, he said.
Lohse said that he too feels bad that investors didn't know where their money was going. "It tears me apart," he said. But, he added, "it's all the more reason to see the company succeed."
Some, if not many, investors believe that the SEC is wrong about Osaki, Wallenbrock and Citadel. And have shifted their promissory notes to another company called Village Capital Trust Limited, located in Belize. The company says it will honor the 20 percent return and pay investors on May 15, and is offering additional promissory notes at that interest rate.
The California Department of Corporations, which regulates securities in the state, has issued a warning to investors about this, but many have failed to heed state's advice or have simply ignored it.
Evidence of many investors' faith in Wallenbrock is found on the Victims Against Scams Web site, where they have launched a defense of the company. No one lost money, they assert, and they ask why then the SEC is closing the company down.
The SEC would not disclose how they were alerted of the potential problems with Wallenbrock. And they haven't publicly presented evidence from any victim who says they were fleeced by the company.
Rana Adamchick, a partner in the on-line company Victims Against Scams, said that the court case will prove if indeed the Wallenbrock investment was illegal but to her "it looks like a regular Ponzi." In her experience, she said, the SEC has hundreds of these types of cases, so when they pursue one they have good evidence backing up their claims.
She said that it's common to get investors to post to the Web site their criticism of the regulators and support for the company. These are "tutors" for the program, she said, who want to get others to keep investing so the scam can keep going.
Donell, the court-appointed receiver, is also finding investor support for Osaki and Wallenbrock. These investors say he and the SEC are trying to ruin a good investment.
Donell said he recently spoke with a 72-year-old investor who had put $1 million into Wallenbrock. Donell said the investor confidently told him, "I'm going to get one-and-a-half million back, and I'm going to get it."
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The Bee's Melanie Payne can be reached at (916) 321-1962 or mpayne@sacbee.com.
Copyright 2002 The Sacramento Bee
Record Number: SAC_0387267358
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