Hedge Fund Fraud Case Study — MRI International

Abstract:

Japanese retail investors poured $800 million into a little-known Las Vegas asset manager’s investment scheme with the promise of stable 6–9% annual returns. Thanks to President Edwin Fujinaga’s marketing skills, MRI International ran a massive Ponzi for 15 years, destroying retail investors’ nest-egg savings.

Important Note: we used information disclosed in a civil class action case, Takiguchi et al v. MRI International, Inc. et al, United States District Court District of Nevada, filed on July 5, 2013, as well as SEC vs. Fujinaga, et al, United States District Court District of Nevada, filed on September 11, 2013. Judgments on these cases are currently pending.

Case Profile:

Background

“Let me tell you my secret way of making a stable return,” said an old woman in Japan, where a near-0% interest rate had been a norm over the last 15 years. She said her secret investment product could generate 6–10% return in Japanese yen and that she was very comfortable with the firm offering this product, since she had been paid dividends every year. She invested almost all of her retirement savings in a little known scheme called medical account receivable system (MARS), offered by MRI International, Inc. (“MRI International”), based in Las Vegas.

In fact, MRI International is quite an open secret as it launched an active marketing campaign in leading business magazines and online publications. The firm also ran multiple websites with many graphical explanations of the MARS investment targeted at inexperienced retail investors. MARS is a type of asset based lending strategy where an investor purchases account receivable for various medicals fees from healthcare providers at discount and receive money from the insurance companies. These medical receivables are usually covered by a private insurer the patient has a policy with, so the investor is not exposed to credit risk of the individual patients.

By 2012, MRI International became very popular among the Japan’s retail investor community and raised over $800 million (some sources say $1.3 billion) from 8,700 investors. Japan’s retail investors were tired of seeing 0.01% annual return on their saving account and weary of the poor performance of equity markets. At the same time, they were increasingly worried about the future of Japan’s various pension schemes.

MRI International was founded and managed by a Japanese American, Edwin Yoshihiro Fujinaga (“Fujinaga”). MRI International set the minimum investment amount at a relatively low level so that undecided investors could start small. As MRI International paid dividends and principal back to the investors on time and word spread, more investors felt confident with the program and re-invested with larger amounts.

MRI International promised its investors 6.0–9.6% returns (in JPY) and 6.5–10.3% (in USD) with a 2–5 year investment timeframe (See Exhibit 11.1). Investors of $3 million or more were invited to the firm’s tour of Las Vegas on an oversized limousine, which included an onsite visit to MRI’s headquarters.

Exhibit 11.1: MRI International’s Investment Program (Select A/Class A)

Source: various media reporting

According to marketing materials, MRI International’s investment scheme appeared legitimate and safe despite its high guaranteed returns. The firm was registered as a Type II Financial Instruments Business under Japanese law and was also a member of American Hospital Association. The firm marketed the following to investors:

• The investors’ money would not be managed by MRI International, but by an independent escrow company, obligated by U.S. law to deposit a set percentage of its funds with the state government each month, which in turn, would be used to indemnify the investors in the event of a default;
• The investors’ money would be placed in a bank’s “lockbox” account, which only the largest and safest banks could establish, and which only the most trustworthy of customers could obtain; the funds in the lockbox would then be used solely to buy MARS that were of greater value than the amount MRI paid for them;
• The “lockbox” account would be independently managed and, even if the banks were to fail, the state government would guarantee the funds in the amount, which the investors having the first right of priority to recover the funds, and
• Each U.S. state guarantees MARS investments up to a legal limit, and MRI International purchases MARS only up to those guaranteed limits. (Source: Takiguchi et al v. MRI International, et al, US District Court Nevada District)

An investment in MRI International was recorded by a certificate of investment. MRI International sent application forms to investors who expressed interest and then investors submitted applications to MRI International. To obtain a certificate of investment, investors either wired money or sent a check to one of two accounts at Wells Fargo Bank in Las Vegas. One account received money from investors in MRI International’s Select A Fund, and the other account received money from investors in Class A Fund.

Problems

MRI International’s investment strategy ran into a problem when their cash balance depleted after making payments to existing investors using proceeds from new subscriptions. In April 2012, Japan’s Securities and Exchange Surveillance Commission announced it had cancelled MRI International’s registration as an asset manager and the Financial Services Agency began an investigation into MRI International’s potential misconducts.

In July 2013, Tokyo District Court seized assets worth approximately JPY 350 million in Japan. Fujinaga told the regulators that the funds were almost gone, but he did not admit the scheme was fraudulent. On September 11, 2013, almost five months since Japanese regulator cancelled the firm’s registration, the U.S. Securities and Exchange Commission finally announced an emergency action to freeze the assets of MRI International and Fujinaga, and charged with perpetrating a Ponzi scheme.

LVT, Inc. aka Sterling Escrow was retained to administer the Select A and Class A accounts. In reality, Sterling Escrow did not provide any escrow services, but instead transferred new investors’ money into accounts associated with prior investors as early as in 2010. It was also revealed that MRI International had stopped buying MARS from independent healthcare facilities in 2008.

Fujinaga also directed Sterling Escrow to use the investor money to pay operational expenses and the payroll of MRI International. MRI International used some of this money to pay phony “marketing fees” to an affiliated entity, where the cash was then channeled to settle Fujinaga’s personal credit card bills, buy luxury cars, and pay alimony and child support of approximately $25,000 a month.

The Japanese regulators also found that the annual reports submitted by MRI International every year were largely inaccurate. For example, the purported $100 mm dividend payment to Fujinaga in 2012 was never made.

Recommendations:

Carefully examine structure of the investment scheme

• As shown in Exhibit 11.2, MRI International led investors to purchase the medical receivables directly through a lockbox accounts, which were escrowed by Sterling Escrow (account name was “STERLING ESCROW TRUSTEE for MRI Series xxxx Class x Account). If structured properly, MRI International should not have any direct access to the lockbox accounts at Wells Fargo.
• If investors purchase a pool of the medical account receivable, the returns they receive should vary over time.

Exhibit 2: MRI International’s Scheme

Source: Estimated by Star Magnolia Research Limited

Conduct more due diligence on the escrow agent

• The lockbox accounts at Wells Fargo were allegedly escrowed by Sterling Escrow, a very little known escrow agency based in Nevada. For the size of MRI International’s account size, it is unreasonable to assume the firm could not have used better-known banks’ escrow services. Well Fargo would have been more than happy to become the account’s escrow agent.
• Usually, the escrow agent is chosen by the party exposed to greater risk, in order to ensure the collection of funds. In case of MRI International, the escrow agent was chosen by the investment manager — not the investors.
• Nevada Department of Business and Industry shows that the registration for Sterling Escrow’s business license is currently closed. (see Exhibit 11.3)
• A website called citysearch.com shows 7 reviews on this small Escrow Agency since as early as 2008, including several highly negative reviews. One of the negative reviewers stated that their insurance commissioner could not verify that it was licensed to do business.
• Both existing and potential investors should have conducted due diligence on the escrow agency, as this was probably the only third party check for the investment scheme.

Exhibit 11.3: Sterling Escrow’s dubious record

Conduct other third-party checks

• Although it was not set up as a hedge fund, there were almost no checks-and-balances in the investment scheme. According to available information, we have not identified any evidence that MRI International had ever hired an auditor or third-party valuation agency for investor accounts. Investors only received statements prepared by MRI International and there was no verification process given for their investments.

Carefully review the firm’s annual reports

• By law, a Type II Financial Instruments Business must keep its annual financial reports available for the inspection of investors.
• According to Nikkei Newspaper on June 5, 2013, the firm’s annual report showed several questionable transactions, including (1) long-term loan increase from zero in Dec 2011 to JPY 8.4 billion in Dec 2012, (2) falsely reported investor’s capital, JPY 117.9 billion, as the firm’s liabilities, (3) average salary payment of JPY 88 million for 310–350 employees, or JPY 300,000 per person per year and (4) dividend payment of over $100 mm to Fujinaga in 2008.

Ask why MRI International was never registered with the SEC

• It is highly likely that MRI International falls under the definition of an investment advisor defined by the United States Investment Advisers Act of 1940, however, we found no registration record for MRI International. The firm may have violated SEC registration rules.

Source:

Court Documents

Securities and Exchange Commission v. Edwin Yoshihiro Fujinaga and MRI International, Inc. http://www.sec.gov/litigation/complaints/2013/comp-pr2013-201.pdf

Edwin Y. Fujinaga and MRI International (petitioner) v. United States of America (respondent), District Court for The District of Nevada, April 11, 2013, http://ia801702.us.archive.org/33/items/gov.uscourts.nvd.93798/gov.uscourts.nvd.93798.1.0.pdf

Takiguchi, et al v. MRI International, Inc., et al, United States District Court District of Nevada, July 5, 2013

Other Documents

“Japan regulators may pursue charges against U.S.-based asset manager MRI,” Reuters, April 26, 2013, http://www.reuters.com/article/2013/04/26/us-japan-mriinternational-idUSBRE93P02F20130426

“MRI, Revealed Last 5 Years’ Annual Reports, SESC Says ‘Almost All False’”, Nikkei, June 5, 2013, http://www.nikkei.com/article/DGXNZO55851860V00C13A6CR8000/ (Japanese and subscribers only)

Reference Material, Securities and Exchange Surveillance Commission, April 26, 2013, http://www.fsa.go.jp/sesc/news/c_2013/2013/20130426-1/01.pdf (Japanese only)

“U.S. SEC says big Ponzi scheme targeted investors in Japan”, Reuters, September 26, 2013, http://www.reuters.com/article/2013/09/26/sec-ponzi-mri-japan-idUSL2N0HM1X720130926