SCOTTSDALE, Ariz - While it probably won't trigger a slew of new slang as did Enron Corp., the debacle of National Century Financial Enterprises, and how to protect against a repeat, was the topic du jour in Arizona last week. After all, the number one question is, who's at fault?

Strategic Research Institute dedicated an entire panel to NCFE, and much was heard during subsequent panels and around the halls.

While nothing about NCFE's debacle is set in stone, it is alleged that fraudulent loans, from as far back as 1998, were made to affiliated parties, operated by Lance Poulsen, who was also NCFE's chief executive. Many loans (when existent) were allegedly often secured by ineligible collateral, or in some cases, no collateral at all. (These alleged improper activities were first reported by ASR in May 2000, predating the fallout by more than two years.)

While specifics of the NCFE scheme are still not entirely clear, different segments of the market have been trading off the blame since the first signs of fraud, as if responsibility could be pinpointed on any one party.

"Not so fast!" cautioned Mark Adelson, director of structured finance research at Nomura Securities. Adelson, who moderated the NCFE panel, explained that the debacle needs to be addressed more as a sum of the parts than as a one-firm-fits-all blame game. Most importantly, the entire securitizaition market lacks, what he termed, a "deal cop."

It is alleged that NCFE was able to meet trigger levels at the end of each month by shifting money between reserve funds, thus creating the appearance that each reserve account was adequately funded.

"They (trustees Bank One Trust Services and J.P. Morgan Chase) should have never allowed the money transfers," contended one audience member.

One often-overlooked rumor is that NCFE management was able to select which assets, (i.e. hospitals, health care providers) were scrutinized during periodic trigger tests of asset integrity. That, in large part, appears to be the golden goose egg in the NCFE blame game.

However, while the trustee is supposed to be tracking the money, and thus the reserve funds, no one is adequately tracking the integrity of the assets.

Adelson contended scrutiny in the NCFE case should not be directed, necessarily, at how trustees should best surrveil money transfers (reportedly $300 million in size) but should go back one step further, to the indenture document. Contained in nearly every one of these securitization documents is something called "agreed-upon procedure."

"We don't have ongoing audits in securitization. We have something called agreed-upon procedures," Adelson explained. "It's a very common use when testing receivables."

Agreed-upon procedures are almost always less stringent than a full-blown audit, said Adelson, also a bar-certified attorney. And therein lies the loophole for an individual aiming to commit fraud. Typically, there are no deal-police rigorously testing asset integrity. Instead, tests are conducted simply using agreed-upon procedures. A firm's executive can finagle trigger tests, for example, by using figures from self-selected assets as opposed to random selection, thus skewing the picture of asset integrity.

"Investors cannot rely [just] on trustees, although hopefully the trustees, role will be better defined going forward," said Eric Rosenfield, vice president, Tequesta Capital Advisors.

Many conference attendees believe that investors shoulder some of the blame as well.

"The investors that avoided NCFE had a host of reasons why they didn't, from not agreeing with the NCFE business model to having seen things in their review, such as NCFE not allowing any parties that they bought receivables from to prepay, which made some investors uncomfortable," said one source.

While monolines bond insurers take on the deal-cop role in transactions, that benefit only comes with wrapped transactions. Increasingly, billions in securitizations are conducted without wraps, as was the case with NCFE's transactions.

Trustees, currently, are not asked to take up the deal-cop role and would have to be properly compensated for expanding into such a new and complicated arena, several market pundits believe.

"There needs to be someone to take on this role. Someone who's been around the business and has a mean streak a mile wide so they won't take I'll-get-you-those-numbers-tomorrow' for an answer today," Adelson said.

"Rating agencies don't rate for fraud," said Laura Langford, director-senior structurer, at HVB Group. "And frankly they're not paid enough to take that risk. They have basically said they won't react, could not react, when they receive anonymous letters."

"Investors cannot rely with a 100% certainty on rating agencies," said one structured finance professional. "They still need to be able to define the risks and pay attention, particularly with respect to know who they are doing business with."

And if investors expect the legal community to move into a deal-cop role, think again.

"Unfortunately, there aren't that many lawyers who are well versed in the ABS market," said Robert Graves, an attorney at Jones Day. "It's very important to make sure you do due diligence...and [the party conducting it] needs to be well versed in esoterics."

A number of suggestions were made to improve fraud protection. While some were as simple as personally calling a company and seeing how the phone is answered, others involved bringing on a co-servicer into the deal.

The competition factor in the issuer's marketplace is an item on Langford's fraud radar.

"A number of the cases we've seen have been companies that have the only mouse trap out in the market," she said, noting that NCFE touted the only health care receivables system able to correctly code complex hospital reporting procedures and flowing them through seamlessly with insurers. Langford also mentioned co-servicing as an option when it comes down to deal surveillance.

The securitization, like any other marketplace, should be treated as "caveat emptor" by investors.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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