Devon's History          

Devon Capital Management was a registered investment adviser. Its principal business was advising municipal bond issuers on the structuring of their bond issue and the investment of the proceeds from those issues. During the nine years of its existence, Devon had advised on over $1 billion of municipal bond issues and the investment of over $3 billion of the bond proceeds.

Financial Management Sciences (“FMS”) was a private corporation formed to be a counter party to derivative transactions, mostly involving municipal bonds and their proceeds. As a counter party, FMS would hold its own assets and utilize those assets to provide interest rate swaps, yield guarantees, and optional future derivative transactions. During the four years FMS was in business, it was the counter party to over $1 billion in derivative municipal transaction.

John Gardner Black was the owner of both corporations and had spent most of his life in the field of municipal finance. During his career, it has been estimated that Mr. Black had increased the earnings of his clients by diverted over $1 billion of arbitrage profits from the federal government to his municipal clients.

On June 18, 1993 the Internal Revenue Service issued its “final” arbitrage regulations. Section 1.148 of the regulation authorizes the creation of a derivative security in which the proceeds from municipal bonds may be invested. The regulations also control the method of valuation and reporting. The regulations may be accessed here.

Beginning in 1994, FMS began offering its version of the derivative called the Collateralized Investment Agreement (“CIA”)

• Devon's Client List

Litigation Against Devon           

The Securities Exchange Commission filed a complaint in ex parte proceedings before Judge William Standish and Judge D. Brooks Smith of US District Court for the Western District of Pennsylvania. The complaint alleged that a certain asset, a collateralized mortgage obligation (“CMO”), owned by FMS was carried on the books of FMS at a price higher than market. The asset was collateral owned by FMS to insure its ability to fulfill its contractual obligation under the CIA, the security owned by FMS’ customers. The complaint states that the CIAs were sold for $233 million, and the SEC does not dispute that valuation. Devon’s position was and still is that the CIAs were worth $269 million on September 26, 1997. The complaint does not state how the value of the CMO affected the value of the CIA. Almost two years later, the government would admit that the CIAs were sold for market value.

The complaint does state that if the assets of FMS were liquidated, thereby precluding FMS from future earnings, the proceeds would be insufficient to allow redemption of the CIA at market value. In other words, the SEC claimed that the counterparty in a derivative transaction must keep sufficient cash holdings to allow for the redemption of the derivative at market value.

It has been the position of Devon that if any owner of the CIA wanted to liquidate its holdings, it could do so for the value represented in the monthly statements by selling the CIA to another party. The complaint can be downloaded here. A copy of the ex parte proceedings can be downloaded here. The SEC issued its litigation release on September 26, 1997 and is available here. Both Devon and FMS ceased operations when the complaint was filed.

On December 17, 1998 the Third Circuit Court of Appeals issued an opinion by Marjorie Rendell in SEC v Black. The appeal was filed by the owners of the CIA objecting to certain lower court proceedings involving the lifting of an asset freeze. Neither Devon, FMS nor Black were litigants in the appeal. The opinion states that the appellants could not frame a reason for objecting to the lower court proceedings. Neither the SEC nor the court appointed receiver Richard Thornburg had informed the owners of the CIAs that the CIAs’ market value exceeded its cost. The opinion in SEC v Black can be accessed here.

On August 31, 1999 the Third Circuit issued an opinion by Theodore McKee in Bald Eagle School District v Keystone Financial, now M&T Bank. Neither Devon, FMS nor Black were litigants in the appeal. The opinion contained a statement that the “CIAs purchased by the School Districts were worth significantly less than their purchase price because of the shortfall in the collateral in the funds already under management.” Devon’s position with respect to this statement is that it is not supported by legal precedent, the facts in the case, the pleading by the government or by governmental regulation. The value of the security owned by the clients, the CIA, exceeded its purchase price when its value is determined by a reasonable expectation of profits, the same valuation metric required by existing regulations and judicial precedent. The opinion is available here.

Appeals           

In June of 1999, the government obtained an indictment of Devon’s owner. The indictment alleged that Black had “…falsely represented the market value of the CIA….” Black’s indictment is available here.

On January 24, 2000, the government and Black entered into a Joint Stipulation of Facts in which the government stated that the CIAs had been sold at fair market value and that Black was not pleading guilty to misrepresenting the CIAs market value. The Joint Stipulation of Facts can be downloaded here. The government moved the district court to amend Black’s indictment by deleting the charge of misrepresentation of the CIA’s market value. The court granted the government’s motion. The transcript of those proceedings can be downloaded here.

On April 27, 2001 the SEC filed a brief in district court in which it stated that the CIA was an investment contract, a security whose value is determined by a reasonable expectation of profits derived from the efforts of others. The SEC's brief can be downloaded here. On May 9, 2001 the district court held that the CIA was an investment contract security with the same investment characteristics outlined by the SEC in their brief. The order is here. This valuation method is the one required by federal regulation and judicial precedent and is in stark contrast to the requirement that the assets of the counterparty to a derivative transaction exceed the market value of the derivatives sold.

On June 25, 2001 the Third Circuit Court of Appeals informed Black that the civil action instituted by the SEC on September 26, 1997 was still open because no final order had been entered. That letter is available here.

The government filed a brief in district court on September 30, 2003 in which it stated that it had never evaluated the CIA, despite having obtained an indictment to that effect. The government did not dispute that the CIA was worth more than its purchase price. Instead, the government states that the action was based upon collateral without stating how that collateral affected the market value of the CIA. That brief is available here.

On December 13, 2005 Judge Donetta Ambrose informed Black that the market value of the CIA had been “litigated and resolved.” The district court did not dispute that the CIA’s market value was $269 million on September 26, 1997. That opinion and order are here.

In February and April of 2006, Plaintiff’s prior attorneys, Richard Levan and Richard Scheff, sent letters to him stating that they did not litigate the value of the CIA in any proceeding.

On October 24, 2006 the Third Circuit intervened in Black’s motion requesting the recusal of Judge Donetta Ambrose for not disclosing that she had conducted litigation into the market value of the CIA.

On December 13, 2006 Black submitted a motion to dismiss the SEC's complaint because the SEC concealed the market value of the CIA from the district court. Black's motion stated that the value determined pursuant to government regulation was $233 million and $269 at fair market value. The motion is here.

On December 15, 2006 Judge Ambrose denied the motion without disputing the market value representations in the motion. That order is here.

On February 27, 2007 Black submitted his Appellant Brief to the Third Circuit. That brief details the valuation for the CIA at fair market value and the valuation required pursuant to the arbitrage regulations. The full brief can be downloaded here.

On April 16, 2007 the SEC submitted a brief in the Third Circuit in which it did not deny that the market value of the CIA was $269 million. The SEC also stated they did not apply the procedures required by the arbitrage regulations to the CIAs. Instead the SEC argued that the arbitrage regulations impose nothing more than an earnings cap on municipalities without any reference to the detailed procedures of accounting and valuation contained in the regulations. That brief is here.

On April 23, 2007 Black submitted a reply brief to the SEC's April 16 brief. The position in Black's brief can best be summarized with an excerpt from the opening line: "...never in the history of securities litigation conducted before any district court in this circuit, or in any published opinion of this Court of Appeals for the Third Circuit, has an alleged securities violation been allowed to proceed without at least a statement that the security in question was 'offered, purchased or sold' at non-market values or that the value of that security was misrepresented to the detriment of the investor." The full brief can be downloaded here.

On June 20, 2007 the Third Circuit Court of Appeals issued an opinion by Thomas Ambro that required Black, who was not then a prisoner, to file for a certificate of appealability, a requirement under habeas corpus, before it heard Black’s appeal. The Court then issued an opinion denying the certificate of appealability. The Supreme Court of the United States declined to issue a mandamus requiring the Third Circuit to hear Black’s appeal.

On January 30, 2008 the Third Circuit issued an opinion by Maryanne Barry, Michael Chargares and Jane Roth in SEC v Black in which it stated that the action was based upon an overvaluation of a collateralized mortgage obligation, a security owned by FMS. The Third Circuit did not dispute that the CIAs were issued pursuant to federal regulation, were valued pursuant to those regulations or that the value of the CIA was $269 million and sold for $233 million. In other words, the illegal activity Black engaged in was not informing the owners of the CIA about the market value of a security they did not own, but was owned by FMS and held as collateral to insure FMS’ obligations under the contract with its customers. That opinion can be downloaded here.

On April 2, 2008 the Third Circuit Court of Appeals notified Black of a Judgment entered on January 30, 2008 in which it upheld the district court's December 15, 2006 denial of Black's motion to set aside. The Judgment did not dispute the market values stated in Black's motion. The Judgment is here.