Wall Street firm dangled massive returns to investors using US aid programs

A New York investment firm pitched wealthy investors in recent days on a way to make returns of 22% to 175% using U.S. government programs designed to help Americans keep their jobs and boost the coronavirus-stricken economy, according to a marketing document seen by Reuters.

Following questions posed by Reuters, Arcadia Investment Partners LLC, which has about $1 billion under management, said it had put its plans on hold.

The idea was in “formative stages” and the firm was not “presently moving forward with this strategy given reasons that include uncertainty surrounding the regulations,” Dahlia Loeb, managing director at Arcadia, told Reuters in an email on Wednesday. She did not elaborate further.

The firm had sent the pitch as recently as this weekend to “a limited number of sophisticated investors,” according to the marketing materials, which are dated April 4 and marked confidential. In an email sent Sunday, and seen by Reuters, Loeb wrote it was a “highly time sensitive opportunity” and had offered to discuss it with investors that day or early in the week.

Arcadia’s pitch offers a glimpse into how some private investors are looking to quickly take advantage of the unprecedented government intervention after the novel coronavirus brought economic activity to a screeching halt.

Under Arcadia’s plan, which has not been previously reported, the firm would have raised money to finance loans to small businesses guaranteed as part of a $2.2 trillion government aid package, the marketing materials show. It called the new vehicle the “Paycheck Protection Program Fund,” named after the government initiative for small businesses launched on April 3.

Arcadia proposed to juice profits by borrowing 90% to 95% of the money from funding markets that were backstopped in recent weeks by the U.S. Federal Reserve.

‘DESIGN FLAW’

The small business lending program has had a chaotic start, with banks and companies saying more crucial details need to be worked out. Under Arcadia’s plan, the actual loans would have been made by online lending platforms. Some such lenders said they are yet to be approved by the government to make the loans.

Had Arcadia proceeded with its plan, its investors would have profited handsomely from a virtually risk-free investment. Arcadia typically generates returns to investors of between 8% and 12%, depending on the type of investment, according to a March regulatory filing. The potential returns would also be far above other options available to investors. The U.S. 10-year Treasury note, for example, currently yields around 0.77%.

Lucian Bebchuk, a corporate governance expert at Harvard Law School who reviewed key assumptions of Arcadia’s pitch for Reuters, said that the potential returns, assuming they are estimated correctly, “suggests a design flaw on the part of the government’s program.”

A spokeswoman for the Fed declined to comment, while a representative for the U.S. Treasury Department did not respond to a request for comment.

In the past, large-scale government intervention has engendered fierce debates about whether they create perverse incentives and lead to unintended consequences.

ARCADIA’S PLAN

Founded by former Donaldson, Lufkin & Jenrette banker Kammy Moalemzadeh in 2001, Arcadia makes investments in areas such as private equity, real estate and distressed credit funds, according to its March regulatory filing. It said its investors include investment funds and wealthy people, including hedge fund managers and chief executives.

In the marketing document, the firm said it would work with an unidentified asset manager on the plan. That asset manager, which Arcadia said has $17 billion under management and was founded in 2012, has experience financing small business and consumer credit through online lending platforms, with more than $6 billion dedicated to the strategy.

If the small business borrowers use the money for employee payroll and other approved expenses, the U.S. Small Business Administration would forgive the 24-month loans in as little as three months, Arcadia wrote in the document. The loans carry a fixed interest rate of 1%.  The remaining loans will be repurchased within 24 months, according to the Arcadia materials.

In its document, Arcadia did not give the size of the anticipated fund. But it noted that investors would contribute 5% to 10% of the equity of the new fund. The rest would initially be borrowed from the repurchase agreement, or “repo” market, which the Fed has backstopped in recent weeks.

After three months, the fund would borrow from the Fed’s Term Asset-Backed Securities Loan Facility, or TALF, another funding initiative launched last month to help the economy.

Investors in the Arcadia fund would pay no management fee but would be charged 20% of profits, the document shows.