SPECIAL REPORT: Heart of darkness

On 17 July, the protracted tale of Garth Ronald Peterson, who pleaded guilty in April to his role in a conspiracy to evade Morgan Stanley’s internal accounting controls, is scheduled for its final chapter. That Tuesday, the 42-year-old former head of Morgan Stanley Real Estate Investing’s China business will face a maximum prison sentence of five years and a fine of $250,000 from the US Department of Justice (DoJ). In addition, the US Securities and Exchange Commission (SEC) wants him barred from practicing in the securities industry, as well as having him pay a “civil penalty.” 

According to SEC documents, between 2004 and 2007, Peterson secretly purchased “millions of dollars” of real estate investments from Morgan Stanley’s real estate funds on behalf of himself, the former chairman of state-owned Shanghai Yongye Enterprise Group – named in the Chinese press as Wu Yonghua – and an unnamed Hong Kong-based Canadian lawyer. The DoJ focused on a “multi-million dollar” ownership interest in a Shanghai building, which Peterson “encouraged” MSREI to sell to Shanghai Yongye. In fact, the property was sold to a shell company masquerading as a Shanghai Yongye company but actually controlled by Peterson, Wu and the lawyer. Through this deceit, Peterson and his conspirators enriched themselves by acquiring a stake in the building at below-market value and receiving distributions from the asset to which they were not entitled.

Assistant Attorney General Lanny Breuer of the DoJ’s criminal division said in a statement: “Peterson admitted that he actively sought to evade Morgan Stanley’s internal controls in an effort to enrich himself and a Chinese government official. As a managing director for Morgan Stanley, he had an obligation to adhere to the company’s internal controls; instead, he lied and cheated his way to personal profit.” 

Janice Fedaryck, assistant director in charge of the Federal Bureau of Investigation’s New York field office, added: “The defendant engaged in a pattern of self-dealing and deception that perpetuated his unjust enrichment. He not only circumvented his employer’s internal controls, he violated the law.”

Plain and simple theft

The US authorities have focused their prosecution on Peterson’s contravention of the Foreign Corrupt Practices Act (FCPA), a law intended to clamp down on US companies bribing public officials overseas and one which the US government is particularly keen to enforce. Wu and the unnamed Canadian lawyer are not subject to FCPA because they are not US citizens, and it remains to be seen whether those two parties will face any charges for their roles in the deception.

After assisting US authorities with their investigations following its own internal investigation, Morgan Stanley also emphasised Peterson’s side-stepping of its controls. In a statement following his guilty plea, the bank said: “Mr Peterson’s intentional circumvention of Morgan Stanley’s internal controls was a deliberate and egregious violation of our values and policies.”

While US authorities are focused on Peterson’s actions from an FCPA perspective, certain sources familiar with Peterson have suggested a greater focus should be placed on him stealing. “The reality is FCPA sounds good on paper. The [US] government wants to make examples of people on that, but that’s not what this is about at all,” one source said. “This is about theft, plain and simple.”

Whether Peterson was seen as a ‘plain and simple’ thief is debatable. As a University of Chicago MBA graduate with blue eyes and blonde hair, Peterson appeared every bit the thoroughbred American. However, having worked in China since the late 1990s (see Fast ascent, quick fall, page 10), certain peers submitted that he became so deeply engrained in its culture that he became susceptible to some of the country’s darker business practices, particularly as his ambition to partake in China’s upper business circles became apparent. Likening Peterson to Colonel Walter Kurtz, the wayward military officer in Apocalypse Now, one source said: “He went too far up the river. No question about it.”

Peterson spoke fluent Mandarin, even picking up Shanghai’s dialect, as he became a successful gatherer of guanxi, loosely translated as ‘connections’. One former investment partner of MSREI recalled: “He thinks of himself as very Chinese.” Nonetheless, the similarities with the fictional character made famous by Marlon Brando have their limits. For one, Peterson handed himself back to the US authorities and has, to date, complied with their investigations. Kurtz’ fate was very different.

While Peterson will learn his fate in July, the fallout of his actions already have been felt by ex-colleagues – specifically his former bosses, then global real estate co-head Sonny Kalsi and then Asia head Zain Fancy – not to mention the firm itself, which PERE has learned has shelled out approximately $30 million to fund a year-long internal investigation as it sought to understand what had occurred. 

None of the individuals would comment on the matter, and neither would Morgan Stanley beyond its statement. However, PERE spoke to sources familiar with the firm in China, as well as those familiar with Peterson, Kalsi, Fancy and the events that unfolded in Shanghai, in order to shed further light on one of the darkest periods of MSREI’s history in Asia. 

One prevailing theme among these sources was a sense of vindication felt today by executives of Morgan Stanley, and by Kalsi in particular. For them, proof is finally public that their parts in the Peterson story were unequivocally above board. Following Peterson’s plea, the DoJ announced that the bank’s controls provided “reasonable assurances” that its employees were not bribing Chinese government officials, isolating Peterson’s actions in the process. 

In a statement, Morgan Stanley said: “Morgan Stanley is pleased that this matter is resolved.  We cooperated fully with the government, and we are very satisfied with this outcome.” One rival fund manager added: “Sonny was cleared completely – no question.”

Conspicuous absentee

According to sources familiar with MSREI’s activities in China, the first time that staff at the firm’s office in Shanghai Square suspected Peterson of any wrongdoing was when he was absent during a routine visit by Kalsi in September 2008. One source recalled how some colleagues at first speculated his disappearance might be due to him having an affair with a co-worker. Others speculated he was missing because he was poised to resign for a role elsewhere. Either way, it was unusual for the office head to not be around when the platform’s global head was in town. “People were walking on eggshells,” the source recalled. 

Peterson’s line manager, Fancy, had resigned that June after being lured by New York-based investment firm Och-Ziff Capital Management to lead its new real estate platform in Singapore. By September, other MSREI executives – Roy Kwok, Bharat Khanna and Anand Madduri – had chosen to go with him. 

“All the guys had left to join Och-Ziff, but they left Garth behind,” one source recalled. “My first question was why?” 

Things became clearer later that month, when it emerged that Shanghai Yongye’s Wu might have had an inappropriate involvement in one of MSREI’s Shanghai investments. That prompted Kalsi to initiate the firm’s internal investigation into the deal, the wider activities of the China operation and, ultimately, into Peterson, who was known to have a close friendship with Wu. 

According to a Reuters report in 2009, concerns about Peterson’s movements were substantiated when an unrelated strategy review into MSREI’s Asia investments, started in mid-2008, also threw up irregularities concerning deals in Shanghai. Peterson was confronted by Morgan Stanley’s legal team in November and, one month later, he was fired. 

In February 2009, Morgan Stanley reported that it was undertaking an internal investigation into “apparent violations of the FCPA initiated by a former employee in Morgan Stanley’s Shanghai real estate office.” Davis Polk & Wardwell, a global law firm specialising in litigation, was understood to have been appointed to assist Morgan Stanley’s legal team in the investigation. At the same time, Kalsi and Andrew Yoon, MSREI’s chief financial officer in Asia, were placed on administrative leave – to the surprise of both, peers recalled. 

According to a letter to MSREI investors nine months later, the investigation comprised interviews with “all relevant employees” and the review of more than 7.4 million pages of emails and related documents “at Morgan Stanley’s expense” – understood to be approximately $30 million. In the letter, MSREI said: “Based on the investigation to date, it is believed the possible violations were centred on the conduct of a single former employee in the Shanghai office.” It also noted that the possible violations were limited to investments in MSREF IV International and MSREF V International, the fourth and fifth in its series of global opportunity funds, through which the firm had collected $2.38 billion and $4.2 billion in May 2001 and April 2005 respectively.  

Web of deceit

The SEC documents centre around investments code-named “Project Wally” and “Project Cavity” – both relating to two apartment towers in the Luwan district of Shanghai, known as the Shanghai Jin Lin Tiandi Serviced Apartments. The documents stated that, in 2002, MSREF IV co-invested as a minority partner with Shanghai Yongye and other investors in the property. In 2004, MSREV IV acquired one of the towers outright.

As a co-investor but also the project manager for the selling consortium, Shanghai Yongye needed to approve the sale. Peterson claimed to his MSREI colleagues that Wu had enabled the bank to buy at a lower price than a competing bidder and, in an email to colleagues in November 2005, said: “We owe [Yongye] a favour… [Yongye] gave us this deal.”  

That favour would be a 12 percent interest in the tower to be sold to Shanghai Yongye once the fund had completed its investment. The SEC alleged, however, that Peterson, Wu and the Canadian lawyer colluded to purchase the same interest in the tower using a British Virgin Island-domiciled entity called Asiasphere Holdings. “They misrepresented to officers and employees of Morgan Stanley that Asiasphere was a subsidiary of [Shanghai] Yongye,” the SEC documents stated. 

Peterson brokered the deal for MSREI at the asset’s 2004 valuation, meaning Asiasphere would instantly realise a gain on its stake. The SEC document said: “Asiasphere’s nearly $3 million investment already was in-the-money by as much as $6 million at the time of the investment because the property had risen in value.”  Added to that, between 2006 and 2008, the trio collected distributions of approximately $2 million from MSREI for their stake in the property. 

Ultimately, Wu owned 47 percent of the stake, while Peterson owned 43 percent and the lawyer owned the remaining 10 percent. Peterson and the lawyer owned their portion in another BVI company called Strong Man Ltd, and Peterson controlled his share of that portion through yet another BVI company called Paraplay. It is little wonder that US Attorney Lynch described the elaborate, multi-company set-up as “a web of deceit.”

The SEC documents noted that, in early 2006, MSREI was negotiating on at least five other separate Chinese real estate investments involving Shanghai Yongye and Wu, although none of those were concluded. Nonetheless, each was in the process of being arranged by Peterson in a way that would see Wu personally benefit for his role in enabling the transactions through his remit as a state official. For his efforts, Wu would have received “finders fees” or “promote” in the form of discounted stakes in the deals and returns on any completed deals. Peterson would have received a percentage of these fees as well. 

Separately, Peterson oversaw another sale of an asset in the Luwan district called Project 138, relating to Shanghai Square Infiniti Mall, a retail asset sold by MSREI to a group of investors that, secretly, included him and the lawyer. Peterson and the lawyer acquired an approximately 1 percent stake in the asset, which was not declared to the bank.

Vindication and closure 

Sources familiar with Peterson said his guilty plea brings long-awaited vindication and closure for colleagues and peers connected to him. The overwhelming support in the private equity real estate sector for Kalsi in particular was evident from PERE’s discussions with sources, who described him as a victim of Peterson’s actions, particularly as he never directly managed Peterson. 

“[Kalsi] had absolutely nothing to do with the whole thing,” insisted a former MSREI investment partner. “It was actually him looking into the whole thing that caused it to be discovered. He became the scapegoat.”

In MSREI’s letter to its investors after its internal investigation, the firm confirmed the fund assets in question “were used for improper purposes not authorised by senior management” – without naming Kalsi. However, in one letter seen by PERE, Morgan Stanley confirms Kalsi as being part of that “senior management,” thereby exonerating him. In addition, Morgan Stanley is understood to have made similar disclosures to the Financial Industry Regulatory Authority, the largest independent securities regulator in the US.

Morgan Stanley never officially apologised nor thanked Kalsi for his involvement in the investigation – thought to be a sore point for the man who worked for the bank for 18 years. Although Kalsi received a financial settlement from Morgan Stanley, there are conflicting accounts as to how related the settlement was to the investigations. In November 2009, in the absence of support from Morgan Stanley, Kalsi took measures to clear his name himself, appointing a spokeswoman to publicly state that the internal investigation conducted by Morgan Stanley found “no evidence that Sonny caused or authorised the alleged misuse of assets.” 

After launching his own private equity real estate firm – GreenOak Real Estate – in 2010 with other former MSREI colleagues, including Yoon, Kalsi was understood to have appointed business advisory firm FTI Consulting to undertake an independent investigation into his career to ensure his new firm’s investors would harbour no residual fears of further repercussions. His efforts evidently paid off because, as of February this year, GreenOak Real Estate had raised about $500 million for opportunity funds focused on the US and Japan.

Despite the general consensus that Kalsi was a victim of Peterson’s actions, one source familiar with MSREI said the firm’s decision to place him on administrative leave was not “particularly controversial” and described it as “standard practice.” He said: “He was put on administrative leave during the investigation because the firm was reviewing whether there was a failure to supervise on his part. At the conclusion of the investigation, he decided not to return.”

Kalsi was not the only person to suffer from Peterson’s action. After being poached from MSREI by Och-Ziff Capital Management, Fancy and his senior team formed Och-Ziff Asia Real Estate with a brief to build a real estate investment management business, only to find their efforts disrupted by the investigations. While Fancy was never asked to contribute to the investigation, some peers speculated that Fancy, and not Kalsi, would have been placed on administrative leave had he had remained at MSREI, given he was Peterson’s direct line manager. 

Subsequently, Och-Ziff terminated its partnership with Fancy, initially claiming the venture was not workable because it could not raise funds as a result of the investigation. Fancy responded by suing the firm in Singapore and in London. The dispute, PERE understands, was settled out of court. 

Today, Fancy runs a boutique Singapore-focused firm called Clifton Real Estate Group. “The ironic thing is that he settled his outstanding issues with Och-Ziff,” one source said. “If he hadn’t, [Peterson’s guilty plea] would have stood in his favour.” In any event, it is now perfectly clear that, along with Kalsi and Yoon, Fancy had no involvement in or responsibility for Peterson’s actions.

Where there’s a will

The SEC documents state that, between 2002 and 2008, Peterson received anti-corruption policies and FCPA training at least seven times, including live, web-based and teleconference training. He also received at least 35 reminders to comply with FCPA rules in the form of circulars. These focused directly on gift-giving and entertainment of consultants, anti-bribery policy, engagement of consultants and other areas related to the Morgan Stanley employee’s expected conduct. The bank also required Peterson on “multiple occasions” to “certify adherence” to its code of conduct, and it imposed onto him its policies with regard to conducting due diligence on partners. Ultimately, the DoJ was content with Morgan Stanley’s controls and decided against bringing “any enforcement action” against the bank. 

Despite such endorsement for Morgan Stanley’s controls, there remain doubts among private equity real estate professionals as to whether other offenders could be detected should such a scenario reoccur. “If someone is making cash on deals off the books, it can go on forever,” one investment manager said. Another added: “If someone is intent on perpetuating a fraud, they may get away with it until someone discloses it. No system is completely fool-proof.” 

More certain is the fact that Peterson will no longer commit repeat offences given the sanctions he faces in July. In addition, it would appear that he has repented for his actions. According to a transcript of the court proceedings, seen by PERE, he told the court: “I know what I did was wrong, and I deeply regret my actions. I apologise to the court, to Morgan Stanley and to my family for what I put them through.”

The Reuters report paraphrased one of Peterson’s friends, who suggested he was planning a comeback in the market once investigations into his actions were done. However, as another rival fund manager told PERE, Garth Ronald Peterson – the one-time guanxi gatherer who went too far up the river like Colonel Kurtz – “is done.” 

Fast ascent, quick fall

Peterson’s rise at MSREI was nearly as speedy as his demise

By a number of measures, Garth Peterson’s ascent at Morgan Stanley was fairly quick. A US citizen and University of Chicago MBA graduate, he was hired by the firm as an associate in 2002 by former MSREI principal Dave Bednar. His networking success in China soon got him noticed and brought onto the China team in 2003, reporting first to then Asia head Timothy Grady. Assigned with searching for deals in Shanghai as the platform expanded its reach in China, his successes quickly saw him promoted to vice president and then executive director two year later, according to a report by Reuters. Come early 2006, Peterson was placed in charge of launching and leading MSREI’s Shanghai office and, in 2007, he was made a managing director. 

Peers and rival investment managers remember Peterson impressing as “smart”, “aggressive” and “focused,” although the Reuters report highlighted how these characteristics were a precursor to displays of arrogance. The news outlet reported: “Peterson developed what sources described as a swagger that rubbed some colleagues the wrong way.” Regardless, he evidently was getting deals done. By the time he was fired in December 2008 following his involvement in a conspiracy to evade Morgan Stanley’s internal accounting controls, he had racked up at least 28 transactions in China, according to SEC documents. 

Peterson’s relationship with Shanghai Yongye Enterprises chairman Wu Yonghua, another member of the conspiring triumvirate and a facilitator to a number of his transactions, dates back to the early 1990s, well before he joined Morgan Stanley. It continued after Wu retired from his post in September 2006 until Peterson was fired. 

Today, Peterson lives in Singapore with his wife and two children. However, in July, he will learn whether he will be sent to a US prison for up to five years.