In a civil trial scheduled to start next Monday, the Federal Deposit Insurance Corp. will blame regional accounting firm BKD LLC for failing to uncover the massive fraud that led to the 2010 failure of First Southern Bank of Batesville.
But BKD, in recently released court filings, argues that the bank’s own officers could have shut down former Little Rock attorney Kevin Lewis’ scam almost two years earlier had they simply done their jobs.
At the end of December 2008, Lewis apparently forged the signature of a business partner to obtain a $250,000 loan from First Southern, according to court pleadings by BKD, which is headquartered in Springfield, Missouri, and has a large office in Little Rock.
“Proper due diligence would have led FSB to discover that Lewis was not to be trusted,” BKD said in a court filing in U.S. District Court in Little Rock. “Further, because Lewis’s scheme would have constituted bank fraud, … FSB would not have thereafter had dealings with Kevin Lewis and would have sustained no losses from Lewis’s [improvement district] bonds as a result.”
Lewis, 47, pleaded guilty to one count of bank fraud for a complex, multiyear scheme in which he manufactured phony property owner improvement district bonds, sold them to banks as investments and used them as collateral on bank loans. He is serving a 10-year sentence in federal prison at Memphis.
Scheduled for release in January 2021, Lewis also was ordered to pay $39.5 million in restitution to nine banks in what is considered the largest fraud ever prosecuted in Arkansas.
By the time Lewis’ bond fraud was finally discovered in the fall of 2010, he had become the majority shareholder of First Southern and had sold his own bank $23.3 million worth of fake improvement district bonds. Bank regulators closed the bank in December 2010.
The FDIC, as the bank’s receiver, sued BKD in 2013, saying the firm should have caught the red flags when its accountants audited the bank between June 2009 and June 2010.
The FDIC’s civil suit accuses BKD of negligence and breach of contract and suggests damages of as much as $22.9 million. The trial in U.S. District Court in Little Rock is expected to last up to three weeks.
The FDIC said in its court filings that BKD “failed to detect and report to Bank management possible fraud in connection with millions of dollars of fraudulent Property Owner Improvement District Bonds sold by Kevin Lewis to FSB.”
It was during a routine regulatory examination of First Southern, the lawsuit says, that the Arkansas State Bank Department and the FDIC “identified possible fraud in connection with the POID Bonds after just a few phone calls. … They confirmed that the Bonds were fraudulent and did not exist shortly afterward.”
BKD and the FDIC have participated in two mediations but didn’t settle the case, according to an April 11 filing by the FDIC.
“We can’t comment on the details of the case, but BKD intends to vigorously defend its work at trial,” said Timothy McNamara of Kansas City, Missouri, an attorney for the accounting firm.
The FDIC also said it couldn’t comment on the pending case.
Hundreds of pages of recently filed pleadings give some more insight into Lewis’ fraud. The new documents also reveal that Lewis was generous with the bank’s money, giving some directors secret bonuses of tens of thousands of dollars’ worth of stock and cash.
Their dealings with Lewis left the bank’s former CEO, Woody Castleberry, and director Jennifer Styron with lifetime bans from working in the banking industry.
Styron, who is now the chief financial officer at the Arkansas Heart Hospital in Little Rock, declined to comment.
BKD said in its court filings that First Southern’s first of many fumbles came in December 2008, when the bank made a $250,000 loan to Michael Hulsey, then of Searcy, who was a business partner of Lewis. The bank made a second loan of $550,000 to Hulsey in February 2009, according to the loan papers filed as exhibits. The proceeds were intended to be used to repay debt.
Hulsey couldn’t be reached for comment, but in a deposition he said he didn’t sign any of the loan documents, according to BKD. “All of the signatures apparently were forged by Lewis,” BKD said.
BKD blamed the First Southern officials for missing the warning signs of dubious loans.
“The loans were collateralized by POID bonds transferred by Lewis to Hulsey at or immediately prior to the loan closing,” BKD said in its filings.
The bank didn’t conduct any due diligence into the collateral, nor did it do any real analysis of Hulsey’s personal financial condition. The officers didn’t investigate any of the “glaring” inconsistencies between Hulsey’s reported finances and what he reported on his income tax returns.
Instead, the loans were made “solely on the representations of Kevin Lewis. The Bank did not know Hulsey,” the filing said. “Castleberry did not explore the nature or basis of the loan but just talked about what a ‘great guy’ Lewis was.”
At Lewis’ request — with no confirmation by Hulsey — the bank gave the proceeds of the first loan directly to a Lewis entity, BKD said. At that point, “Lewis was not a bank employee, officer, director, or owner,” BKD said. “There was no basis for any reliance on Lewis.”
Had First Southern “adhered to even the most basic loan underwriting protocols, it would have discovered the Lewis scheme, thereby avoiding all or virtually all of the losses the Bank ultimately sustained,” the filing said.
Lewis and Hulsey were partners in Benchmark Clothiers Inc., which specialized in custom men’s shirts and suits, according to an Apparel Magazine article in 2004. Separating itself from other retailers, Benchmark planned to use body scanners to measure its customers so the clothes wouldn’t need alterations.
“We feel we don’t have potential customers until they are scanned,” Lewis told the magazine. “Body scanning turns customer suspects into prospects.”
Castleberry told Arkansas Business last week that First Southern’s lending officer in Searcy knew both Hulsey and Lewis.
Castleberry, now working at White River Health System in Batesville as its managed care coordinator, said he didn’t know if the loans were ever repaid.
First Southern was a young bank when Lewis invested in it in 2009. Castleberry had resigned as chairman, president and CEO of Citizens Bank of Batesville in late 2004 and announced plans to start a competing bank in town.
The new bank was chartered in August 2005 with a little more than $9 million in capital, significantly less than the $15 million its founders had hoped to raise.
David Estes, CEO of First State Bank of Lonoke, and a group of business associates invested in the startup bank, Castleberry said in a deposition taken in the FDIC case.
“They had said all along that this was a short-term investment for them, five to seven years,” Castleberry said in the deposition taken on Sept. 1.
Castleberry, who was paid about $190,000 annually at that time, said he understood that he needed to find a buyer for the Estes group’s shares or risk being replaced as president.
In walked Lewis. At that time, BKD said, Lewis was a “prominent and well-respected lawyer” who helped communities pay for improvements by creating property owner improvement districts and issuing POID bonds.
The filings don’t say when or why Lewis started creating fraudulent bonds. One of the banks that accepted them as real was First Southern.
Near the end of 2008, Lewis learned that the controlling interest in First Southern was for sale. Lewis arranged for a family trust, PA Alliance Trust, to buy controlling interest in First Southern. Kevin Lewis’ father had created the trust for his grandchildren.
Lewis took control of the bank in May 2009, and it continued buying his phony bonds.
In an interview with Arkansas Business last week, Castleberry suggested that Lewis might have bought the majority interest in First Southern in order to make it easier to find other banks that would buy his phony bonds. “Because he knew he was going to have to, at some point … find other outlets to keep that scheme going,” Castleberry said.
Lewis also may have wanted to grow the bank so that it would be worth a lot of money, he said. “I really don’t know what he was thinking,” Castleberry said. “It doesn’t make a lot of sense.”
Gives Directors Bonuses
After buying controlling interest, Lewis had set his sights on developing a First Southern branch in Searcy, his hometown.
“He had talked about wanting to grow the bank and specific strategies in different markets we might go into,” Castleberry told Arkansas Business. “Frankly, the kind of stuff any de novo bank would talk about.”
While Lewis was at the bank, he quietly gave some directors bonuses.
Director Jennifer Styron, who at the time used the last name Styron-Ripa, received approximately $143,000 worth of First Southern stock from Lewis, according to the FDIC’s pleadings. Lewis also personally guaranteed her home mortgage.
The filings don’t contain Styron’s complete deposition, and the excerpts that were made public don’t explain why Lewis guaranteed her mortgage or specify where the home was.
Styron declined to comment to Arkansas Business.
In a deposition taken last August, Styron confirmed that Lewis gave her the shares but said she didn’t know who had owned them. “It was supposed to be for retirement,” she said.
Styron’s signature appears on three of Lewis’ fraudulent improvement district bonds, where she is listed as the registrar, the FDIC said in its filings.
In the deposition she confirmed that it was her signature, but she didn’t remember signing them. “I have no clue” what a bond registrar is, Styron added.
In June 2012, Styron, without admitting or denying any unsafe or unsound banking practices or any breaches of fiduciary duty, agreed to a lifetime ban from the banking industry.
Jim Haynes, a director of First Southern and its executive vice president and chief lending officer, said in his Aug. 21 deposition that he didn’t know Lewis had guaranteed Styron’s mortgage and given her other gifts.
Haynes said he received about 150 shares of First Southern from Lewis but couldn’t remember details of the gift.
Also in February or March 2010, Lewis gave Haynes $26,000 in the form of a check from the Lewis Law Firm. Haynes said he considered that money to be a bonus to compensate him for the bonus he missed out on when he left Centennial Bank of Conway to join First Southern in 2009.
“I had made it known when I took the job that, you know, I’m giving up this,” he said.
He didn’t receive any tax forms for the money and he didn’t claim it as taxable income. “I guess the IRS will come back and look for that,” he said.
Haynes, who is now Centennial’s regional president in northwestern Florida, declined to comment.
First Southern’s appetite for Lewis’ investment bonds continued. Castleberry disclosed the purchases on the bank’s monthly balance sheets in 2010.
“None of FSB’s board members questioned the ever-increasing number of POID bond purchases, and indeed, many board members never even noticed, even though the information was presented to them,” BKD said in its filing.
By the time the bank acquired its final POID bond, it had less than $14 million in equity capital but more than $23 million in POID bond holdings, BKD said.
“Had the Bank or its board performed its due diligence on the POID bonds, or at least limited its exposure to the POID bonds, it is highly likely that FSB would have sustained very little, if any, damages,” BKD said.
The trial is scheduled to start at 9:15 a.m. Monday in the federal courthouse in Little Rock before U.S. District Judge James Moody Jr.