CRESTVIEW HILLS, Ky. - It was January, and the directors and officers of Peoples Bank of Northern Kentucky had cause to be optimistic.
The bank, in a Cincinnati suburb, had grown in just a decade from a one-branch start-up with $6 million of assets to eight branches with $208 million of assets. It had just reported record earnings of $3.1 million.
Apparently convinced of the bank's future success, 17 directors each purchased $236,000 of stock that month, roughly the sum each had put up 10 years earlier. One director, the owner of a chain of local grocery stores, bought an additional $1 million worth from another shareholder.
"The bank was doing great. We were so proud of it," said director Tom Sumerel, whose family runs tire stores in the Cincinnati area.
But by July stone-faced directors stood before a roomful of reporters to announce that Peoples' assets would be sold to a rival.
Three months earlier the board had fired its top two executives - president John Finnan and executive vice president Marc Menne - and said they had been operating a side business with a customer that, though not illegal, posed serious conflict-of-interest concerns.
At the same time the directors said they had learned that employees of that customer, home builder Bill Erpenbeck, had stashed in his company's Peoples account some $24 million that should have been used to pay off construction loans. As a result, more than 200 homeowners discovered that they did not hold clear title to their homes, and many sued Peoples as an accomplice.
The scandal has clearly stunned this small, tight-knit community, where Mr. Finnan, 49, and Mr. Menne, 46, were well known for their involvement in civic and business affairs. Though no charges have been filed against them, the Federal Bureau of Investigation and the Federal Deposit Insurance Corp. are trying to determine if the fired bank executives had any knowledge of the converted checks.
"It's been tough," said builder John Yeager, the chairman of the bank's board, in a recent interview. "No one in a million years ever expected anything like this from [Mr. Finnan and Mr. Menne]. They were the salt of the earth as far as we were concerned."
The bank has admitted some liability, saying it unwittingly allowed Erpenbeck Co. employees to deposit checks made out to other lenders. Peoples has already paid back $8 million to those lenders - thus giving the homeowners clear title - and has said it plans to pay off the rest with the proceeds of its sale to $535 million-asset Bank of Kentucky Financial Corp. of Florence.
Through their lawyers, Mr. Finnan and Mr. Menne said they had no knowledge of the check conversion scheme, though they have acknowledged their business dealings with Mr. Erpenbeck. Both have lost not only their jobs but also their opulent homes, and a Florida condominium they jointly owned is on the block. Neither is working, and both could face jail time if charged with and convicted of federal crimes.
Mr. Erpenbeck, who left his homebuilding business a shambles earlier this year, has been cooperating with investigators from the FBI and U.S. Attorney's Office in Cincinnati. His attorney, a white-collar defense specialist from Cincinnati named Glenn Whitaker, has said Mr. Erpenbeck is trying to work out a plea agreement under which he would plead guilty to yet unspecified crimes in return for reduced jail time.
Federal prosecutors continue to piece together the paper trail in the case. A resolution is not expected before November, the lead prosecutor in Cincinnati has told lawyers involved in the case.
Meanwhile at Peoples Bank, directors say they are pondering how two trusted executives and a once prominent home builder destroyed what had grown into a successful financial institution.
"We still wonder " said Mr. Yeager, "what caused all of this to make this happen."
A BANK IS BORN
The greater Cincinnati banking market underwent profound changes during the 1980s, when superregionals began moving in. To avoid being gobbled up by larger companies, local banks began buying community banks in Cincinnati and nearby, including northern Kentucky, a growing three-county area along the Ohio River.
In the late 1980s, John Finnan, a native of Richmond, Ind., was the president of Peoples Liberty Bank, a small bank in Covington, Ky., that Star Banc Corp. of Cincinnati bought in 1987. (Star became Firstar Corp. in a 1998 merger and U.S. Bancorp in one last year.)
Mr. Finnan stayed with Star for a few years, running the northern Kentucky operation. In 1991 he began soliciting businessmen to invest in a start-up bank, and among the first he recruited was Mr. Yeager, a builder of luxury homes and small office and retail buildings.
"John was a very close friend, and when I look back at the time we started the bank there was a lot of disenchantment in the community with the regional banks that were moving into the area," Mr. Yeager said. "We wanted a more personal banking system and knew this was the perfect place to create a niche for a small bank."
Peoples Bank of Northern Kentucky was launched in January of 1992 with assets of $6 million. Its first branch, which also served as headquarters, was a trailer.
From the start Peoples' targeted wealthy business owners and executives living in a nest of affluent suburbs nearby. The bank's executives and directors wanted to know every major customer.
Board member Mark Arnzen, a lawyer, described it as a "character-based lender".
"The most fundamental and basic ingredient in lending is know who is a good credit risk and who isn't," Mr. Arnzen said. "That was the basis of how we lent money. We always did our due diligence, but we live and work in this community, and we made it a point to know who are customers were."
Among those customers was a flamboyant young home builder named Bill Erpenbeck.
Handsome and athletic - he attended college on a baseball scholarship - Mr. Erpenbeck was in his mid-30s when he left his family's home-building business to start his own. He was among Peoples' early customers, and by early this year he was its biggest depositor and borrower. His loans totaled $6 million, the most that federal guidelines let a bank Peoples' size lend to one customer.
By 2000, Builder magazine had listed Erpenbeck Co. as the fourth-largest developer in greater Cincinnati, with sales of $84 million.
Mr. Erpenbeck seemed as successful as his company. He built a $1.3 million home on a golf course he developed, threw big parties, and spent time at the Waterfront, a swanky riverfront bar frequented by professional athletes and rich businesspeople.
Mr. Finnan and Mr. Menne became close to Mr. Erpenbeck and even lived in houses that he built. Mr. Finnan's home cost $800,000 and was on the same exclusive street as Mr. Erpenbeck's. Mr. Menne's cost $600,000 and featured an award-winning garden he tended.
JOHN, ALICE, MARC, SUSAN
In 1997 the two executives started a business with their wives - without the bank board's knowledge, Mr. Arnzen said - that bought model homes from Erpenbeck Co. developments and made money by leasing them back to Erpenbeck until he no longer needed them.
JAMS - the company's name used the first initials of the four partners - would sell the homes to recover their initial investment. Mr. Erpenbeck benefited because the deals allowed him to remove debt from his books while providing cash for him to develop more homes.
Mr. Yeager said the practice is common in the home-building industry. Still, bankers are required to fill out personal financial disclosure forms - but Mr. Arnzen said Mr. Finnan and Mr. Menne never disclosed details about JAMS, though they did indicate that they were investing in real estate.
"If [the board] knew about JAMS we would have put a stop to it," Mr. Arnzen maintains.
Fred Alverson, a spokesman with the U.S. Attorney's Office in Cincinnati, said federal investigators are looking at JAMS, but he would not offer specifics.
Last year Mr. Erpenbeck's fortunes began to dim, with the economy. Sales dropped by nearly 30%, contractors were not being paid, and at midyear Peoples began closely watching Erpenbeck's loans, Mr. Arnzen said.
"We knew his business was slowing and he was having trouble paying his bills," Mr. Arnzen said. "But we didn't know what was really going on." On examining Erpenbeck accounts, he said, Peoples discovered trouble going back for more than a year.
When an Erpenbeck home was sold, he said, the title agent would entrust the builder with the check cut at closing to the bank that had financed the construction. Such checks usually eliminate all debts and liens attached to a home; Erpenbeck was expected to forward them to the lender.
But in January 2000, Mr. Arnzen said, Erpenbeck employees started depositing those checks in Erpenbeck accounts at Peoples. The banks that financed the construction claim they never knew this, because Erpenbeck Co. did not report sales to them.
Merwin Grayson Jr., a former Huntington Bank regional president brought in by Peoples' board in April to run the bank, said the checks eluded its tellers because Erpenbeck employees often slipped them in with others when making deposits.
Mr. Arnzen said that a teller discovered a discrepancy in mid-2001, and that a branch manager contacted Mr. Erpenbeck, who promised that it would not happen again. But the practice continued for nearly another year until the scheme was uncovered, Mr. Arnzen said.
Federal investigators have said they became aware of the checks this January and launched an investigation. Over the course of a few days in late March and early April, after Erpenbeck abruptly resigned from his company, Mr. Finnan finally informed Peoples' board about JAMS and the checks, Mr. Arnzen said.
Mr. Finnan and Mr. Menne were immediately fired, he said, and directors later learned that Finnan covered $1.2 million in overdrafts for the Erpenbeck Co. in early March, essentially flouting the limit on loans to one customer.
Bert Ely, a banking consultant in Alexandria, Va., said he could see how a check diversion scam could work.
"Tellers don't look at checks that closely, unless they're being cashed," Mr. Ely said. "If you're a regular customer, I don't think things are looked at that closely."
Peoples has since been hit by dozens of lawsuits filed by homeowners, contractors, title companies, and others wanting money they are owed by Mr. Erpenbeck. Most claim the bank was negligent in allowing the checks to be diverted.
Peoples was standing tough and preparing to fight, trying to recover some of the diverted funds from title companies and other lenders that were also represented at the closings. Negotiations are continuing, but no settlement has been reached.
EPILOGUE
The bank's days were numbered once plaintiffs' attorney Stan Chesley filed a class action on behalf of the homeowners. Once the news broke in April, lawsuits piled up, customers withdrew millions of dollars, and directors conceded it was better to sell than fight.
"We probably could have survived the lawsuits and the bad Erpenbeck loans" of as much as $5 million, said board member Paul Hemmer. "But we just couldn't cover all those checks and still stay in business. That put us over the top."
Peoples' directors have steadfastly insisted that they knew nothing about JAMS or the check scam; they point to the January stock purchases as evidence of their confidence in the bank's condition. But many of the lawsuits, including the homeowners' class action, say the board was negligent for not knowing what was going on at the bank.
Peoples agreed to sell most of its assets, excluding the Erpenbeck loans, to the publicly traded Bank of Kentucky Financial in nearby Boone County. A price has not been disclosed, but Peoples' directors say they will receive enough to cover the $16 million in diverted checks and still have some money with which to fight lawsuits and pay at least something to its shareholders.
Meanwhile, Mr. Finnan and Mr. Menne are waiting to see whether they will be charged with crimes. The federal government has placed liens on most of their personal assets - hoping, according to Mr. Alverson of the U.S. Attorney's Office, to recover money if the two are convicted of any crime and it can be proven that homes, stocks, or other things were purchased with ill-gotten money.
Mr. Finnan has sold his house and moved to northern Florida, according to his lawyer, John Schuh. Already humiliated in a community where he was viewed as corporate and civic leader, he has also sold many possessions - including his children's toys and banking awards he had won - at a public auction covered by local reporters. He has claimed repeatedly that Mr. Erpenbeck duped and misled him.
Mr. Menne has also sold his house and downsized to a $300,000 one the government immediately attached. His attorney said Mr. Menne - known for his garden - might go into the landscaping business.
