Stanford International Bank may not have been investing client funds in the kind of secured assets they had claimed.  Among the many revelations in the unfolding scandal was the company’s majority position in Health Systems Solutions, Inc. (HSSO.OB), a pink-sheet stock with negative shareholder equity, that has been operating at a loss for several years.   It’s difficult to say how Stanford’s 82% equity position, plus a substantial holding of convertible preferred stcck and warrants, is serving them in such an endeavor.

However, as each day brings yet another unwelcome revelation about Stanford, or another foreign bank seizure, it does make one wonder what the company was up to with this purchase.

Let’s take a look at another holding of Stanford’s that has yet to be reported.  Through an affiliate, Stanford Financial Group, they began investing in Superior Galleries, Inc. back in 2002.  The company, a rare coin auctioneer, also traded on the pink sheets and had a history of annual losses, which continue to this day.

Call me crazy, but why would any investor (much less a bank) want to inject millions of dollars of capital into a business that regularly lost money, with a low barrier to entry, and didn’t seem to have much of a future?

Then, in July of 2006, Superior announced a merger with DGSE Companies, Inc. (DGC).  Here was another struggling entity, albeit one that had been turning a tiny profit from their business of selling wholesale and retail jewelry, gold bullion, and most recently had also entered the rare coin business.  It had tried, and failed, to launch a payday loan business in New Mexico, and ran a pawn shop out of Dallas.  DGSE’s stock had floundered in the $2 range for years.  It had a credit line with Texas Capital Bank, but the sad truth was that they were consistently generating negative cash flow.  While they had been making interest payments and their inventories were enough to cover the credit line, they never would have gotten out of debt.  Texas Capital essentially owned the business.

So who facilitated the merger of these two flea-bitten mongrels?  Stanford.  They swooped in, offering an $18 million credit line subordinated to Texas Capital Bank, exchanging $6.5 million of it for about a 35% equity stake in the new company. 

So, call me crazy, but why would any investor throw money at not one, but two struggling companies?  Did they see some way of altering the merged entity’s strategies to make them more profitable?   Not much has changed since the merger, so apparently that theory doesn’t work. Was it just really bad due diligence?  Stanford didn’t become a billionaire by making such silly mistakes.

Perhaps the answer lies on Page 17 of the Sept. 30, 2006 10-Q for Superior.  “On November 21, 2006, the company entered into an agreement with SIBL (Stanford) pursuant to which the balance outstanding under the Commercial LOC will be reduced by up to $2,408,481.81 through the transfer of rare coins to SIBL.”

Then there’s the 10Q for Q3 of the combined entity, in which “”During the first nine months of 2008, approximately $2,800,000 of our revenue was for bullions sales to Stanford Coin and Bullion, a wholly-owned subsidiary of Stanford International Bank Ltd., our second largest shareholder.”

Hmmm.  $2.4 million of rare coins and $2.8 million in gold bullion transferred into Stanford’s possession?   And all these media reports of money laundering?   And investments that no savvy investor would ever make – unless one wanted to be invested in hard assets such as rare coins and bullion because one wanted to be able to convert cash into these hard assets for some reason.

I would caution that these revelations don’t prove anything.  It is merely circumstantial.  But when there’s smoke, there is often fire.   And as if investors needed yet another reason why penny stocks should be avoided, they’ve just got two new ones.

Lawrence Meyers is a former writer for the Motley Fool, and is President of PDLCapital, a private equity firm (www.pdlcapital.com). He does not own shares in any company mentioned. This article is only an expression of the author’s opinion, may contain inaccuracies, and is not a solicitation to buy or sell any security. All readers are advised to consult with a financial advisor prior to making any investment. The author may be contacted at pdlcapital@earthlink.net