Practice of Undisclosed Commissions Declines; Debate Rages On
by Ryan Conley
Date Posted: 7/31/2007 9:22:28 PM

One side calls them secret commissions. The other side calls them tips.

Some call them kickbacks. Others call them gifts.

There are those who point fingers and shout that such dealings are out and out fraud. But some, including many who don’t agree with the practice, simply shrug their shoulders and say it’s just the way business has always been done.

Buyers stung by what they call bad deals say they need protection — asking legislators to draft laws with teeth that bite — and some have asked courts to help them collect retribution in the way of cold cash.

Most sellers say they will be glad to play by the rules, but some suggest the buyers – including known champions in other industries – should have done a little detective work on the folks with whom they were entrusting large sums of money.

The debate within the horse auction industry over the ethics of undeclared commissions for buyers’ agents may rage on, but one thing appears certain: Such activity appears to be on the decline.

High-profile crusades by such owners as James McIngvale and Jess Jackson have focused bright spotlights on auction practices previously hidden mostly in the shadows, including dual agency, private purchases of horses before entering the sales ring, and undisclosed medical and surgical procedures, among others.

And now, love it or hate it, the cries for transparency are having an impact.

“Some civil actions that have come about in the last years have made a lot of consignors re-evaluate how they do business,” said Bayne Welker, president and chairman of the Consignors and Commercial Breeders’ Association. “We are selling horses in a different time, and things that may have at one time been a way of doing business aren’t looked (at) in favor anymore.”

And that’s like music to the ears of McIngvale, the Houston furniture king who in May settled his lawsuit with nine horsemen and sales entities named as defendants.

“Part of my objective was to let people know that these practices go on,” said McIngvale in a July interview while sitting on a sofa in one of his Furniture Gallery locations in Houston. “And if the horse racing industry wants to grow this business, they need to be transparent. I think that is the key word in the 21st century: transparency. Things need to be transparent. What you see is what you get.”

PAPER TRAIL

McIngvale’s legal team claims documents collected in the course of both formal and informal discovery clearly indicate money was paid by consignors and/or sellers to limited liability companies affiliated with the Florida agent team of brothers J.B. and Kevin McKathan, who were original defendants in the dispute along with trainer Bob Baffert.

McIngvale invited The Blood-Horse to review material not protected by confidentiality agreements.  A collection of documents housed at the offices of his Houston attorneys included copies of multiple canceled checks and paperwork detailing a couple undisclosed intermediary sales in which the McKathans were allegedly involved.

The preponderance of evidence was the primary factor McIngvale’s attorneys credited for settling the dispute just eight months after the original complaint was launched.  The action was filed just before the opening of the 2006 Keeneland September yearling sale.

“This is a case that Hank and I would have loved to have tried,” said attorney Dan Pipitone, who credited his lawyer colleague Hank Stout with performing much of the investigatory endeavors. “We feel as though we gathered some overwhelming evidence.”

All told, Pipitone and Stout said they were able to link undisclosed sellers' commissions and intermediary transactions to about 20 purchases the McKathans made for McIngvale from 2001 to 2004.  The attorneys claim those deals netted the agents more than $630,000 more than the 5% fee per sale McIngvale had agreed to pay the agents. They also obtained ancillary evidence suggesting that such dealings weren’t limited to McIngvale.

“When you see the type of conduct contained in all of these documents, the first question in your mind, the only logical question, is: 'Am I buying a great individual, or am I buying a horse that the McKathan brothers made some money off of?'” Stout said.

J.B. McKathan, who regularly asked to defer comment until the legal dispute was over, said in an interview that he would never do anything to hurt either his clients or the industry.

“I would never do anything that would be contrary to making our game better,” he said. “I would never do anything that I felt in my heart would hurt the game. I am always trying to get someone a good horse.”

Rather, McKathan said the money he received from consignors and sellers, which he described as tips, was a standard way of doing business for a broad cross-section of the industry.

“We were playing the game as it had always been played,” he said. “As far as tips go, I’ve paid them and I’ve made them. But the scene and climate have changed. And now that the climate has changed, I’ll change.”

“The point I would really like to get across is that we would never, ever buy a horse because we were going to make money on the deal,” he continued. “I would never do anything like that. This is my life’s blood. I wouldn’t do anything to hurt the business. And frankly, there are people out there who would only buy a horse if they can make money on it. I’m not naming any names, but that’s not us.”

According to McIngvale’s complaint, more than half (30 of 50) of McKathan-related transactions didn’t involve what it called “secret commissions.”

MAKE A DEAL

Many of the key documents collected by McIngvale’s legal team came from cooperating consignors and/or sellers involved in the transactions, including some who paid out commissions. Those who cooperated were given assurance they would not be joined in the action, the attorneys said. Conversely, those who didn’t were added to the lawsuit.

“The principle we adopted was that we wouldn’t enjoin the consignors, but would only change that when the consignors proved to be uncooperative,” Pipitone said.

One of the more intriguing sets of documents involved the $450,000 purchase of Compulsive for McIngvale at the 2004 Ocala Breeders’ Sales Co. March 2-year-old in training sale. Pipitone and Stout contend that handwritten notes by the consignor on his OBS statement of account suggest the McKathans purchased the horse in advance by guaranteeing its three partners $200,000.

The attorneys obtained a copy of a canceled check for $118,750 that was ultimately cut by the consignor to Emerald Aviation Enterprises, a Florida corporation in which Kevin McKathan is listed as a manager.

“One of my problems in life is that I trust people too much,” McIngvale said. “That’s probably more of a virtue than a fault, though some would consider it a fault. I always thought that they had my best interest at heart. I always wanted to make sure that I paid them quick and I paid them well. I figured they were making money on the deal, so there was no reason to bamboozle me.”

J.B. McKathan said the lawsuit’s version of the Compulsive transaction wasn’t true, but he declined to elaborate.

Stout acknowledges the premise that undisclosed commissions, as opposed to intermediary sales, were accepted by many as a way of doing business, i.e., tips for a job well done. He claimed some consignors he spoke with said they always pay a commission to the buyer agent without being asked. Others said they did only when asked, and among them, there wasn’t a consensus whether the practice was right or wrong.

But none of that matters, Stout said, claiming that “common law says that agents have a duty to disclose all material facts to (their) principal -- all facts that are going to affect the principal’s decision."

“McIngvale had the right to know whether or not the McKathans were going to receive a commission … (or) whether the person had an ownership interest in the horse, and that was never told to him,” he continued. “And for anyone to say that’s just an industry practice and that (McIngvale) should have known about it, that’s just not true. That’s not what the law says.

“The obligation that an agent owes to his principal is pretty much the same wherever you go: Texas state law, Kentucky state law, Florida state law, wherever.”

UNKNOWN IMPACT

It’s impossible to determine how much of this activity has gone on through the years.

“We don’t know how widespread it was,” said Dan Metzger, president of the Thoroughbred Owners and Breeders Association.

Metzger said calling seller fees either a secret commission or a gift is “in the eyes of the beholder,” and open for interpretation by many in the industry.

“And that is the difficult part,” he said. “But now we know, at least in Kentucky, that dual agency is prohibited … and now there is potential legislation that could be introduced in Florida. I would believe that would give someone pause before they engage in practices that they may have done in the past."

Horsemen surveyed on condition of anonymity at the recent Fasig-Tipton July yearling sale agreed such activity has dwindled, but some suggested the lawsuits and legislation have simply forced such dealers into more secretive settings.

“I think there is a probably a 90% decline in what did go on, as to what goes on now,” said one prominent consignor. “But those that have the criminal element are going to try and do it regardless. It won’t matter; it will still go on. There will always be people that will try and circumvent the rules.”

McIngvale accepts that fact and has continued to buy horses and race – although on a much smaller level, employing his sister-in-law, Laura Wohlers, as a trainer. He has said from the beginning of his lawsuit he believed only a tiny minority has committed fraudulent acts in the horse industry.

“I like the game,” McIngvale said, adding he is always on the lookout for a “big” horse. “I’m bound and determined to be one of the 5% that makes money at the game. That’s admittedly a tough assignment. But perseverance has always been my strong suit. So if I stay in long enough, I’ll get a horse … that will get me even and get me ahead.”

J.B. McKathan said he hopes McIngvale gets that moment in the sun.

“I wish Mac would get what he wants,” he said. “I wish he would get a really good horse. He’s put (in) enough time and effort, and enough of his emotional energy, that I really hope he gets one.”

McIngvale said the McKathans are good horsemen, and that Baffert is a good trainer.

“I’m satisfied that it’s all over,” McIngvale said. “I think that I am satisfied with the results, and that it is behind me, and that hopefully, some good things will come out of it.”

Attempts by The Blood-Horse to obtain comments from Baffert were unsuccessful.

The McKathan brothers, who operate a training center near Citra, Fla., are focusing on their business of preparing 2-year-olds for such trainers as Baffert and Bill Mott, and are promoting their own sales horses. One such product is Leonides, a runner-up in the July 4 Hollywood Juvenile (gr. III), who was pinhooked and sold privately by the McKathans to trainer Vladimir Cerin.

Metzger said the industry should give credit to men like McIngvale and Jackson, “because they shed a light on some practices that needed to be addressed. And while some may have questioned their methodology, at the end of the day, what they did was a tremendous service to the industry.”

As does Metzger, Welker believes the effects of such legal actions, as well as teaching efforts of such groups as the CCBA, have already brought new owners into the marketplace.

“Let’s hope, that by some of these things being addressed and coming out in the open, that it would embolden more people to come into the game,” he said.



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