For decades now management consultants have told us that one of the best predictors of a company’s success is whether or not the management of a company has put their own personal wealth into the company. The more a manager has at risk if the company’s stock price declines, the more likely he is to work hard to generate “shareholder value.” Investors got into the habit of monitoring management shareholdings – they would buy the stock if management was buying shares in the company, and sell the stock if management was dumping their own shares of the company’s stock. We are beginning to learn, though, that management shareholdings were a mirage, because behind the scenes and out of the view of investors, management was “hedging their bets” The most recent example is Boston Scientific.

This company has been a darling of investors all through the 90s and this decade. Founded by Peter Nicholas and John Abele, the company is a leading manufacturer of heart stents, pacemakers, and defibrillators. When, Nichols and Abele started the company they held patents on several such medical devices, but they cannot be considered as manufacturers. Their real strength was in buying small medical start-up companies, and providing them marketing and distribution muscle to sell their products. Both men became very wealthy, and between them owned over 8% of company stock.

While investors and analysts were keeping their eyes focused on the growth story that was Boston Scientific, and the steady appreciation of the stock price, they did not notice the fine print in SEC filings that indicated that Nicholas and Abele were borrowing over $1.0 billion from the likes of Goldman Sachs, Fleet Bank, Merrill Lynch, Bank of America and many other lenders. The borrowings were collateralized by their stock holdings in Boston Scientific.

One of the earliest loans, way back in 1992, was done by Peter Nicholas to finance a $900,000 home renovation, an aircraft lease, and a $100 million line of credit to build a “diversified portfolio of securities.” In other words, from the beginning, Peter Nicholas really didn’t have any personal exposure to declines in Boston Scientific stock, unlike the investors who believed he had put his fortune into the company. Instead, Nicholas was hedging his risks, and putting his wealth in a portfolio of other companies so he would be diversified. John Abele was doing the same, and along the way both of them would use this debt to purchase billionaire goodies like airplanes, vacation homes, and million dollar redecoration projects.

None of this lending was illegal, and Wall Street went along with the program not just because of the lucrative fees involved, but because it believed it made no investment sense for a wealthy person to put all their eggs in one basket. There are certainly questions of ethics involved if the founders of Boston Scientific, or street analysts, talked up the stock because of the supposed high ownership stake the founders have in the company. What some of these people were telling the investing public was very different from the reality found in small-print in periodic and little-noticed filings with the SEC.

Things started to come undone for Nicholas and Abele last year when Lehman Brothers went under, preventing the two of them from accessing one of their “diversified portfolio of securities” that was now subject to a bankruptcy freeze. The assets were needed because the stock market was starting to sell Boston Scientific, and banks all around the world were beginning to issue calls for more collateral to shore up their loans to the two principals. When Nicholas and Abele couldn’t come up with the collateral, the banks had no choice but to force the two of them to sell some of the collateral and pay back a portion of the loans. So far between them they have sold nearly half a billion dollars of Boston Scientific stock. The sales have been so large, that the stock has lost a quarter of its value since the collateral liquidation began.

In the end, the diversification program ended badly for Nicholas and Abele. Their diversified portfolio sits frozen at the bench of a bankruptcy judge, and has been losing value in the stock market rout, while the two have been forced to sell Boston Scientific stock for such large amounts that the price has dropped considerably.

Investors in the stock are very unhappy with this turn of events and there is talk of a shareholder lawsuit. But for small investors at least, they shouldn’t be surprised. What Nicholas and Abele have been doing over the past twenty years is what many Americans have been doing as well – treating their home like a piggy bank or ATM cash machine, and not paying much attention to the debt being created in the process. For Nicholas and Abele their “home” was their ownership interest in the company they founded – their principal asset. Like a lot of Americans, they decided to leverage their home to the hilt.

Investors do have some small comfort. After this debacle, a few of them are going to need some of the heart stents, defibrillators and pacemakers Boston Scientific sells. Maybe Nicholas and Abele will give them a discount.

(For more facts on the Boston Scientific stock sales see Bloomberg.com - reporter Alex Nussbaum)