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A federal grand jury is sifting through the collapse of Sonoma Valley Bank and its use of taxpayer bailout money, part of a criminal probe examining loans the bank made to one of its largest borrowers.

The bank, which imploded 11 months ago amid overwhelming loan losses, was only the fifth bank in the nation to fail after receiving an infusion of money through the federal bank bailout program.

A government agency created by Congress to examine misuse of bailout money has interviewed at least a half-dozen former bank employees. Most of the questions have focused on Marin County developer Bijan Madjlessi and his relationship with the bank and its senior management, said a former bank employee, who spoke on condition of anonymity.

The far-reaching criminal investigation, which includes agents from the FBI and Internal Revenue Service, is also exploring personal financial ties between Madjlessi's wife and one of the bank's loan officers, according to sources close to the case.

The full extent of the probe remains closely guarded while investigators work with the U.S. Attorney's Office to present evidence to a grand jury that has been meeting in U.S. District Court in San Francisco.

The grand jury ultimately will decide whether anyone should be indicted on criminal charges. No criminal charges have been filed.

The bank repeatedly broke standard lending rules in its dealings with Madjlessi, his companies, his employees and his business associates, The Press Democrat discovered in public records, private documents and interviews with dozens of former employees, borrowers, investors, analysts and other banking executives.

"There is no question there was a violation of standard bank lending practices," said Fred Ptucha, a local banking analyst with Financial West Group in Santa Rosa. "Whether they broke any laws, well, that remains to be seen."

Loans to Madjlessi were arranged by a bank officer who had a personal financial relationship with the developer's wife, according to documents obtained by The Press Democrat.

Brian Melland, who helped arrange more than $40 million in loans for Madjlessi and his business partners, solicited and accepted startup money from people associated with the developers in order to fund his fledgling energy drink company, according to a copy of an investment agreement.

Melland's wife alleged in January that her husband was under investigation as part of an FBI probe into bank fraud, according to divorce papers she filed in Sonoma County Superior Court.

Melland, who now works for Sonoma Bank in Santa Rosa, declined to comment on the investigation.

Madjlessi referred questions to his attorney, David Lonich. Lonich said his client had done nothing illegal.

Last year, when regulators suddenly locked the doors on Aug. 20 at the close of the banking day, Sonoma Valley Bank became the only Sonoma County bank to collapse since the economic downturn began toppling financial institutions across the country in 2008. Its three branches and most of its assets were purchased by San Rafael-based Westamerica Bank.

Former Sonoma Valley president Sean Cutting, who is now senior relationship manager at Rabobank in Sonoma, and other former executives and directors of the shuttered bank declined to comment.

But shortly after its closure, Cutting issued a public statement signed by bank directors blaming the sharp real estate downturn for their troubled loans. They said overly aggressive regulators shut down a stable, profitable bank that had earned a reputation over two decades of being "one of the most generous, helpful, caring and supportive institutions in town."

Loans to Madjlessi

A major factor in the bank's demise was the role of Madjlessi and his business partners, who had defaulted on at least $34 million in loans — equivalent to about 14 percent of the total money deposited at the small community bank.

The loans were made for three Sonoma County projects — a condominium development in west Santa Rosa, a condo-conversion project at an apartment complex in Petaluma and a self-storage facility in south Santa Rosa.

If not for those failed loans to Madjlessi and his associates, the bank could have survived, Ptucha said.

"It would have suffered like all banks suffered, but the bank would still be here," he said. "But they loaned him too much money."

When Madjlessi and his business partners began defaulting on the loans in the spring of 2008, the bank granted them extensions and even loaned Madjlessi additional money.

"That in and of itself is a problem," said Ann Fulmer, a former white-collar crime prosecutor and a bank fraud expert in Southern California. "It gave the appearance that these troubled loans were performing better than they were."

In late June, several people tied to Madjlessi received subpoenas to testify or provide documents to the grand jury, according to court records. Madjlessi was identified as a target of the grand jury investigation in the same records, which were filed in a civil lawsuit in Marin County.

Won't testify in case

Madjlessi has decided not to testify in the Marin County lawsuit because "given the subject matter of the Investigation, the risk of self-incrimination is readily apparent," according to a document filed by Madjlessi's attorney in the case.

"That is what the Fifth Amendment provides him," Lonich said. "That does not indicate any culpability at all."

Subpoenas for the grand jury are being administered by the Special Inspector General for the Troubled Asset Relief Program. The program, known as TARP, was created in 2008 to stabilize the U.S. financial system by shoring up struggling banks with taxpayer money. Sonoma Valley Bank received $8.7 million through the program in February 2009.

The agency investigates allegations of waste, theft and abuse of TARP money, according to its website.

The grand jury also appears to be looking at loans Madjlessi received from other banks, according to both public and private documents obtained by The Press Democrat.

Assistant U.S. Attorney Jeffrey Finigan, who signed the grand jury subpoenas, declined comment.

Former Sonoma Valley Bank shareholders, who lost everything when it closed, also filed a class-action lawsuit last month blaming Cutting and other bank management for failing to appropriately manage lending — particularly with regards to Madjlessi.

The Federal Deposit Insurance Corporation, which is hoping to recover some of the estimated $14 million it lost in the bank's collapse, continues to investigate the failure as it decides whether to file a civil lawsuit against bank executives for negligence.

Now federal investigators are sifting through the wreckage left by the bank's collapse to see if there is evidence of bank fraud or other criminal activity.

Relationship under scrutiny

Federal criminal investigators are examining the financial relationship between Melland and Madjlessi's wife with particular interest in the timing of their private deals, according to sources close to the case.

Melland co-owned a company, Magnus Innovations Group, that had created a line of energy drinks targeting Spanish speakers. In one instance, the loan officer's startup company received money from Madjlessi's wife only days before he arranged a new loan for her husband.

On April 1, 2008, his company received a $50,000 investment from Biganeh Madjlessi, the wife of Bijan Madjlessi, according to a copy of the investment agreement obtained by The Press Democrat.

That same week in 2008, Sonoma Valley Bank made $3.7 million in loans to one of Bijan Madjlessi's companies involved in the condo-conversion project in Petaluma, according to county land records. Melland helped arrange the loans, part of $11.1 million in loans made during a five-month period for the Petaluma project.

Those loans eventually went into default in 2010, and the Petaluma apartment buildings used as collateral were recently valued at only 22 percent of the outstanding loan amount, according to court records.

Lawyer: No conflict

Lonich said Biganeh Madjlessi did nothing wrong by investing in Melland's company. The investment did not create a conflict of interest because she was not involved in the loans from Sonoma Valley Bank, Lonich said.

Lonich, in an email Saturday, also said that Sonoma Valley Bank was aware of her purchase of stock in the drink company on or about the time she made it and had determined it did not violate bank policy.

According to the 2008 investment agreement, by the times the bank loans were made, Biganeh Madjlessi and a business partner of her husband had invested $250,000 in Melland's company.

For a loan officer to intermingle personal and bank business is "absolutely unacceptable," said one local bank president, who had no direct knowledge of the situation and asked to remain anonymous given the ongoing federal investigation.

Another North Bay bank president said, "No way. You are not going to solicit our customers for your own business. It's a conflict of interest."

Melland's company eventually failed, said Brion Norby, a Williston, N.D., resident who invested money in the company.

Another investor identified in the defunct company's records was Glenn Larsen, a longtime business partner of Bijan Madjlessi.

Larsen said he never invested in Melland's company, but acknowledged the loan officer had discussed the venture with him.

"I heard about it from Brian Melland," Larsen said. "He mentioned that he was doing it, and asked if I knew anyone who was interested in investing."

Larsen said he did not know why he was identified as an investor on documents that sources said both Melland and Madjlessi had distributed.

"Preferential treatment"

Larsen, a private lender from Marin County, said he and Madjlessi have teamed up on several development projects in the North Bay.

But when one of their projects collapsed in late 2009 and Sonoma Valley Bank sued Larsen to collect its money, Larsen filed a countersuit alleging the bank had negligently provided Madjlessi "preferential treatment."

The countersuit, which Larsen dropped last week, alleged bank management allowed Madjlessi to divert $3 million in loan funds for "his own personal use."

Larsen and Madjlessi had owned a self-storage project in Santa Rosa that received a $10.7 million loan from Sonoma Valley Bank in 2006.

His lawsuit alleged bank representatives removed Madjlessi as a co-borrower on the loan in 2007, relieving him of responsibility to repay the loan. The action, Larsen alleged, was designed to circumvent federal lending limits and enable the bank to make additional loans to Madjlessi so bankers could enrich themselves by charging "more points and fees" on the new loans.

Melland was a loan officer on the deal, according to the lawsuit filed in Sonoma County Superior Court.

Lonich denied Larsen's allegations.

"It's false," he said. "There was never any diversion of any funds."

Larsen, who defaulted on the outstanding loan balance of $11 million in late 2009, sued the bank to erase the debt or reinstate Madjlessi as a co-guarantor of the loan, meaning they both would be on the hook for repaying it.

Larsen dropped the lawsuit Thursday after being contacted by The Press Democrat. He declined to discuss the lawsuit, or why he thought the bank provided Madjlessi preferential treatment.

Favorable loan terms

Madjlessi's business partners and employees received loans from Sonoma Valley Bank under apparently favorable terms that several senior executives at other local banks described as imprudent and risky.

For instance, in early 2009, the bank made a $5.5 million unsecured loan to one of Madjlessi's business associates, James House — a loan that Madjlessi had helped arrange.

At that time, near the peak of the financial crisis when the economy ground to a halt because banks were not lending, it was highly unusual to receive a loan without providing some form of collateral such as a real estate deed.

Yet Sonoma Valley Bank did not record any security from House until 11 months after making the loan, and during that time it loaned him an additional $4 million, according to public records. It eventually recorded collateral on the combined $9.5 million loan with the Sonoma County Recorder's Office in early 2010.

"That is odd," said a local bank president. "That is not the prudent way."

House, a Southern California construction contractor, was subpoenaed by the federal grand jury in San Francisco, according to court records filed in Marin County Superior Court in late June. He could not be reached for comment.

Lonich, who represented House at the time, denied the loan was unsecured, and said the bank had simply decided to record its collateral at a later date.

However, waiting to record collateral is dangerous, Fulmer said.

"Someone else could have come in and filed a lien, and the bank's lien would no longer have first priority with regards to being repaid," she said. "It is highly unusual for a bank to delay recording a security instrument."

In another case in 2009, the bank approved a $436,500 home loan for one of Madjlessi's employees who had just defaulted on another real estate loan.

Jennifer Irvine, who worked for Madjlessi at his condo development in west Santa Rosa, received a loan to purchase one of the units on Sebastopol Road just two months after she lost her Cloverdale home to foreclosure for defaulting on a $600,000 loan. The loan from Sonoma Valley Bank has not fallen into default, according to public records.

Criminal investigators are now focused on sifting through loan deals tied to Madjlessi to determine which should be presented to the grand jury, according to sources.

Regulators have shuttered more than 375 banks across the country since the U.S. financial system began to buckle in mid 2008. Sonoma Valley Bank is one of the few to come under criminal investigation, experts said.

"There are an alarming number of red flags here," Fulmer said.

You can reach Staff Writer Nathan Halverson at 703-1577 or nathan.halverson@pressdemocrat.com.