You Can't Cheat an Honest Man (20 page)

The SEC and the local authorities weren’t far behind. The SEC made a series of requests for information about ATS and the money it was managing. In late October, Douglas supplied the SEC with a document showing that ATS investors had $35 million deposited in segregated trading accounts. The document was a fake, though. It was based on a single trading account which actually contained less than $28,000.

In November 1989, the Feds arrested Douglas and charged him with stealing about $12 million from his investors. The SEC ordered all of Douglas’s operations closed. A federal court appointed Chicago lawyer Steven Scholes as receiver of ATS to untangle its finances and recover as much money as possible for its investors.

Douglas had divorced his first wife and married a second time. The second marriage collapsed after his arrest. Douglas—who often spoke about himself with a strange detatchment—said, “When my wife found out about all this, she simply could not fathom how I was able to commit such a huge fraud and keep it hidden from her.”

More family shocks followed. Four months later, Douglas’s father was accused in a civil racketeering lawsuit of illegally pocketing more than $800,000 in “finder’s fees” from the scam.

Scholes argued that Douglas
pere
was paid the finder’s fees for acting as a middleman who solicited investors by phone and at meetings. “David Douglas knowingly joined, combined and conspired with Michael S. Douglas and others in schemes to defraud investors in connection with the sale of interests in investment partnerships,” the suit charged.

The father reached a quick, quiet settlement with Scholes. The settlement limited his ability to help his son.

In October 1990, Douglas
fils
pleaded guilty to three counts of mail fraud and one count of lying to the Securities and Exchange Commission. At his sentencing hearing a few months later, Michael Douglas offered a tearful explanation for his actions:

The investor money was coming in too fast—so fast, in fact, that I couldn’t find a place to invest it.... I could see the handwriting on the wall, but I did not want the train to stop. The money’s coming in at $2 million a month, and I’m stretched nine ways to Sunday, $15 million in the hole at one point.

People want to know how I slept nights. It was easy, because I am a winner. I’m goal oriented, and in my mind I’m saying, “One more trade. I can make up the difference. I can be all things to all people.” I tried to trade my way out of my losses.

That statement could be part of a psychological profile (egocentrism, insecurity) as easily as a legal tactic. In any case, it didn’t have the intended effect. Douglas was sentenced to 12 years in prison by U.S. District Judge William Hart, who called the fraud “a cruel crime.”

By early 1995, Scholes had recovered $12 million, consisting mainly of real estate that Douglas had bought with stolen money. Scholes was also trying to recover about $2 million in charitable donations, another $1 million in undocumented personal loans that Douglas had made (including money he’d given his first wife) and some money early investors had taken out of the scheme.

Citing fraudulent conveyance laws that bar giving stolen money to someone else, a federal district court and an appeals court both said the charitable groups had to turn over the contributions. One lawyer involved in the case called the charities to whom Douglas bestowed donations “the real victims,” because they ultimately were “the ones that had to pay the money back.”

But the court ruling was a fitting close to the Douglas story. His greed overwhelmed and obliterated his charitable acts.

CHAPTER 11
Chapter 11:
Family Ties

One of the most surprising—but most telling—factors that control the size and shape of pyramids and Ponzi schemes is the involvement of family members. Many pyramid schemes actively encourage investors to recruit family members. This recruitment serves several purposes. It provides an easy source of new investors. But, in a more Machiavellian sense, it co-opts the most likely critics of someone pouring hard-earned money into a scatter-brained scheme.

On the flip side of the family structure, a consistent theme among Ponzi perps is to divorce long-time spouses as the stolen money begins to roll in. A spouse who’s been around long enough often falls into the thankless role of the conscience to his or her significant other. A perp who’s decided to throw morals to the wind will often decide to throw the potentially most incriminating witness out with the morals.

Finally, and most perversely, some families actually seem to cultivate scams as a common activity. These people usually share a cynical view of money and business—passed from a parent or spouse to other family members.

It’s a cliché of the 1990s that many families are
dysfunctional
. Ponzi schemes offer some of these families the chance to project their eccentricity—and, sometimes, malevolence—on the wider population.

Father-and-Son Ponzi Perps

Sidney and Stuart Schwartz were father and son—but they were also partners in Schwartz & Topper Co., an accounting firm in Nassau County, New York. They also ran STS Acquisition Corp., which set up bridge loans for small businesses and financiers in the midst of mergers, acquisitions or other transactions.
Bridge loans are short-term financing mechanisms that most traditional lenders find too risky to make. For this reason, lenders who are willing to make the loans—most often Wall Street investment banks— make a lot of money from them.

The father and son used their social setting to create a sense of legitimacy in potential STS Acquisition investors. The Schwartzes were regarded as pillars of the community in their section of Long Island; the focal point of their business and social circles was The Old Westbury Club. Sidney was the club officer in charge of membership and former president of his synagogue. (Old Westbury was a “Jewish club,” opened in reaction to other country clubs that excluded Jews as members.) Stuart, with his good looks, wit and gregarious personality, flirted with the women and made friends easily with the men at the club.

Of course, the appearance of legitimacy was only part of the equation. As is often the case, some investors were motivated by simple greed. The Schwartzes offered high interest rates on money invested in STS Acquisition, as much as 18 percent plus bonuses on 90-day loans. These numbers meant annual interest rates ranging between 64 and 216 percent.

Bridge loans are profitable—but they’re not
that
profitable. Despite the impression Sidney and Stuart cultivated with their neighbors and friends, they were crooks. STS Acquisition was a Ponzi scheme. And the father and son used Old Westbury as a proving ground for investors. “I gave them money because I felt, how could a family so involved with the temple and their country club...steal from me,” said one.

For at least four years, from 1988 to 1992, the Schwartzes sloshed investors’ money through a series of pyramid transactions. As their bogus empire was reaching its limits, the Schwartzes claimed a joint net worth of $5.7 million. In truth, their companies were running in the red.

Like many Ponzi perps, the Schwartzes had some problems which they managed to resolve but which pointed to the bigger collapse ahead. The crisis came in early 1992 when the Schwartzes defaulted on interest payments to their biggest client—who would eventually lose $2.4 million in the scheme. Stuart used his personal relationship with the big investor to plead for more time. His story was that STS Acquisition was growing so fast that all of its money was out working. Better to be cash-poor and collecting big interest than just sitting on the money.

The big investor would later say: “[Stuart] came to weddings and birthdays. He was like a son to me. When he asked for money, I said, ‘What’s the collateral?’ He said, ‘Collateral? I’m dealing with millions of dollars and bank presidents.’ So I gave a series of loans, and he gave me promissory notes. But now there is not a day I get up that I don’t wonder how could I be so stupid.”

By late 1992, the Schwartzes couldn’t charm investors fast enough to prevent the collapse. Dozens of STS Acquisition interest checks were bouncing. Sidney and Stuart were suddenly hard to reach. Panicky investors got together and demanded a meeting.

The first meeting took place in Florida, where many STS Acquisition investors had either winter or full-time residences. Because the Schwartzes had been receiving physical threats, they hired a security guard to keep order. At one point Stuart put his head against the wall of the conference room and cried, one investor who attended the Florida meeting recalled. Another investor said: “One man was so agitated, saying, ‘This is not just my money, it’s my son’s money, and he can’t afford to lose this.’ He leapt across the table and tried to strangle Stuart.”

After this meeting, the Schwartzes decided that the best tactic was to admit their theft. The candor was disarming. An investor who attended the second meeting, in Manhattan, recalled: “I looked straight at Stuart and said, ‘Did you ever invest any money? Did you ever have any bridge loans?’ And he said, ‘No, we used it personally.’”

Most of the STS Acquisition investors were so shocked that they left the meetings without extracting any repayment—let alone liquidation—plan from the Schwartzes. But the shock wore off and, by early 1993, various investor groups turned the case over to prosecutors for criminal charges and moved in civil court to have the Schwartzes declared bankrupt.

When word of the fraud spread, the Schwartzes became pariahs in the Old Westbury social circle. In a strangely naive turn, Stuart was surprised by this. He continued going to the club and acted insulted when one member said “Hello, crook” in the locker room.

Ponzi perps don’t usually play stupid about their deeds. And acting indignant about being called a crook after admitting to investors that he’d stolen their money seems downright weird. But, one Old Westbury member offered this insight into Stuart Schwartz: “He was the son of a well-known man. He probably didn’t have the brains or the guts that [Sidney] had. It might be true that he didn’t mean for things to turn out the way they did. But that would be because he didn’t have complete command of what was going on.”

What was going on was that the Schwartzes really were—by just about any standard—crooks. Government investigators discovered that they’d duped two pension funds and dozens of individuals into giving them nearly $8 million. (And they may have taken even more. Investigators for the U.S. Attorney only checked records back to 1989, though several STS Acquisition investors said the scam started earlier. One problem: Many investors failed to file complaints because they were embarrassed or because they invested to avoid taxes or to launder illicit money.)

Instead of using the money to make bridge loans, the Schwartzes paid off other investors and spent on themselves. Over the three years that investigators checked, Sidney and Stuart bought several Mercedes, homes on Long Island and in Florida, fancy dresses for their wives and various other trinkets of wealth.

In May 1996, Sidney and Stuart were both named in a 50-count federal indictment accusing them of conspiracy and mail and wire fraud. Their lawyers quickly arranged a plea bargain.

The Schwartzes claimed that all of the money raised in the scheme was gone. But many investors had doubts. Their homes were in upper-middle-class neighborhoods—but they weren’t mansions. (And, because they were both mortgaged, the lenders quickly foreclosed.) Their tastes may have been
nouveau riche
and vulgar, but the Schwartzes didn’t spend the big money that some Ponzi perps do— on things like yachts and private jets. Neither had a gambling or drug habit to eat up the cash. So, some of the old boys at Old Westbury grumbled that Sidney and Stuart had stashed the proceeds. “I’m sure there’s money in a shoe box or a vault,” said a member who’d invested in STS Acquisition.

In July 1996, Stuart started a 43-month sentence at the federal prison in Fort Dix, New Jersey. “I think he’s contrite,” said Stuart’s courtappointed lawyer. “He’s suffered from the day he was arrested. He has lost all his friends. He’s lost his assets.”

Sidney had wrangled several medical postponements but, in August, he was sentenced by U.S. District Court Judge Arthur D. Spatt who said, “There have been few cases involving a defendant of 80 years of age—in fact I could not find any. Maybe the reason is that people, when they get to [this] age, don’t commit crimes like this.”

Federal sentencing guidelines suggested 30 to 37 months. Sidney’s lawyer pleaded for a reduction because of the old man’s age and history of a stroke and heart irregularities. Spatt noted that the guidelines allowed for reduced terms for illness but not age: “This defendant is a youthful 80 years. He played golf up to the time these occurrences took place, and while in his 70s he knowingly cheated his friends and relatives of millions.” In the end, however, the judge took pity on Sidney and sentenced him only to 18 months in jail.

At his sentencing, Sidney read a prepared statement in a halting but unemotional voice. “I must confess that I have sinned,” he said. “I have been shamed and disgraced.” He said his health problems were God’s punishment for the money he stole from friends and family.

God’s punishment for leading his childish and naive son into a major criminal enterprise would, no doubt, come later.

What Constitutes an Innocent Spouse?

If your husband or wife runs a Ponzi scheme but keeps you in the dark, will the courts hold you liable for the resulting damages? Usually not. However, the Feds may try to tax you for your significant other’s ill-gotten gains.

The IRS has practice guidelines for dealing with married couples who have big legal problems. When one of the spouses turns out to be a crook, the other will usually try to avoid responsibility for the wrongdoing by claiming protection under the
innocent spouse doctrine
. The twin 1992 U.S. Tax Court decisions
Phyllis M. Curtis Berenbeim v. Commissioner of Internal Revenue
and
Jerome P. Berenbeim v. Commissioner of Internal Revenue
deal with this issue.