You Can't Cheat an Honest Man (23 page)

The trader/investors at AYM would have been better off talking to the Feds. Their secrecy may have made them feel like princes of commerce, but all it did was prolong and enlarge the scheme—and their losses.

In affinity schemes, reluctance to speak with investigators will often be attributed to cultural issues. In family schemes, it will be chalked up to protection. What it should be chalked up to is embarassment.

The embarassment Ponzi investors feel and the reticence that follows are the main reasons perps rarely go to jail. One west coast law enforcement agent estimates that his office hears from fewer than one in 10 pyramid or Ponzi investors who get burned. “People are embarassed because they know they should have known better. They’re worried that they’ll seem greedy and stupid—which, to some degree, they will,” he says. “They shouldn’t feel this way. Ponzi schemes are illegal for a reason.”

Because prosecutors have such a hard time getting the cooperation they need to build Ponzi cases, their bosses will usually argue criminal charges aren’t a good use of the state’s resources. That’s why in these situations civil lawsuits often come first, followed later by criminal charges—the opposite of how most legal issues proceed. The nature of most Ponzi schemes—participants taking advantage of their friends and family members—makes it more difficult to acquire witnesses. “They’re not exactly jumping up and down to turn each other in,” a Nevada police officer said in the wake of one Ponzi collapse.

But the reluctance occurs in more than just a few specific situations. And it happens too often to be dismissed as the deserved embarassment of greedy investors with enough money to lose in the first place. The reluctance comes from a deeper impulse. It comes from the desire that most people in a capitalist system have for secrecy. Ponzi perps understand this desire—and the smart ones exploit it.

The impulse toward secrecy serves as a contrast to several good human instincts. It can be a side-effect of privacy. It can also be an extreme—and twisted—product of trust. Finally, it supports greed by hiding the ugliness that usually marks that impulse.

To an experienced and balanced investor, the urge for secrecy is a logical application of a general sense of caution. It can also be seen as a by-product of trust: To believe in one person or idea is, in practice, to believe less...or not at all...in another.

But Ponzi investors aren’t always experienced and balanced. They’re often inexperienced and excitable—about money in general or the premise of the particular scheme. Excitable people tend toward extreme responses in all things; inexperienced investors will often take secrecy to an extreme.

“The sure sign of a thief, a sucker or an idiot child is that they think everything has to be a big secret,” says a world-weary New York money manager. “The first thing they’ll do is call me and say they’ve got a hot piece of information on a stock. Then they’ll tell me something that was in the
Wall Street Journal
last Tuesday. The second thing they’ll do is call me with another hot tip—multilevel marketing for long-distance [phone service] or some Ponzi scheme to sell ostrich eggs or Lithuanian gold pieces.”

His conclusion: There really aren’t such things as hot tips that need to be whispered on the QT. Useful information comes in pieces that are too small—on their own—to make or break an investment. Top secret information is usually hype.

Case Study: Colonial Realty

Jonathan Googel and Benjamin Sisti formed Connecticut-based Colonial Realty in the 1960s as a vehicle to sell limited partnerships that invested in property in and around Hartford. For the first 15 or 20 years they were in business, the two boyhood friends seemed to do things legitimately. During the 1980s, though, they engaged in scores of secretive and questionable dealings. The reason: Colonial Realty had become a vast Ponzi scheme.

Googel, Sisti and their investors were joined in their downward spiral by a proven loser named Frank Shuch. By most reckoning, Shuch brought the tendency for heavy larceny to the operation.

Shuch joined Colonial Realty as the result of a relationship between the company and accounting firm Arthur Andersen which had begun in 1975, when Googel and Sisti were introduced to Andersen tax partner Richard McArdle.

McArdle helped Googel and Sisti find investors—although he told them that if Colonial Realty “wanted to play in the big leagues, then it had to pay.” Andersen’s initial contributions were “unofficial.” Colonial Realty was not allowed to put the firm’s name on any of the documents it prepared. The accountants said that their involvement was best left a secret.

That came to an end in 1981, when Andersen started formally putting its name on financial documents prepared for Colonial Realty’s syndications. In exchange for the expertise, credibility and business contacts that the Andersen name provided to Colonial Realty, Googel and Sisti agreed to hire Shuch, an alleged embezzler who was the brother-in-law of an Andersen partner.

Shuch also wanted his involvement to be kept secret. Toward this shady end, he started a company called Consulting Enterprises. He performed all his work for Colonial and related entities as an employee of Consulting, for which he received in excess of $5.5 million in payments between 1986 and 1990.

Why all the secrecy? Colonial Realty sold limited partnership interests in various real estate properties located primarily in Connecticut. These investments were offered through Private Placement Memoranda (PPMs), pursuant to the exemption in the registration requirements for “privately placed” transactions.

Colonial Realty offered money-back guarantees, minimum returns of 14 percent, and projected overall returns as high as 300 percent. And the company’s offering materials contained misrepresentations and omissions about revenues, financial reserves, rental income and cash flow. It wasn’t a situation that would stand up to much scrutiny.

The cornerstone of Colonial Realty’s marketing system was a secret network of
finders
—lawyers, accountants, insurance agents, real estate agents and stockbrokers who were given fees in return for either recommending people to buy Colonial Realty investments or providing lists of wealthy clients.

Most of the finders were, themselves, investors in Colonial Realty projects. Generally, they were paid $1,500 for each person who bought a $50,000 investment. Most received either checks or credits on their investments; some were paid in cash.

Colonial Realty’s head bookkeeper said that Sisti and Googel kept several million dollars of cash on hand for paying finders’ fees.

This aspect of the company’s marketing system was kept secret until after the company was forced into bankruptcy in September 1990. Colonial Realty salesmen maintained that the finders did not want it known that they were getting money in return for recommending their clients, relatives or friends make investments. (Many of the payments violated federal securities laws, which prohibit anyone other than registered brokers from being paid commissions.)

In September 1990, involuntary bankruptcy proceedings were filed against Colonial Realty in federal court. Six banks that had loaned money initiated the proceedings. Investors had a total of more than $350 million in limited partnerships at the time.

In October 1990, Googel, Sisti and Shuch were indicted on federal felony charges.

Shuch killed himself in February 1992 by putting a plastic garbage bag over his head. The suicide took place in his $10 million custombuilt home.
On May 5, 1993, Googel pled guilty to two counts of wire fraud, one count of bank fraud, and one count of attempting to impede the administration of the internal revenue laws. Two weeks later, Sisti pleaded guilty to two counts of bankruptcy fraud, one count of wire fraud, and one count of structuring transactions to evade reporting requirements.

Both men cooperated extensively with prosecutors and the civil attorneys. Under federal sentencing guidelines, Googel and Sisti faced sentences of between two and five years. They hoped their cooperation would convince the sentencing judge to impose even less time.

It didn’t. The judge not only concluded that they deserved no leniency but found that the guidelines did not adequately reflect the severity of their crimes. He chastised Googel for recruiting millions in investments even after bankruptcy experts had advised that Colonial Realty was failing. And he concluded that Googel had obstructed justice by attempting to arrange a meeting with a witness being interviewed by federal authorities.

Worse still, as Colonial Realty was collapsing, Googel had transferred millions to relatives. Much of that had been recovered as part of a deal with the bankruptcy trustee; but Googel’s family was allowed to keep about $1.25 million in cash and other assets—including a halfmillion dollar house.

The judge sentenced Googel to nine years in a federal prison camp.

The judge sentenced Googel to nine years in a federal prison camp. square-foot mansion with a movie theater and shooting range and ordered custom-made multimillion-dollar yachts. At his sentencing hearing, though, Sisti seemed delicate and humble. He spoke in a calm, unimposing voice, telling the judge he was sorry for his crimes and sorry he could not make things right. “I can’t change what I did,” Sisti said, “but I can change the person who did them. I just hope I live long enough to make it all up to [my family].”

The judge gave him an eight year sentence to work on the change.

The criminal sentences moved the focus to various civil lawsuits. In April 1994, a panel of mediators approved a settlement worth about $100 million. The deal resolved some 3,000 lawsuits, representing most of the civil actions spawned by Colonial Realty’s collapse; it bailed out investors who’d not only lost their investments but also owed banks for loans that had paid for limited partnerships. All but $18 million of the $100 million owed by the investors was forgiven by the banks under the settlement.

In exchange for the forgiven debts, the banks reserved the right to collect half of any judgment from Andersen or other defendants.

Two of the legal and accounting firms accused of improprieties by Colonial Realty investors and creditors were also part of the settlement, agreeing to pay a total of $11 million. Admitting no wrongdoing, the law firm of Levy & Droney agreed to pay $10 million and the accounting firm of Kostin Ruffkess & Co., $1.1 million. (The payments were covered by professional liability insurance.)

A few months later, Sisti and Googel reached a settlement with the investor groups that allowed each of their families to keep about $1.1 million in return for assurances that they had fully explained their tangled finances and disclosed all assets. The perps turned their burned investors into reluctant allies by helping their lawyers prepare lawsuits against accounting and legal firms that participated in selling Colonial Realty partnerships.

In 1996, a federal appeals court considered the burned investors’ claims against Arthur Andersen in detail. They alleged that Andersen had prepared or approved financial projections for the limited partnerships that “bore no relation to reality” and misrepresented the real estate market.

The investors alleged that Andersen “knew that the projections would make an investment in [the limited partnerships] appear economically feasible...notwithstanding the excessive fees charged by the general partners and made the projections, which they knew to be excessive, for the express purpose of distracting the attention of plaintiffs from those fees.”

Andersen argued that the language contained in the PPMs concerning the limited scope and inherent uncertainty of the projections prevented reliance on the projections as a matter of law. The court disagreed.
According to Andersen, the investors could not sustain their negligent misrepresentation claims because they failed to allege either that they had a fiduciary relationship with Andersen or that Andersen possessed actual knowledge that the investors would rely on the alleged misrepresentations. The court disagreed.

Because Shuch was merely the “brother of a member’s spouse,” Andersen argued that he could not have jeopardized its professional independence. Therefore, the firm believed it was not required to disclose Shuch’s relationship with its errant employee. The court disagreed.

The burned investors alleged that Andersen broke RICO law because it secretively “sought to place Shuch as an employee of Colonial so as to obtain control of Colonial,” that “[t]he dramatic increase in Colonial’s business was a direct and proximate result of Andersen’s control over the Colonial syndications,” and that Googel and Sisti “may not have fully understood” the financial status of their burgeoning operations, while Andersen “knew everything” because it was “[sophisticated] and highly skilled in business, real estate finance and syndication.” In short, they claimed that:

Andersen created in Colonial an industry giant which Andersen could and did display to other potential clients as an example of the success and prestige which any company could attain if it hired and paid Andersen.

But the court doubted that Arthur Andersen controlled Colonial Realty through Shuch. The investors’ lawsuit described Googel and Sisti as “Ponzi Participants,” which the court called “an unlikely description for entirely subordinate, dominated toilers in the Ponzi vineyard.”

Finally, in May 1996, Arthur Andersen agreed to pay $10.3 million to settle the charges. This brought its total settlement to about $15 million. (After a state investigation in 1993, Andersen had paid $3.5 million in refunds and fines.)

As a result of the various settlements and the bank forgiveness, most of the burned Colonial Realty investors were able to recoup more than half of their losses. Of course, it took them more than five years to get the money back.

CHAPTER 13
Chapter 13:
Loneliness, Fear and Desperation

White-collar thieves often think they can make up a loss and come to believe they deserve what they are taking. But these rationalizations usually crumble under the weight of anxiety and paranoia.