You Can't Cheat an Honest Man (35 page)

[T]hese defendants have unjustly enriched themselves at the expense of others through the acceptance of proceeds from the unlawful sale of securities. Even though defendants did not actively solicit or recruit, they relied upon others to do this and accepted the benefits of these unlawful acts. The Commissioner argues that it is ironic that defendants could receive and retain sale proceeds but bear no responsibility or accountability for the unlawfulness of the sales. We adopt the “but for” or proximate cause test. Thus, for an individual to be liable for the injury, all that must be established is that the injury flowed directly and proximately from the actions of the person sought to be held viable.

The court upheld the trial court decision’s requiring 10 people who participated in the scheme to pay back about $60,000 to other investors. “This allows us the ability to require the repayment of profits,” said Securities Commissioner Jim Parrish. “We needed an opinion like this.... It’s going to strengthen the law in that regard.”

Case Study: The Feds Versus William Kennedy
Several regulatory agencies cooperated to bring a big Ponzi scheme known as Western Monetary Consultants, Inc. (WMC) to justice.

WMC was founded in 1979 by William R. Kennedy, a Colorado businessman (no relation to the Massachusetts Kennedys) who used a variety of pitches—including supposed political affiliations—to sell WMC investments.

Kennedy was “quite an intelligent guy, very aggressive, always,” said Willard Walker, a Colorado stockbroker. “He was a by-God, sort of a bull-like guy who did get a lot done.” But Kennedy’s ego and sense of urgency were his undoing. Walker recalled advising him not to run for Congress against a popular incumbent in the late 1970s.

Kennedy ran, anyway. But his bid for the congressional seat didn’t get as far as the party primary. “He has an ego like the Graf Zeppelin,” Walker said. And a destiny like the Hindenburg.

WMC promoted itself as a wholesale distributor of precious metals and coins. In fact, it wasn’t anything like what most merchants would call a wholesaler. It sold precious metals to the public over the phone and, beginning in about 1984, at what it called “investment seminars” or “war colleges.”

The seminars were Kennedy’s forte. He targeted wealthy, older investors with conservative political and religious beliefs. And he paid outof-work right-wing politicians top dollar to deliver speeches on geopolitical topics. Speakers at the seminars would warn of the “imminent collapse of the global economy and the possibility that common currency and standard securities would become worthless,” one lawyer for disgruntled investors said.
These speeches were designed to convince listeners that world events justified investment in precious metals as a hedge against inflation and political instability. Jules Diamond, a retired executive from a big liquor company, invested after spending three days at an all-expensepaid war college seminar. Kennedy recommended that Diamond put his money in silver to hedge against a collapse of the commercial banking system. “It all seemed so reputable. It didn’t dawn on me to check it out independently,” Diamond said.

When an investor agreed to purchase precious metals from WMC, an employee would quote the investor an approximate price. The employee would then contact the WMC trading department, which would locate the best price for the metal from a network of dealers. The employee would then inform the investor of the exact, or “lockedin,” price. The investor would then transfer funds to WMC. Investors bought the metals with either cash or through cash down-payments coupled with bank loans arranged by WMC.

There was one complication: If WMC did not provide the dealer with the locked-in purchase price within 48 hours of ordering, the dealer usually nullified the contract with WMC. This meant WMC had to reorder at a new price, which could be higher or lower than the investor’s quoted price.

At some point about 1984, WMC began delaying purchases in the hope of making money on the difference between locked-in prices and actual prices paid. Word of WMC’s questionable practices reached the CFTC pretty quickly—certainly by 1986. But the commodities regulators didn’t have enough evidence to take any action.

Once the delays started and no regulators responded, Kennedy seemed to conclude that WMC could collect both buy and sell commissions for metals that were never actually bought or sold. Instead, he diverted much of the investor money to other uses. Among these:

•
a 6,000-square-foot Colorado home with an indoor basketball court and other amenities;

•
several luxury cars, including the obligatory Mercedes-Benz;
•
the purchase of and payment of expenses necessary to run
Conservative Digest
magazine;

•
the purchase, refurbishment and transport of a helicopter for Nicaraguan “Contra” counter-revolutionaries.

Ownership of the magazine and the support of the Contras gave Kennedy access to higher-profile politicians, including Ronald Reagan, George Bush, Oliver North and Jerry Falwell. This increased the star-quality of the speakers at WMC’s seminars. The magazine’s mailing list also provided Kennedy with a ready source of potential investors for his seminars.

Between 1984 and 1987, WMC increased its sales rapidly and began to experience serious cash shortages. Nevertheless, Kennedy continued to promote sales to new investors, without telling them that WMC was between $10 million and $13 million behind in filling orders.

If the precious metals market had been moving downward during the mid-1980s, WMC’s delays would have been profitable. But the market was moving upward during the height of the deception. So, the delays were increasing the obligations WMC owed its investors. Kennedy’s plan for dealing with the chronic problem: Sell more contracts and fulfill old orders with new money. Hello, Ponzi scheme.

In March 1988, Kennedy sent letters to WMC’s clients which blamed the failure to fill client orders on the tremendous growth of the business and the pressures this put on his overworked staff. At this point, the federal regulators were working with the Denver U.S. Attorney’s office and local law enforcement agencies to build the case again Kennedy and WMC.

Later that month, WMC’s cash shortages were so great that it filed for Chapter 11 bankruptcy protection, listing over 600 creditors from whom WMC had received over $18 million in orders that remained unfilled. The market value of these unfilled orders at the time of the bankruptcy was more than $37 million.

WMC moved to San Diego and continued to operate for a while under a court-approved reorganization plan. “Building a criminal case was still going to be difficult,” said one federal regulator. “We had a team of people from the FBI, CFTC, SEC and the U.S. Attorney’s office. So many Ponzi crooks get away....we were determined not to miss the chance to nail this guy.”

In July of 1992, after a five-year investigation of WMC’s practices, the government indicted Kennedy and numerous employees on charges of racketeering, mail fraud, wire fraud and money laundering. Kennedy himself was charged with 109 separate criminal counts related to operating “a Ponzi scheme in the unregulated sale of precious metals.”

Because Kennedy was broke (he and his wife had declared personal bankruptcy in 1990), the court appointed a lawyer to defend him. At trial, the government relied in part on the testimony of Douglas Campbell, from the National Futures Association, as an expert on precious metals and commodity markets. Campbell concluded from reviewing WMC’s records that WMC had not purchased enough metal to cover its obligations to numerous investors and had lost money speculating in metals futures trading.

The centerpiece of Kennedy’s defense was that he lacked the criminal intent necessary to be convicted of the charges. He admitted that his poor business judgment had caused investors to lose millions—but had never intended to defraud anyone. Kennedy’s lawyer called him an “eternal optimist, too inept and untrained to see what was going on under his own nose.”

The jury didn’t believe Kennedy’s stupidity defense. In fact, while it acquitted most of his co-defendants, the jury convicted Kennedy on the most serious charges.

The judge ordered Kennedy taken into custody, noting that because his family lived in San Diego the felon was a flight risk. In January 1994, Kennedy was sentenced to 20 years in prison by U.S. District Judge Lewis Babcock. “His victims were elderly, trusting,” Babcock said. “They invested retirement funds, the fruits of life-long labors.” Babcock also ordered Kennedy to complete three years of supervised release after his prison term. Because Kennedy had been declared indigent, Babcock waived $18.5 million in restitution and $750,000 in fines.
Kennedy’s attorney had tried to lessen the sentence by arguing that the felon would be targeted for attacks in prison because he was “a formerly rich, white, Republican conservative who had every advantage the other inmates never had.”

Babcock wasn’t moved. Kennedy never acknowledged that he had intentionally defrauded investors. But he did make a tearful statement after the sentence was announced. Among his conclusions:

Whether I agree with the jury’s decision or not, in operating the company I was reckless and arrogant. And I’ve caused a lot of pain.... I hope some day to clear my name and pay these people back. I know this sounds crazy under these circumstances, but this is my heart.... I don’t want my children to be bitter toward this country or this system because of what has happened to me.

One of the lawyers who worked on the case noted, “It’s not surprising that this guy was a crook. He was a major egomaniac. The court’s sending him to prison for 20 years and all he can talk about is how he’s really a stand-up guy. But look at how he said it.
I
this,
I
that.
Me
.
My
.”

CHAPTER 19
Chapter 19: Go After the People Who Got Money Out

It’s difficult to define the relationships of the parties involved in a Ponzi scheme by traditional legal or business principles. Many of the most distinguishing features of a Ponzi scheme have little to do with either business or law.

One the most painful parts of being burned as an investor in a Ponzi scheme is the conclusion that you’ve been taken advantage of by someone that you thought was a compelling entrepreneur or reliable advisor—but turned out to be a smarmy crook.

Prosecuting the perp after a Ponzi scheme has crashed is usually tough.
Locating
the perp can be difficult. And, even if you do manage to find the person, he or she is usually broke—so collecting a judgment is practically impossible. But there are some things a burned investor can do to achieve some degree of either personal satisfaction or financial reimbursement.

A piece of strategic advice: If you’re a burned Ponzi investor, you’ll probably have to go after the perps for personal satisfaction and then set your sights on fellow investors and the lawyers or accountants who advised the perps for monetary satisfaction.

Investors Turn on Each Other

The twenty-three-year litigation resulting from the ill-fated HomeStake Production Co.—discussed earlier in Chapter 5—involved one of the biggest and most protracted Ponzi scheme legal battles in American history.
In the early 1950s, Robert Trippet organized Home-Stake to develop oil and gas properties. He raised capital by selling percentage interests to investors through private placements. From 1964 to 1972, HomeStake organized separate annual programs, units in which were registered as securities with the SEC.

Trippet told investors that each of the programs was organized to develop a particular oil and gas property or properties in the Midwest, California or Venezuela. Like most Ponzi perps, Trippet tailored HomeStake’s pitch to each individual investor’s needs.

At first, the operation seemed successful. Quarterly progress reports indicated that substantial oil was being produced. In fact, very little oil was being produced. Payments to early investors came from money raised from later investors. Still, there were some investors who complained that their returns weren’t what they’d expected. Home-Stake paid substantial sums of money to hush these unhappy investors.

Shortly afterward, the fabric that held Home-Stake together began to fray. Despite the settlements, word began to circulate that Home-Stake was crooked. Disgruntled investors started turning on each other— which didn’t result in much that was good for anyone. “I just remember feeling like I’d been played for a fool,” says one Home-Stake investor. “I was angry. I didn’t like the idea that a few people with connections were getting their money out while I was just some schmuck stuck in a scam that was heading for the toilet.”

In fact, the early settlements had little to do with “connections.” But there was so much brewing discord that the facts hardly mattered.

In March 1973, two investors who were dissatisfied with their returns and one who’d been told that the IRS was going to disallow HomeStake tax deductions filed a lawsuit in California. Six months later, Home-Stake filed for bankruptcy in Oklahoma. A flood of lawsuits from angry investors followed the filing. The various civil cases were combined into one big action.

The Ponzi scheme wasn’t giving rise only to civil liability. In December 1974, a grand jury in Los Angeles returned indictments against thirteen officers and associates of Home-Stake for violations of the securities and income tax laws. So, the legal fallout of the HomeStake collapse followed two separate tracks. Both are worth a look.

In the civil lawsuit, called
Anixter v. Home-Stake Production Company, et al.
, the investors claimed that the funds collected by HomeStake through the annual securities offerings were not segregated for use in developing particular oil properties—as Trippet had said they would be. Instead, the investors said money was commingled with the general funds of Home-Stake and paid out in the form of bogus profits. As is often the case with Ponzi schemes, Home-Stake was running out of money from the beginning. Since there was no real profit from oil operations, each succeeding year generated less bogus profit. That explained the disgruntled investors—and the amount of in-fighting among investors.