You Can't Cheat an Honest Man (13 page)

“It was a very fair settlement under the circumstances,” said Bob Hill, an attorney for the investors. Hill said that proving Kidder and Morgan committed wrongdoing would have been difficult because the two firms did not actively defraud investors. Instead, they permitted Donahue to trade recklessly. “Our view was, if they had followed their internal policies, they would have realized what was happening,” Hill said.

“The problem with Donahue was that on every measure of a money manager, he pushed the limits of credibility,” said another fund management analyst. “We have a number of tests that a manager should pass. In the case of Donahue, he didn’t pass any. He had none of his own money [invested]. He was still accepting an unbelievably low minimum of $100,000. And, he had no industry references. But the clincher was lack of an audit or any credible third-party verification that assets existed and the record was real.”

Again, the problem was one of suspicious consistency. All investment markets—and especially the options and commodities markets—are volatile. Good investment managers try to diversify their holdings and hedge this volatility—but not even the best ones can smooth out every spike.

CHAPTER 7
Chapter 7:
Precious Metals, Currency and Commodities

While vaguely defined “investments” and elaborate loan programs will probably always be the favored pretenses for Ponzi schemes, commodities programs usually run a close second. These financial mechanisms—which, for the sake of our investigation, include currency investments, precious metals deals and true commodity goods—are complicated and volatile things from the start. They offer a Ponzi perp plenty of cover in which to hide.

Even when they are traded legitimately, precious metals, currency and commodities can sound like schemes. They trade in markets which rise and fall dramatically—often in short bursts of activity. Trading them successfully requires steel nerves and good timing. Many transactions are heavily margined, which means an account with a few thousand dollars can make—or lose—tens of thousands of dollars in a few hours.

This trading is usually regulated by a federal agency called the Commodities Futures Trading Commission (CFTC), which is smaller, poorer and generally less sophisticated than the SEC or IRS.

Many of the same legal theories that apply to investment contracts connect commodities investments to Ponzi schemes. In practice, though, the connection between commodities deals and Ponzi schemes is usually more simple...and more crude.

One of the most dramatic and detailed commodities Ponzi scheme in recent history was operated by Thomas Chilcott, a Colorado-based financial adviser who desperately wanted to be considered an investment genius. As is so often the case, the most surprising thing about Chilcott is how many people he convinced.

From 1975 to 1981, Chilcott attracted nearly $80 million in investments for a commodities pool from approximately 400 persons. He talked grandly about his market perspective as a “quant,” financial industry jargon for a
quantitative investor
. He didn’t care for stories that might impact commodities markets—he focused instead on market trends and abstract formulas to keep ahead of everyone else.

On paper, Chilcott was entirely legitimate. He was a registered commodities adviser and investment pool operator with the CFTC. In person, he seemed to fit the part—with a young, aggressive demeanor and an office full of computers (still a novelty during his peak) blinking quotes from around the world.

It was all a fraud. Chilcott didn’t make very many commodities trades...and the ones he did usually didn’t do very well. (At one point, he invested heavily in worthless Oklahoma oil wells being peddled by
another
Ponzi perp.)

What Chilcott did do well was follow Carlo Ponzi’s model. He pooled investment money into a few accounts, moved it around and then gave small pieces back to investors as dividends and distributions.

The Chilcott funds collapsed in the fall of 1981. No longer able to keep the illusion going, Chilcott started issuing distribution checks that bounced. He tried the usual delaying ploys—blaming the banks and trying to convince investors to reinvest their distributions.

Within a few weeks, the FBI had taken over Chilcott’s Fort Collins office. The Feds estimated that the commodities pool had only about $8 million in liquid assets, more than half of which were held by Chilcott in his own name. The rest of the $80 million had been diverted into personal ventures, lost in speculative trading and returned to investors as bogus profits.

Denver lawyer James P. Johnson was appointed receiver. The court ordered him to take custody of all money and records and prevent further dissipation of assets. About that time, Chilcott was indicted on criminal fraud charges. He struck a plea bargain and avoided trial. Meanwhile, several civil lawsuits, filed by Johnson as well as groups of Chilcott investors, inched through the federal courts.

Chilcott was released from prison in early 1987 and promptly began a new commodities investment pool. Between March 1987 and February 1988, he attracted about $1.3 million—some of it from investors who’d put money into his old scheme.

In January 1988, a federal jury awarded $39.4 million in damages to the original Chilcott investors, who’d charged that Shearson/American Express Inc. had substantively helped Chilcott defraud them of $31.6 million, by refefering clients to him. The jury found Shearson liable for negligent management, breach of fiduciary duty and conversion of funds. The award included the defrauded funds and an additional $7.8 million in punitive damages. Shearson lawyers said they would appeal—if only to convince the court to reduce the size of the verdict.

In the meantime, Chilcott’s new venture was collapsing. This time, he skipped town before his distribution checks started bouncing. In the spring of 1988, a federal arrest warrant was issued by an Evergreen, Colorado, court charging Chilcott with wire fraud.

For almost a year, Chilcott evaded FBI agents and other law enforcement officials by moving around the west coast. Finally, in February 1989, he was arrested by federal agents near Del Mar, California. He’d been doing business in southern California since late 1988 as the supposed CEO of an oil exploration company.

“This guy was like an addict. He couldn’t control himself,” said one of the federal agents who’d investigated Chilcott in Colorado. “And it couldn’t have been fun. You should have seen him when he came back [after the Del Mar arrest]. He was still barely 40. But he looked ten years older.”

Precious Metals

Just as the complexity of commodities trading and currency exchange rates invites bogus theories and Ponzi scammers, trading in precious metals provides a rich setting for scams.

“There’s something about the idea that an ounce of gold fluctuates in value against the dollar that strikes most people as magic,” says an FBI agent based in the Midwest who’s investigated several goldbug Ponzi schemes. “For a big part of this country’s history, the dollar was backed by gold. When that link was broken, both dollars and ounces seemed a little less legitimate.” And may, in fact, have become less legitimate.

The recession of the mid-1970s planted the seeds of uncertainty in many people’s minds. Those days were the most recent shining moment for goldbugs. While stocks and bonds floundered along with the economy in general, gold exploded in value. People who wouldn’t normally invest in gold were hoarding gold coins: American Eagles, Canadian Maple Leafs and South African Krugerrands. The coins have been out of financial fashion pretty much ever since.

Theories about the gold standard, usually the realm of economists and conspiracy-minded novelists, have given birth to Ponzi schemes based on exploiting the shifting connection between dollars and gold.

David and Martha Crowe started Gold Unlimited, a multilevel marketing company based in Madisonville, Kentucky, in November 1993. The company conducted seminars to recruit people willing to invest $400 in the company. In return, investors would receive a gold coin and be placed on a list giving them the right to recruit additional participants.

Once investors recruited two other people to join, they were promised a commission on the recruits brought in through them. From the beginning, the company struck some people as a pyramid scheme. But its participants insisted Gold Unlimited was legitimate. According to them:

•
people paid nothing to become representatives nor were they paid for bringing in others as representatives;
•
participants could earn profits on goods they sold, but they could only earn commissions when they brought others into their sales networks who either brought or sold products;

•
participants had to qualify to establish sales networks by producing $200 in “personal business volume credit.”

For 1994, the Crowes’ company claimed sales of $25 million. It boasted more than 90,000 sales representatives worldwide and with divisions in Canada and Hong Kong. The company’s headquarters had once been a private mansion. There were walk-in safes on each floor to store the gold and silver bullion and coins, precious stones, jewelry and rare books the company sold through its independent representatives.

But, in early 1995, the company started running into trouble with state courts and regulators throughout the South and Midwest.

Mississippi Attorney General Mike Moore said consumers in that state should exercise caution about putting money in the firm. “Our main problem is that several representatives of the company appear to be concentrating on the recruitment of people into the company, not the sale of gold coins,” said a spokeswoman for Moore’s office. “We’ve also heard people saying that since our office met with the attorneys from Gold Unlimited, we’ve approved the program. Nothing is farther from the truth.”

Iowa authorities reported that a growing number of residents had been lured into investing about $200 in Gold Unlimited. Each investor then had to recruit two more investors who also paid $200 each. After the company received the $600, the initial investor would get a gold coin worth about $300.

Arkansas Attorney General Winston Bryant called Gold Unlimited’s plan a pyramid scheme and warned Arkansans to avoid it.

On March 13, 1995, while some of the state actions were just being announced, FBI agents and U.S. Postal Service inspectors seized Gold Unlimited’s assets and sent its employees home.

The U.S. Attorney in Louisville said Gold Unlimited and the Crowes “have knowingly devised a scheme or artifice to defraud or for obtaining money or property by means of false or fraudulent pretenses, representations or promises.”

The only way a Gold Unlimited representative could recoup his payment to the company is to recruit others who were, in turn, successful recruiters. Payments to representatives came from the cash sent in by new recruits. As the number of levels increased, more representatives would earn commissions on a set amount of business, requiring evergrowing profit margins and price markups just to cover the commissions.

Kentucky law enforcement officials said that Gold Unlimited was set up like an earlier Crowe venture, American Gold Eagle. That company had gone out of business in 1991, resulting in $367,000 in investor losses. But this record didn’t seem to bother many Gold Limited investors.

At a hearing on March 22, 1995, more than 200 investors, some from as far away as Arizona and Texas, packed a federal court in a show of support for the company. The court ordered the assets and bank accounts of Gold Unlimited frozen. The company would, effectively, stay closed. “We’ve got to keep a positive attitude,” said Kellan Lamb, the company’s executive vice president.

But the legal moves were just beginning. Worried state officials filed a civil lawsuit, charging the Crowes with operating a pyramid scheme. In June, U.S. District Court Judge Thomas B. Russell indefinitely suspended the civil suit, saying that there was “apparently grand jury activity” involved in the case (that is, a criminal prosecution was underway). Russell said that he would appoint a receiver in the case to preserve company assets and to try to pay some outstanding debts.

The Crowes were indicted on July 12, 1995, on 22 counts each of mail fraud, securities fraud and money laundering. The indictment alleged the company induced “individuals to invest money for the right to receive compensation for inducing others to join the scheme.”

Government prosecutors said the Crowes “perpetuated the scheme by paying ‘commissions’ to earlier investors, not from profits from the sale of...products but from the fees paid by new investors.” The criminal charges carried penalties of up to 145 years in prison and fines of $5.5 million. The Crowes were free on $50,000 unsecured bonds each. After consulting with their lawyers, they reached a plea bargain with the Feds.

A Silver Scheme and How Ponzi Perps are Punished

Con men are always a challenge for criminal courts. Since their investors are often willing, are they somehow less guilty than other criminals? Since they’ll often give some useful advice or counsel to their victims in the course of a greater theft, do they mitigate their crimes? A Ponzi scheme that made big promises about silver futures trading brought these questions into focus.

For more than six years, Richard Holuisa convinced investors to give him $11 million. His plan was to invest the money in silver futures and high-yield government securities. He told potential investors that he’d developed a computerized program for exploiting discrepancies in the silver futures and government bond markets. His company, Certified Investment Co., could put their money in either market.

In this way, Holuisa was like Carlo Ponzi. He was touting a Great Idea.

Funds were used to cover Certified’s operating expenses and were never invested in anything. Holuisa and a close circle of trusted associates sent investors fraudulent weekly and monthly statements detailing both the principal investment and the interest that had purportedly accrued.