You Can't Cheat an Honest Man (19 page)

“You hear about Bill Gates being worth $40 billion. You hear about Netscape or Yahoo! going public and making receptionists millionaires. You hear about the guy who started Dell Computer being a billionaire—and he’s not 30,” says a California prosecutor. “And you believe there’s got to be some quick money for you out there somewhere. It may be subconscious, but you believe it. And this affects your decisions.”

When lots of money is being made, scam artists will be there trying to take some. They rely on the greed of potential investors. This reliance gets to one of the key issues that law enforcement agents face when dealing with the schemes. They tend to look at these things—like prostitution and certain forms of illegal gambling—as victimless crimes.

“There’s a long tradition of ambivalence about ‘protecting’ people who get involved in con schemes,” says another West Coast prosecutor. “You have to be a lot greedy and at least a little stupid to get sucked into a chain letter or Ponzi scheme. If you lose money, that’s the price you pay. You’re not going to be on the top of anyone’s victims list.”

On the other hand, it’s hard to tell someone who’s just lost her life savings that she was greedy and stupid. This is especially true if the scheme involved her family or church.

This is why other law enforcement types give the Ponzi investors a break, drawing an important distinction between
greed
—which perps and investors both may have—and
dishonesty
—which usually only the perp has.

Arthur Lloyd, director of investigations and financial risk management with Control Risks Group, says that there are important differences between a greedy person and a dishonest one. He says, “An honest person can still be greedy, and you could fool him. A bank that sees profit in fees may be greedy, but it does not come by the money dishonestly.”

Applying the Greed-vs.-Dishonesty Distinction

In late 1995 and early 1996, an illegal pyramid scheme swept across southern California’s Coachella Valley. All kinds of people got involved—from the country club set in resorts like Palm Springs to working-class families in dusty desert towns like Cathedral City and Indio.

Most believed the scheme, known as “Friends Helping Friends” and the “Gift Exchange,” was no more dangerous than an office football pool. But a number of lower-middle-class people invested thousands of dollars that they couldn’t afford to lose.
The scheme’s participants rented banquet rooms in local hotels to hold their meetings—and recruiting campaigns. The meetings had the feel of a pep rally. As players forked over $2,000 in cash, a hundred-dollar bill at a time, giddy participants shouted aloud: “One hundred! Two hundred....”

Charts decorated with foil stars showed the structure of four-tiered pyramids: eight places on the bottom, then four, then two, then finally one at the top. When the bottom eight people each paid $2,000 to the person at the top, the recipient “retired,” the pyramid split in two and everyone moved up a level. Eight new participants then had to be recruited to sustain each new pyramid.

“It was amazing how much these people were motivated by greed,” said one undercover police officer who attended several of the meetings. “These were supposedly upper-crust people acting like junkies. Screaming and whooping for the money.”

The people running the meetings seemed to understand that the scheme had a problematic relationship with the law. Promotional material handed out at the meetings touted the scheme’s supposed legality. One brochure said vaguely and rather lamely that a player’s neighbor who was “a judge” had looked at the plan and concluded, “Go for it!”

Players were warned to pay “all appropriate income taxes” on their profits from the pyramids. Brochures announced an ending date of December 31, 1996. By that date, new players would be “weaned off.” This deadline, the promoters said, made the scheme legal.

Even if it were legal (a big
if
), the scheme wasn’t any more financially sound than any other pyramid or Ponzi scheme. It collapsed during the summer of 1996.

People at the top of the pyramid had taken out as much as $100,000 while people at the bottom lost between $5,000 and $6,000. Of more than 1,000 people who allegedly exchanged an estimated $1 million during the scheme’s lifespan, nine were eventually indicted by a Riverside County grand jury. They were charged with enticing people to pay money into an endless chain. “Many Riverside County residents lost thousands of dollars as a consequence of this criminal activity,” District Attorney Grover Trask said.

Some residents were surprised by how many community leaders were in the scheme. Among the people indicted were: the president of the area’s only higher education institution, the College of the Desert; the superintendent of the Desert Sands Unified School District; and the executive director of the McCallum Theatre—the region’s performing arts venue.

An internal investigation by the College of the Desert had found that at least 20 employees put in money, though there was no evidence that anyone had been pressured to take part. Still, it accepted President David George’s resignation.

It whad been a College of the Desert employee—Joyce Moore, president of the local college employees union—who’d first brought the scheme to public attention. When she heard that George was involved, Moore had confronted him and then complained to the local newspaper and television station.

Deputy D.A. Edward Kotkin, who was prosecuting the criminal cases, said the area’s tight-knit social and business circles provided the perfect environment in which the scheme could incubate. “My office is most concerned about people who may have used their influence or positions of public trust to bring others into the scheme,” he said.

But the argument that the investors were as greedy as perps resonated with many people who lived in the Coachella Valley. One teacher at the College of the Desert noted that the area’s country club set bred a lot of “country-club wannabees” who tried to act the part but didn’t really have the financial resources to keep up.

Social climbing—which one loser called “the greed for recognition”— certainly was a major factor. With so many of the local swells involved, the social element of the scheme was important. One local society columnist explained:

A friend said...the pyramid party was the damnedest thing he ever saw. So I went two nights later. There were 150 people there—people who own art galleries, charity chairpersons, real estate people, members of the Daughters of the American Revolution—very respectable people. And people were turning over money and hugging one another, like a spiritual revival. And it was the damnedest thing I ever saw.

Moore—the original whistle-blower—offered her explanation to a national newspaper: “We think we’re sophisticated, but we’re an isolated community. Greed was what did it.”

Case Study: Michael Scott Douglas

Like most compulsive behavior, the greedy rush for money makes little sense to outside observers. Michael Scott Douglas was a twice-convicted felon who used a little bit of computer knowledge to build a Ponzi scheme that bilked investors out of more than $20 million. His effectiveness is a testament to greed—his own and his investors’.

From August 1987 through November 1989, Douglas operated a bogus investment firm through which he induced investors to purchase limited partnership interests in four entities: D&S Trading Group, Ltd., Analytic Trading Systems, Inc., Analytic Trading Service, Inc. and Market Systems, Inc.

The companies were headquartered in a single fancy, computerequipped office suite on LaSalle Street—the heart of Chicago’s banking and financial district. The pitch was simple. Douglas claimed he’d developed a proprietary system for exploiting price differences between stocks and related stock options or various kinds of commodities futures. He promised returns of 10 percent to 20 percent per month on investments.

As a federal court later explained:

Although some trading of commodities was done, most of the money raised from the sale of the limited-partner interests was used simply to pay the promised return. These payments gave the scheme credibility, enabling Douglas to sell additional limited-partner interests.

In a little more than two years, Douglas raised $30 million from the sale of limited-partnership interests and paid back less than $10 million in phony profits. During the same period, Douglas paid himself $3 million in salary. He bought 19 cars, two condominiums near Palm Springs, and homes, commercial property and vacant land all around metropolitan Chicago.

Despite the ostentatious spending, Douglas hadn’t come from poverty. He was born and raised in the suburbs around Milwaukee. His father owned a successful company that made plastic containers for household use. The future Ponzi perp went to good private schools— but he wasn’t a keen intellect. He fumbled his way through several colleges, finally dropping out and marrying his high school sweetheart.

The newlyweds moved to Chicago, where Douglas worked in several local banks while attending night school. He had his first brush with financial trouble in 1980 when, as a commercial loan officer at a community bank, he was fired by supervisors who accused him of stealing a $2,000 cash deposit a customer had left on his desk. The charge was never proved.

Later that year, a grand jury indicted Douglas on charges of theft by deception. In a crude confidence swindle, he’d written two bad checks totaling $99,000 to a former Chicago Bears football player. He pleaded guilty and served 18 months in prison.

On his release from jail in 1983, Douglas took a job as a sales manager for a retail outfit called Lake Shore Computers in yet another Chicago suburb. The job was a chance for Douglas to go straight. But his greed got the better of him. Within a few months, he was running another crude con scam—stealing customers’ credit card numbers and using them to buy computer equipment which he would sell on the black market. Again, the scheme wasn’t particularly smart. Douglas was back in prison for two years in 1985.

A few months after his release from prison in 1987, Douglas landed a job writing software programs for a trading firm that was a member of the Chicago Board Options Exchange. The programs that Douglas was hired to write tracked the firm’s trades and generated client statements. This was considered basic back-office administrative work by the firm; but it was a revelation to the felon. It taught him the operational details of how stock option trading worked.

Though Douglas hadn’t been much of a student at school, he learned enough in six months to embark on a new level of criminal activity. He left the trading company, teamed up with a veteran con man he’d met in prison and started D&S Trading.

Douglas refined his pitch with D&S Trading. He offered investors huge returns through an arbitrage strategy exploiting differences between prices in blue-chip stocks and options on those stocks. He’d learned enough about computer programs and options trading to sound expert. And as one family friend put it, “[Douglas] is brilliant with numbers, so options would really be his niche, and that’s partially why he was so convincing....He really dazzled people because of his command of numbers.”

What sold D&S Trading even more than the technical jargon were the guarantees Douglas made. The firm would receive a management fee equal to 25 percent of monthly profits, which was high by industry standards. The trade-off: Douglas personally guaranteed to cover any losses.

This was a hollow promise, since his net worth was only a few thousand dollars. But it worked. By the middle of 1988, less than a year after he’d started D&S Trading, Douglas had taken in about $6 million from more than 100 investors. Instead of segregating customer funds, as required by law, Douglas kept all of the money in just two bank accounts—a D&S Trading account and one under his name. (This is a common sign that an investment firm is running a Ponzi scheme.)

Like many Ponzi perps, Douglas made great claims of religious piety. Though he was raised a Roman Catholic, he had become an evangelical Christian during one of his prison stays. He used the connections he made through church donations to lure ministers and members of their congregations to invest in D&S Trading and ATS. “He used the cloak of Christianity to lure these investors to their financial slaughter,” one lawyer representing investors would later say.

Almost from the beginning, D&S Trading had problems making its dividend payments as promised. Douglas didn’t have the mental discipline that some Ponzi perps use to keep things running smoothly. Instead, he talked about investment strategy and vision—explaining to investors that he was an idea person rather than a detail person. But his vision was no more reliable than his command of details. Within a year of starting D&S Trading, Douglas had abandoned his arbitrage strategy for a series of high-risk investments in stocks the firm had “carefully researched.”

Although D&S Trading was a long way from collapsing, some investors made complaints to the SEC and state regulators in Illinois and Wisconsin. The SEC sent letters to D&S Trading, seeking information on its investment program and principals. In September 1988, under the auspices of Illinois securities regulators, Douglas agreed to be barred permanently from selling securities in the state and made a full refund to all his clients.

But Douglas would not be sidetracked. In an astounding act of brashness, he asked the D&S Trading investors to put their refund checks into Analytic Trading Systems (ATS), a new company he was starting. Many of them were still happy with the performance of their investments with Douglas, so they agreed.

ATS continued to operate the Ponzi scheme started by D&S Trading. Early winners spread the word that Douglas was an investment
wunderkind
. More money flowed in.

Douglas did make some investments. He boasted to anyone who would listen about a $4.2 million profit he made on 42,000 shares of RJR Reynolds Inc. stock he bought and sold during a three-week period in February 1989. “He probably did make that money because he was so impressed with himself about it,” recalls one investor. “It should have been a sign. He was too excited. It’s like [college football coach] Joe Paterno says: ‘When you get in the end zone, you should act like you’ve been there before.’”
Douglas didn’t. And, still, more money kept flowing in. By September 1989, ATS had raised almost $40 million from more than 300 investors spread across seven states.