Litigation + Valuation Perspectives

Demystifying Valuation, Economic Damages + Forensic Accounting

Ponzi is Not the Dude on Happy Days – Fraud in the Marketplace

A few years ago I was asked to be an expert witness on a federal court case involving several management members of an investment firm, which I will call Big Scheme (“BS” for short). BS was selling interests in foreign mortgage products. At least that’s what BS was marketing to unsuspecting investors in the U.S. before the Securities and Exchange Commission closed in on them. BS was touting as much as a 40% return to anyone buying one of the investment interests. There was one huge problem, however – there were no investments to be purchased. They were non-existent. Instead, the management team would collect investment dollars from innocent folks and give them a “return” which the management members would take out of the invested dollars from subsequent investors. For example, let’s assume that you invested one dollar into the scheme. Right after the end of the first year of your investment you would receive forty cents. The forty cents was taken out of the next one dollar amount invested by the investor who came into the program right at the end of the year of your initial investment. And then that next investor would receive their forty cents from the dollar invested by the next person, and so on.

By the time the SEC caught up with these scallywags, they had bilked $100,000,000 (that’s one hundred million dollars) out of investors. And by the time I was called into the case, several of these bad BS characters had been arrested and tried before a federal court judge, Judge Harry, in a Dallas federal courtroom. They were already in prison by the time I was called in on the case.

It seems there was one investor, Morris, a business owner from a small town in Arizona, who had invested $2,000,000 into the scam as an equity owner of BS. Morris, I came to find out was a very gullible person. He had been befriended by one of the lead culprits in the case, Karl. Even after Karl had been arrested and put into a federal prison, Morris was convinced Karl was innocent. He loaned Karl several thousands of dollars to pay creditors and attorneys. Morris even encouraged a little old lady in his hometown to invest in Karl’s scheme, and guaranteed the little old lady that she would get a 40% return on the $100,000 she invested. At the end of one year, the little old lady got her 40% return, even though by this time the SEC had shut BS down. She wouldn’t have, except Morris paid it. The little old lady was his aunt.

The SEC decided that Morris was in “apparent” cahoots with the schemers and decided that he would have to put up a $2,000,000 bond while waiting to get his invested funds out of the now defunct investment firm. A hearing for this purpose was to take place in Judge Harry’s court. My job was to analyze a ton of accounting records to show that Morris was not involved with the schemers but, rather, was an innocent victim himself. Had Morris prevailed with Judge Harry in Dallas, he would not have been required to put up the $2,000,000 bond – this, in addition to the $2,000,000 he had already invested.

The SEC, with the aid of the court, hired a receiver to take over the assets and accounting records of BS. The receiver was convinced that Morris was in collusion with Karl and BS. On the day of the hearing, the receiver, who testified prior to my testimony, actually lied on the stand in order to get a ruling against Morris. Unfortunately, although I had documents that supported the fact that Morris was innocent, Judge Harry ruled that the receiver’s testimony was more credible than mine and ordered Morris to cough up another $2,000,000 for bond money.

I felt bad at first that I did not have enough in my testimony to help Morris, who I believed was completely innocent. I felt bad even though I knew that the receiver had testified before Judge Harry several times before against the management members of BS, whom the judge locked away – including Karl. Yes, I felt bad, that is, until I found out that only six months before the hearing, Judge Harry, who did not like my testimony all that much, was found in the early morning hours wandering in a daze in his neighborhood wearing nothing but a t-shirt and cowboy boots. The story was true. I verified it with the Dallas newspaper that printed the story. And, by the way, the presiding judge of the federal district court in which the “bare necessities” Judge Harry sat on the bench, said that the old judge was still a good judge for the courtroom. He was just off his medication the morning he was found wandering. I wondered whether he was off his medication when he gave his ruling at the trial the day I testified.

Don Bays, CPA/ABV, CVA