You Can't Cheat an Honest Man (6 page)

And even if investors
did
see the paperwork, they wouldn’t have been able to deduce much. Unlike most limited-partnership prospectuses, Financial Concepts’ deal books didn’t contain analyses of cash flows or any other financial data. In at least one case, the prospectus did not disclose the address of the apartment building in which investors were supposed to put their money. Nor did any of the documents mention the fees and expenses that absorbed large amounts of investment and funds.

These fees were often steep. Up to 25 percent of investors’ money was taken off the top by Financial Concepts as a commission. Investors were also charged an “acquisition fee” of 10 percent on purchased property, various accounting and management fees and a 15 percent “termination” fee if they elected to sell early. In one two-year period, Financial Concepts took $121,000 in “fees and commissions” and another $37,000 in “legal and accounting fees.”

In late 1987 and early 1988, Illinois securities regulators started investigating Financial Concepts to find out whether money from new investors was—in fact—being used to pay off previous investors.

During the early stages of the investigations, Gordon agreed to address a meeting of nearly 1,000 Financial Concepts investors. He called the state inquiry “a total rehash of two-year-old news.” He said the charges stemmed from a technical violation of securities regulations the company had committed several years before by failing to file a form and pay a $30 filing fee. “The day we learned of that, we voluntarily suspended doing that,” he said. “We haven’t done what we’ve been accused of for two years.” And then he made his pitch:

I’m not asking for your sympathy... but evaluate in your hearts the relationship we’ve had to this day, outside of having the hell scared out of you. I’m asking for your strength, for the same friendship we’ve always enjoyed and for your prayers, to help us endure what we have to endure.

After the meeting, a number of investors went away happy with their investments. But the grind of regulatory scrutiny continued.

The investigations forced Financial Concepts to start recognizing the money problems caused by their numerous distressed projects. In March 1988, the Illinois Securities Department obtained a court order barring Financial Concepts from selling real estate limited partnerships on the ground that the ones it had sold were not properly registered. With that order, the scheme collapsed. Gordon and Boula declared bankruptcy for themselves and Financial Concepts.

A federal lawsuit followed a month later, in April 1988. The suit claimed that Gordon and Boula had sold property to partnerships at prices far above their true market value, mailed false financial statements and juggled funds among partnerships.

Prosecutors estimated that as many as 8,000 investors entrusted at least $60 million to Gordon and Boula. “Equity” partnerships bought real estate, including homes and resort property, and “income” partnerships lent money to the equity partnerships to buy property. They claimed that many of the income partnership investors were unaware the assets of the equity partnerships were “significantly less in value” than amounts lent to them.

All entities owned or controlled by Gordon and Boula were eventually placed under the receivership. Illinois-based real estate expert Jeffery Cagan was appointed receiver and charged with managing the remaining assets of Financial Concepts. Cagan’s appointment meant that investors could not withdraw any money pending a resolution of the case. Worse still: Under the court order, investors could be required to make additional payments to the partnerships in which they invested.

At the time of the receivership, a preliminary review placed the value of property owned by the partnerships at $10 to $20 million. Investors hoped to recover between 30 to 40 cents on the dollar of their investments. That hope turned out to be optimistic.

Prosecutors charged that, just before they entered bankruptcy, Gordon and Boula transferred $270,000 in investor funds to Swiss bank accounts in an unsuccessful effort to conceal their wrongdoing. The two were charged with three federal counts of mail fraud.

Gordon and Boula pleaded guilty and their surprise were sentenced to 108 months in jail. Using terms like “incredible greed,” and accusing them of destroying people’s “capacity to express love,” U.S. District Judge Brian Duff told Gordon and Boula, “There will be no tears for the sentence I impose. It will be well deserved.”

Duff ordered a deputy U.S. marshal to lock both men up immediately to begin serving their sentences. But, after court personnel informed the judge that additional time was needed to designate a prison for the defendants, he begrudgingly allowed them to remain free.

Gordon and Boula’s attorneys said they would appeal Duff’s sentence. They contended that he had exceeded federal sentencing guidelines, which would call for a prison term ranging from 30 to 46 months for each man.

A federal appeals court later held that sentences for crimes arising out of a Ponzi scheme were not subject to enhancement on the grounds the defendants specifically targeted elderly investors. So, it asked Duff to reconsider his sentence. He did—and found stronger legal grounds for keeping the same, harsh sentences. Specifically, he wrote:

In this court’s view, the crime is more heinous if, as in this case, there are 3,300 [investors] and the total loss is $7 million as opposed to if there were 10 [investors] with the same loss....

CHAPTER 3
Chapter 3: A Better Mousetrap Makes a Good Scam

New technologies have a rich history of fraudulent promotion. Over the last hundred years, crooks have promoted perpetual motion machines, water engines and magic elixirs. In the last 20 years, real technological advances have made outlandish promises seem a little more plausible.

As recently as the early 1980s, few people would have guessed that hundreds of millions of dollars would be made in stock offerings for companies that make Internet web browsers. A few years before that, no one would have known what to think of recombinant DNA drugs. And these issues say nothing of more modest tech advances, like cellular phones and satellite TV.

Like predators sensing a kill, Ponzi scheme perpetrators are drawn to this high tech confusion. “Whenever a new technology comes over the horizon, we see the same types of scams,” says Paul Huey-Burns, assistant enforcement director at the SEC. Though this remark could apply to any high tech issue, Huey-Burns was talking specifically about a favorite Ponzi scheme premise of the early 1990s—wireless cable.

The wireless cable television business centered on a new technology that transmitted television programming signals through microwave relay systems, rather than through wire cables. This eliminated the capital-intense process of connecting homes to cable networks. It removed the
cable
from
cable TV
. It also made it possible—at least theoretically—for small, scrappy start-up companies to compete with giant cable companies. And the actual product is virtually unregulated. Ponzi perps didn’t miss the chance to exploit this opportunity. They promise outlandish returns—as much as several hundred percent—in a few months. The pitch will usually have something to do with acquiring licenses for transmission access cheaply and then selling them to an established cable player. It has nothing to do with the truth. The perp takes a big chunk of money out immediately, never puts anything into the cable system and runs the pyramid long enough to blur his tracks.

Other wireless cable deals will have some basis in truth. The perp will actually acquire a license and will use at least some of the investment proceeds to build a system. The rest of the money goes in the perp’s pocket. Then, he’ll operate the company for a while or sell it to a larger company for less than the amount he raised in investments— hoping no one loses enough to sue.

As far-fetched as they may be, these schemes were a booming business in the mid-1990s. In 1997, the SEC was prosecuting more than 20 wireless cable fraud cases, involving more than 20,000 investors and $250 million. In a single 1996 civil lawsuit, the SEC sued four companies and 14 stock promoters who pitched nearly $19 million in investments in wireless cable systems from 1992 through 1994.

Wireless cable is another example of an idea that makes more sense to investors than it should. Many people think they know the cable industry because they watch a lot of ESPN and HBO. “It was the largest mix of people I’ve ever seen,” says a southern California perp who sold bogus wireless cable securities in the early 1990s. “When you’re selling gold or real estate, you get wealthier people who think they know what they’re doing. In wireless cable, you get all kinds. Doctors and dentists, sure. But also truck drivers and people working retail. They’re greedy. They might have heard Peter Lynch or somebody say ‘invest in things you understand.’ And they think they understand TV.”

The State of the Crooked Art: Pre-paid Telephone Cards

As the 1990s wore on, consumer complaints and SEC investigations chased many Ponzi perps out of the wireless cable business. Many moved into a field in which the technology issues were much more basic—but popular demand was much greater: long distance telephone service.

The deregulation of AT&T was a shining moment of 1980s smallgovernment ideology. It allowed companies like MCI and Sprint to become billion-dollar giants and drove down the cost of most long distance telephone service. It also created dozens of small long distance companies that focus on finding cheap, aggressive ways of marketing their services. In short, the long distance telephone business became a commodity market, in which price drove market share.

While investment-oriented Ponzi schemes do best in industries with big mark-ups and profit margins, sales-oriented pyramid programs do well in fields with thinner margins. This is one of the most important distinctions between the two. And it’s the reason that some of the most devoted Ponzi perps have experience running either kind of scheme. They size up a market, a company and a population—then start an investment- or sales-oriented scheme based on which will work best, accordingly.

When an industry transforms from a regulated monopoly (or near monopoly) to a price-driven commodity market, legitimate multilevel marketing mechanisms will flourish. They’re cheap and relatively effective
¹
. Where legitimate multilevel marketing schemes flourish, illegal pyramid schemes—their black sheep relatives—will follow.

In early 1995, the Better Business Bureau of San Diego County warned that southern California residents were being exploited by a multilevel marketing operation that was engaged in the long-distance phone business.

The company was Irvine-based National Telephone & Communications (NTC). Its corporate parent was Incomnet, a publicly-traded company also based in southern California. NTC sold long-distance telephone service and prepaid cards which allow people to make calls from public telephones. It also sold distributorships for selling the service and cards. Critics claimed that it cared more about selling distributorships than signing up actual long-distance customers.

¹
For more detail on multi-level marketing and its uneasy relationship with Ponzi schemes, see Chapter 14.

For $95, a person could become an NTC distributor. But distributors were strongly encouraged to pay $495 to attend Long Distance University, a “leadership course.” (According to an NTC newsletter, the course was “a requirement for becoming an area marketing manager.”) Finally, for another $700, a distributor could become a “certified trainer”—and sell distributorships to other people.

The BBB was concerned that Incomnet made its money from a pyramid scheme—not from selling long-distance service. About 24 percent of Incomnet’s 1994 revenue came from fees paid by distributors and trainers. “Based on our investigation, we believe the average sales rep for NTC can expect to make less than $100 a year,” said Lisa Curtis, president of the San Diego BBB. Curtis went on to say that ethnic groups—primarily Hispanics—were being recruited with particular intensity by NTC.

Beginning in the summer of 1994, NTC and Incomnet started having some severe problems. A number of sales representatives were leaving NTC—and many of these were complaining that it hadn’t paid them earned commissions. The Better Business Bureau noted: “Our complaint history shows a failure to eliminate the basic cause of complaints alleging problems with billing for long-distance service.”

Incomnet insisted the approach was legitimate and that it wasn’t the pyramid critics alleged. But, as the BBB group was making its announcement, word was circulating that NTC and Incomnet were being investigated by the SEC for operating an illegal pyramid scheme.

A January 1995 Incomnet press release said that rumors that it was under SEC investigation were “categorically false.” But the next day, a company spokesman sheepishly said Incomnet wasn’t under a “major” investigation. Two weeks later, the company issued a “clarification” conceding that it had indeed been under an SEC investigation since August 1994.

The SEC wasn’t the only group looking into the companies. The California Attorney General’s office was probing whether Incomnet complied with the state’s “business opportunities” law. (The law requires marketers to register with the state if, among other things, sales representatives must pay $500 or more to join.)
As much as anything, critics of NTC were concerned about some of the people running it. The long-distance operation was designed by two people who were involved with Kansas-based Culture Farms, Inc.
²
—an infamous pyramid scheme in which some principles went to jail.

Jerry Ballah, NTC’s marketing director, had settled a civil lawsuit over his role as a consultant to Culture Farms. (Ballah was also involved with another multilevel marketer of long-distance phone service, Arizona-based NCN Communications.) Chris Mancuso, NTC’s director of product development for a brief time, had served nine months in prison for his role in Culture Farms.