You Can't Cheat an Honest Man (9 page)

In 1975, there was a sign of trouble. Martin’s gambling debts—he played in Las Vegas casinos and bet on horses at tracks in Louisiana— caught up with him. He filed voluntary personal bankruptcy.

In 1981, Martin joined a local travel agency as a sales representative. A few years later, he left full-time employment to become one of the company’s outside contractors. Martin’s colleagues in the travel business considered him little more than an ambitious country bumpkin. “We thought he was a simpleton,” said one former travel agency customer. “It’s hard to understand how he could have masterminded an operation like [a $50 million Ponzi scheme].”

In the first few years of the scheme, Martin had only a handful of investors. But, by the end of 1986, word had started to spread about LPM Enterprises. One of the most active salesmen for the scheme was Johnny St. Pierre. As time went on, some LPM Enterprises investors were not personally acquainted with Martin—but they usually knew St. Pierre. A 25-year veteran in the insurance industry, St. Pierre (who was also Martin’s uncle) had a large network of contacts in the Louisiana business world.
In 1987, checks worth as much as $50,000 began passing through the company checking account every day. (By early 1988, that figure had increased to between $100,000 and $200,000.) In 1987—the scheme’s biggest year—more than $97 million passed through LPM Enterprises’ account at the Bank of LaPlace. Through all this growth, the scheme was always pushing the edge of solvency. “[Martin] had to bring in cashier’s checks every day to cover the overdrafts,” one bank officer remembered.

In fact, the bank had a special policy for LPM Enterprises. Every morning, tellers would begin processing the post-dated checks written to investors on the account. They’d usually find that the company didn’t have enough money to cover the checks. But the bank would cover Martin for a few hours. A teller would call LPM Enterprises with an amount and Martin or one of his associates would drop by in the afternoon with a bundle of cashier’s checks to cover the overdraft.

Because Martin was careful about covering the overdrafts, the bank rarely returned his checks. Of course, it was making good money from the LPM Enterprises account. For each check that overdrew the account in the morning, LPM Enterprises paid a service fee. By one estimate, the bank was collecting $3,000 to $3,500 a month in services charges during 1987.

Martin kept his scheme alive by obtaining funds from new investors to honor the interest checks given to earlier ones. Through early 1988, all went well and most of the bogus profits generated by LPM Enterprises were returned by investors to be reinvested. Then trouble hit.

April 1988 was the cruelest month for Martin. A number of big investors had begun scaling back their involvement in LPM Enterprises. Some were cashing out large portions of their investments to help pay income tax; others had become uncomfortable with their level of exposure.

Whatever the reasons, Martin was having trouble covering his daily overdrafts for the first time in five years. The bank returned quite a few checks. Just about every day, Martin was having to explain to some angry investor that there’d been a foul-up at the bank. On Friday, April 22, Martin phoned Lee Leonard—an attorney he had used occasionally in the past. “I thought it might be a tax problem or a speeding ticket,” Leonard said. “I had no idea what he was going to talk about.” Martin was visibly shaken when he arrived at Leonard’s office. Some LPM investors had made threats; others had sworn out arrest warrants. Leonard convinced Martin that he would have to turn himself in to the authorities. But Martin said he needed the weekend to think things through. Sometime that night, he flew to Las Vegas...where he spent the next two days gambling heavily.

On Monday morning, April 25, Martin walked into the federal building in downtown New Orleans and surrendered to federal authorities. By the time LPM Enterprises finally collapsed, about 500 people had been swindled out of an estimated $50 million.

Compared to what might have happened to him outside, Martin felt relatively safe in custody. An Assistant U.S. Attorney said, “Without going into specifics [about death threats allegedly made against Martin], let me just say that we recognize the possibility in a confidence game like this where you have so many victims, so many people were defrauded, the possibility exists that someone may try to take matters into their own hands.”

In the late summer of 1988, Martin pleaded guilty to one racketeering count, two counts of interstate transportation of money stolen by fraud and two counts of filing false income tax returns for the years 1986 and 1987. U.S. Attorney John Volz asked the court to give Martin the maximum sentence of 25 years in prison. Volz called LPM Enterprises “one of the biggest scams ever perpetrated in this state.” In September 1988, Martin was sentenced to 15 years in federal prison and fined $1 million.

The criminal charges were resolved so quickly that most of Martin’s burned investors weren’t sure how to proceed. Many were frightened of being identified as participants in the deal. “This damn thing could destroy me,” said one prominent insurance executive. “What I sell is knowledge, ability, integrity and judgment. Who’s going to trust me if this thing gets out?”

One group of angry investors sued Bank of LaPlace for negligence, arguing that it should have known that Martin’s activities were improper. In the course of covering his daily overdrafts, Martin had gotten to know several bank officers. He explained LPM Enterprises’ supposed business to them—but never deposited checks from or wrote checks to Las Vegas hotels or airlines. The investors argued that the bank effectively aided and abetted Martin’s perpetration of the fraud.

On the negligence charges against Bank of LaPlace, the trial court said:

The Court is of the opinion that the banks violated no duty to plaintiffs. The banks owe no duty to the plaintiffs to protect them against the type of harm arising from the fraudulent scheme.

Several investors tried arguing that Martin’s post-dated checks should count as securities under federal or local laws. A federal court ruled that “post-dated checks, issued in return for investments in a bogus air travel business, did not qualify as
securities
or
investment contracts
under federal or Louisiana securities law.”

In 1993, Martin was released from prison after serving a third of his 15-year sentence. Out of jail—but still on probation for years to come—Martin moved to Florida and found a job as a sales representative for a travel agency. He started making his restitution at the rate of $100 a month. At that pace, he was scheduled to pay off the fine in 833 years.

Most investors, who considered Martin little more than a nervously ingratiating salesman, didn’t believe he could have done it alone. “Lynn was the bag man,” said one burned investor. “Someone else was pulling his strings.” One common scenario: Martin had a silent partner in Las Vegas who made the important decisions—and was holding some $5 million in missing money.

Even the pros were suspicious. “I don’t think Martin did it alone,” U.S. Attorney Volz said. But, after months of interviewing Martin’s associates, pouring over records and grilling the star witness, the Feds had no hard evidence linking anyone in Las Vegas to the operation.

Lee Leonard, Martin’s attorney, offered a different explanation: “Maybe you don’t have to be that smart to cheat greedy people.”

CHAPTER 5
Chapter 5:
1040-Ponzi

Tax hedges and dodges are a major appeal for Ponzi schemes. There seems to be something buried deep in the subconscious financial mind that links the phrases
tax shelter
and
con scheme
.

There are some good reasons for this. One reason that Ponzi schemes work so well as tax shelters is that the secrecy on which they rely appeals to many people who have a strong aversion to paying taxes.

But secrecy isn’t the only aspect that makes a tax shelter a perfect place for a Ponzi scheme to flourish. There are other elements, too— primarily, greed and fear. An investor drawn by greed and fear (of the IRS) is a prime candidate for being burned in a Ponzi scheme.

Columbus Financial, a company that packaged and sold taxadvantaged limited partnerships in oil wells, was founded in 1987 in Beverly Hills, California. The company’s pitch: Taking advantage of specially-written language in the U.S. tax code, investors could put money into Columbus partnerships, take a tax credit for developing oil wells and later recoup the investment plus interest on a taxadvantaged basis from income generated by the wells.

The brokers selling Columbus partnerships worked through any hesitation. They insisted on sitting down with potential investors to deliver prospectuses—which had been filed with the SEC—in person and go over the fine print. To financially inexperienced people, the paper trail seemed to support the company’s legitimacy. “I didn’t understand how little it means to file something with the SEC,” says one burned investor.

Still, the promises sounded suspicious enough that the regulators who oversee partnership sales looked at Columbus’ operations carefully and often. The National Association of Securities Dealers inspected Columbus every year. The SEC periodically checked the NASD’s work. Both gave the operation a clean bill of health for eight years.

The agencies weren’t looking in the right places. Columbus was running a Ponzi scheme the whole time—using cash from new investors to pay old ones returns of up to 14 percent. (The supposed tax-advantage of the deal increased the effective rate of return to 20 percent.) It covered up the misappropriation with phony financial reports and geological studies.

The Internal Revenue Service, which was initially confused by Columbus’ claims of tax advantage, uncovered the fraud where the other Feds missed it. But, by the time the scheme was exposed by IRS and U.S. Postal Service inspectors, thousands of investors had lost $139 million.

Columbus had put $10 million—at most—into wells. The legal and financial pros brought in to sort through the mess predicted that investors would be lucky to get back seven cents on the dollar from the bankruptcy liquidation. Many of the brokers selling the bogus investments claimed they had been conned, too. They’d believed that the oil deals (which paid them 8 percent to 10 percent commissions) were legitimate. “How were we supposed to tell something was wrong if the SEC and NASD didn’t know?” asked one former salesman.

Columbus president Neal Stein spent a lot of the money on himself. He lived in an ostentatious Beverly Hills mansion. He owned at least five luxury cars, including several Mercedes-Benzes and a Bentley convertible. He had three nannies to watch two children. But, even considering these extravagances, nearly $60 million of the money raised by Columbus was simply missing at the end.

A number of angry investors argued that Stein may have moved what was left to overseas bank accounts.He pleaded guilty to tax evasion and securities fraud in September 1995. He faced up to 10 years in prison and a fine of $1 million at his sentencing, which was delayed indefinitely. The Justice Department was investigating several of Stein’s compatriots—and wanted his cooperation.

One of the surprising aspects of the Columbus scheme was the failure of the regulatory agencies to pick up any sign of fraud. Many of the investors did their homework before handing over their money—and still bought in because the partnerships looked legitimate. “What you need to remember is that this was basically a tax fraud,” said one burned Columbus investor. “All the stuff that was wrong from the beginning was stuff the NASD doesn’t even know to look for. Their people focus on securities issues. The IRS people would have been able to see that Columbus was a scam.”

But the IRS didn’t get involved until Columbus had already sold tens of millions in limited partnership shares. As one IRS fraud specialist said: “We don’t look for problems pre-emptively. A crime has to take place before we can begin.”

Lump Sum Pension Payments

The lump sum payments that many employees receive when they leave a company or retire are prime targets of Ponzi perpetrators who promise tax advantaged investments. Often, the perps will exploit the common misperception that “tax advantaged” means low risk.

For several years beginning in the late 1980s, Harold Sherbondy convinced a number of his San Diego County neighbors to invest almost $5 million in what was supposed to be a tax-advantaged commodities trading partnership (that is, essentially, an oxymoron). Most of the money came from retirement buyout funds that pilots, flight attendants and mechanics received when U.S. Airways bought San Diego-based Pacific Southwest Airlines.

Sherbondy’s pitch: He had discovered a novel way to obtain IRS approval to invest buyout funds in commodities and have the income be tax free. His plan would allow investors to realize profits of between 25 percent and 50 percent a year.
This was an unlikely proposition. Commodities trading is not only one of the most volatile forms of investment around, it’s also taxed just like any other investment. Other than the tax breaks given—by law—to certain kinds of government debt instruments (muni bonds, T-bills, etc.), the IRS doesn’t offer tax advantages to particular methods of investment. It focuses its tax breaks according to how the money being invested is intended to be used.

However, Sherbondy never got to the point of hashing out tax policy. He never really invested his clients’ money—only putting about 1 percent of the funds in a commodities account he used for show.

Most of the money went directly into Sherbondy’s personal bank accounts. Like so many Ponzi perps, he needed to keep up the impression of wealth. The trappings—the Mercedes Benz, the private plane, the big house—were important elements of his credibility.

He also used church membership and apparent religious piety to convince people to invest with him. Sherbondy and his wife were regular members of a Christian church in northern San Diego county. Through this connection, Sherbondy met the first investors in his commodities scam—and these people went even further, convincing their friends to invest.