19. Testing, Testing
Bernie Madoff. Robert Allen Stanford. Danny Pang. From the fall of 2008 through the winter of 2009, it seemed every month another scandal was uncovered that profiled how well known businessmen had victimized their clients, leaving them with nothing but a television screen to watch the scam and their bank accounts unravel. While investors were shocked, they began scratching their heads wondering how this unprecedented level of graft had come to be. Were there any warning signs? Could these massive schemes have been avoided?
Using the methodology we have discussed throughout the book, we conducted investigative research regarding Madoff, Stanford, and Pang to see if we would have come up with any red flags had we done background checks on these individuals for our clients. In each of these scams, the ringleaders went to great lengths to hide their criminal activities for their own personal greed and gain. Yet when taking a closer look at these individuals, there were a few warning signs that could have been heeded to avoid being involved in these financial disasters. As you will see, when properly executed, the investigative tools outlined in this book will help you pre-empt fraud.
The Brazen Bernie
Let’s discuss the biggest: Bernie Madoff. We all know Bernie pled guilty to a Ponzi scheme that went on for over a decade and robbed investors of billions of dollars. From his closest friends and advisors to the arm’s-length-friend-of-a-friend investor, Bernie successfully portrayed the persona of a reputable genius whose ability to make profits for investors was unparalleled. While some criminals rely on their salesman-like personality traits to rope unknowing victims into their lairs, Bernie relied on his aloof sensibility to perpetrate the aura that his skills were unique and any investor was truly blessed to be a part of his investors’ club. The persona Bernie created for himself forced new investors to feel an element of social pressure: Who are you to question Bernie’s tactics? Look at everyone else who has invested with him.
When conducting our research on Bernie and his related entities, we found that his lack of transparency was one of the biggest red flags we found for him. Neither investors nor regulators had access to Bernie. While we now know that he had lied for years to the Securities and Exchange Commission (SEC), Bernie’s Form ADV (the form submitted to the SEC to be registered as an investment adviser) is rather lackluster. In the document, submitted on behalf of his firm, Bernard L. Madoff Investment Securities, there is scant information on Bernie himself (almost all of the required questions were left blank), no mention at all as to who was executing the trades for the firm (the fact that we now know these trades were nonexistent may explain it a little), and the only other individual listed on the form as retaining a 25% or less interest in the company is Peter Madoff, Bernie’s brother. The only relevant information on this Form ADV are the two disclosure events that detail how Bernard L. Madoff Investment Securities was censured and fined $8,500 in 2007 by the National Association of Securities Dealers (NASD), now the Financial Industry Regulatory Authority (FINRA), for violating “limit order” displays, and in 2005 was censured and fined $7,000 by the NASD for failing to display customer “limit orders” that failed to comply with NASD regulations.
Beyond the void Form ADV for Bernie’s firm, other red flags for Bernie Madoff include the size of the minor-league accounting firm Madoff used: a three-man operation in New City, New York (in a strip mall approximately 30 miles outside of New York City) that hardly seemed capable of overseeing billions of dollars. Further, we found that Bernie had some potential conflicts of interest with affiliate companies, such as Cohmad Securities. Cohmad Securities was supposed to have been the independent securities broker used by Bernie’s firm, yet we found through our review of corporate records that both Bernie and his brother, Peter, were officers of Cohmad, and the company was located in the same suite in New York City’s Lipstick Building (at 53rd Street and Third Avenue) as Madoff’s investment company. While this connection was not included on the Form ADV for Bernie’s firm, it was disclosed on his personal registration with FINRA (the largest independent securities regulator in the U.S.). At the least, the regulators should have asked him about his relationship to Cohmad. While there are many successful family businesses throughout the country, the fact that Bernie’s brother, his sons, and his niece were among the only senior officers of the company would have given investors reason to question why the books were not opened to people outside of his family.
We also found there were numerous employees who had left Bernie’s firm over the years. These former employees would have been great resources for investors and may have been exposed to some element of Bernie’s scam that caused them to leave, and/or Bernie may have fired them if they had gotten too close to what was really going on.
Lastly, we found some controversial news stories reported in 2001 in Barron’s and MARHedge that questioned Bernie’s investment strategies. These are some of the yellow flags that would have given reason to pause before committing to Madoff. While nothing is overtly criminal, the subtleties speak volumes.
Stanford’s Instabilities
Next up: Robert Allen Stanford. In February 2009, the SEC charged Robert Allen Stanford and three of his related companies with engaging in an $8 billion fraud. In essence, the SEC alleged Robert Allen Stanford, or “Sir Allen” as he preferred to be called after he was knighted in Antigua, falsely promised investors high returns on certificates of deposit. Sir Allen, a Texan native and a resident of St. Croix and Antigua, and his main company, Stanford Group Company, were well known for making sizable donations to politicians on both sides of the aisle. These politicians were also conveniently involved in international offshore banking. Stanford was also known for having a seemingly cozy relationship with regulators, specifically those in Antigua, where Sir Allen prospered.
Like Bernie Madoff, Sir Allen relied on his name and reputation to woo other investors into his fraudulent web. But what would an earnest investor have found if a little homework had been done before agreeing to hand over cash to Sir Allen?
We confirmed Stanford Group Company, an affiliate of Mr. Stanford, was registered with FINRA, and this registration (which can be accessed for free on the FINRA website) detailed numerous arbitration matters filed against Stanford Group. Specifically, between 2001 and 2006, there were seven arbitration matters in which Stanford was charged with varying degrees of fraud, including breach of fiduciary duties, negligence, omission of facts, churning, unauthorized trading, and misrepresentation. Stanford lost four of the seven arbitrations.
As if that were not enough of a reason for any investor to question Stanford, the FINRA registration also listed several actions taken by FINRA against the company. These regulatory disclosures included the following
• In 2007, the Group was censured and fined $10,000 for misrepresenting facts surrounding CD disclosures.
• In 2007, the firm’s retail brokerage operation was censured and fined $20,000 for failing to meet net capital requirements and maintain adequate compliance systems, among other charges.
• In 2008, the Group was censured and fined $30,000 for multiple failures to disclose valuation methods and risks that may impede investors’ ability to reach target prices as advertised.
• In 2008, the Group was censured and fined $10,000 for failing to properly report and supervise customer transactions in municipal securities.
To recap: Any investor could have hopped on the FINRA website and found that Stanford was accused of fraud on several occasions and fined by FINRA four times in less than two years for either misrepresenting facts to customers or failing to disclose proper information and strategies. While certain violations or allegations may seem routine given the size and nature of Stanford’s enterprise, when a company has had multiple actions taken against it, there is definitely reason to use caution or at least ask questions before moving ahead with any business relationship.
Outside of the information reported to FINRA, in January 2008, two former employees of Stanford Group Company sued the firm for wrongful termination/employment discrimination and fraud in Harris County District Court, Texas. A review of the complaint filed in the case determined the plaintiffs were former financial advisors for high net worth clients at Stanford Group who became aware of illegal practices involving the sale of the company’s certificates of deposit and other securities offerings. The plaintiffs requested that management comply with legal requirements, but when the firm refused, the plaintiffs were forced to resign in order to avoid participating in these illegal practices. As it turns out, these two former employees had testified before the SEC in 2007 before this case was filed. The complaint in this case provides an uncanny glimmer into the future as the SEC’s allegations against Stanford are very similar to the plaintiffs’: that the company misrepresented the value of certificates of deposit.
For those of you not satisfied that claims of exaggerated returns are cause for concern, what about the term “Ponzi scheme?”
In March 2006, Stanford Financial Group was sued by a former employee in Miami-Dade County, Florida. The former employee alleged that the firm “was operating a ‘Ponzi’ or pyramid scheme, taking new money to its offshore bank, laundering the money and using the money to finance its growing brokerage business, which did not have any profits of its own.” This was not the first time the term “Ponzi scheme” was used to describe Stanford Group.
In November 2005 a civil case was filed against Stanford Group Company and several affiliates in U.S. District Court, Southern District of Florida. The lawsuit was filed by two Venezuelan investors in Stanford who alleged that Stanford International Bank “knowingly aided and abetted...a classic Ponzi scheme,” targeting current and former residents of Venezuela. Specifically, the plaintiffs alleged that Freddy Manzano, a co-defendant in the case, was a fugitive from Venezuela and was a perpetrator of a Ponzi scheme known as “La Vuelta,” of which the plaintiffs were investors. The plaintiffs claim that Manzano used Stanford International as a bank for his funds and that Stanford International, through Stanford Financial, knew about the fraud yet still allowed Manzano to deposit his funds and issue sham promissory notes. The case was ultimately settled out of court.
Having established that Stanford Group has been accused of fraud, operating a Ponzi scheme, and misrepresenting information to investors, what else could possibly be out there in the public domain for investors to know about this company? You guessed it: money laundering.
In August 2002, Kadir Overseas Ltd. and Jorge Bastida Gallardo filed a federal-level civil case in Florida against Stanford Group Company and Stanford International Bank. The plaintiffs, who were, according to media articles, front men for the Mexican drug lord Amado Carrillo Fuentes, alleged that Stanford Group failed to protect the launderers’ money when the bank voluntarily gave $3 million of the launderers’ money to the U.S. Drug Enforcement Administration in cooperation with a narcotics investigation. Yes, there is implicit comedy in the fact that money launderers used legitimate legal channels to blame Stanford for not protecting their illegally gained money and handing it over to authorities. Yet beyond that, the statement is clear: Stanford Group was holding money for Mexican money launderers. There were also several media articles published that discussed Stanford’s ties to these Mexican drug cartels.
The money laundering whispers spread beyond the ears of the courtroom. In the late 1990s and into the 2000s, various news articles tied U.S. government concerns regarding money laundering in Antigua to Stanford’s bank, given that Stanford International Bank was the largest on the island and an established offshore banking center. Antiguan leaders described Stanford as the “most influential” man on the island. And while Sir Allen himself was not implicated in criminal wrongdoing, he was at the center of a controversial 1998 overhaul of Antigua’s money laundering legislation. Antiguan Prime Minister Lester Bird, with whom Stanford had a close relationship, personally asked Stanford to lead the reform effort. The U.S. government complained that new secrecy rules only deepened the country’s reputation as a haven for money laundering. Stanford’s presence on the six-member regulatory authority, the United States said, was a conflict of interest. Subsequently, the Treasury Department issued a special advisory against Antigua, warning banks to take extra precautions when handling transactions routed through there. Eventually, according to these media reports, Antigua changed its banking laws substantially enough to be dropped from a list of problematic offshore havens in 2001.
It is also interesting to consider that Stanford, like Bernie Madoff, used a small accounting firm to oversee the bank’s operations. The accounting firm, C.A.S. Hewlett & Co., was based in Antigua and run by Charlesworth (Shelley) Hewlett, who died in January 2009.
There was an enormous amount of information available in the public domain about Robert Allen Stanford and the activities of his companies. Had investors bothered to follow our suggested research methods (as laid out in the preceding pages of this book) and found out what transpired with Stanford’s companies in the last few years, we doubt that any investor would have committed money to the Stanford-run financial institutions.
The Sting of Pang
So, what about Danny Pang? Danny Pang was a Taiwanese man who established offices in California and ran Private Equity Management Group (PEMG). In raising millions of dollars from investors, many of whom were from Taiwan, Pang abused his connections to the wealthy in Taiwan and relied on one talent: telling lies. In April 2009, the SEC filed a civil case against Danny Pang, stating he had defrauded investors of millions of dollars, and the SEC went so far as to freeze Pang’s assets. Two weeks after the SEC’s actions, the FBI arrested Pang, claiming he had deliberately structured his cash withdrawals in amounts under $10,000 so as to avoid notifying federal regulators, who had established the $10,000 mark as a means to identify money laundering activities. Five months after his house of cards crumbled, in September 2009 Danny Pang committed suicide.
In looking into Pang’s background, we attempted to confirm the Master of Business Administration degree that Pang told investors he received from the University of California at Irvine. It seems Pang was the only one aware of this degree. The school said that while Danny Pang was enrolled for one class in the summer of 1986, he never attended any other classes, and he certainly never received an undergraduate or an MBA degree from this school.
We also sought to confirm other statements made in Pang’s biography posted on PEMG’s website. The bio stated Pang served on the boards of “many” public companies. We scoured SEC filings and did not find Pang as a member of the board of any publicly traded company. Further, we checked with the SEC and determined that Pang’s investment firm was not registered as an investment adviser, and Pang was not individually registered with the SEC, FINRA, or any other state or federal regulatory body. Again, this information is readily available on the SEC and FINRA websites and would have made any investor realize that Pang was 0 for 2 in the game of truth and had deliberately not disclosed his activities to any appropriate regulatory agency.
Our next step was to see if Pang had been involved in any material lawsuits or court filings that would have given investors some clue as to how Pang would use investor money. While we did not conduct an inquiry in Taiwan, we did review court records in California and found Pang as a defendant in several civil cases. Most notably, Pang and one of his affiliates, InterPacific Capital, were sued for fraud in April 2001 in Orange County Court. The case was not settled until February 2006, five years after the case was filed. If the cause of action is listed as fraud, racketeering, or if someone has been sued by a financial institution, then investors definitely need to learn more before moving forward.
Also, in September 2003 Pang was sued by Eagle Guo for breach of contract, according to the case index information in Orange County, California. At first glance, “breach of contract” did not appear to be anything out of the ordinary. But we learned that “breach of contract” was just one of the many causes of action in this case. Once we reviewed the complaint filed in this case, we learned Eagle Guo, the plaintiff, was an investor of Pang’s who charged Pang with constructive fraud and damages for sale of unqualified securities, in addition to breach of contract. This investor claimed he gave Pang more than $80,000 to be invested in a fund (later believed to be nonexistent) and that Pang “absconded with” the money and used it for his own personal gain. Had investors retrieved the court documents filed in this case, they would have known that Pang had a history of defrauding his earnest investors. Finally, in 1999 two financial institutions, Midland National Life and CitiCorp, filed lawsuits against Pang personally.
Erring on the side of trust and optimism, Pang theoretically could have lied about his education to get ahead, and then before he knew it, the lie had been going on for so many years that it became almost too late to come clean. And it is always possible the lawsuits filed against Pang were baseless, and maybe even that he was a target of prejudice against Taiwanese people. But what about the media articles published in 2002 that repeatedly state the FBI said Pang “might have” connections to the Taiwanese mob? Or that the president and CEO of Pang’s former employer, Sky Capital Partners, alleged Pang stole $3 million and forged the CEO’s signature? And then there are the disconcerting personal issues about Pang: that his former wife, Janie, was a stripper who once called the police to their house, alleging Pang had beat her and stole money from her parents. In 1997, Janie Pang was killed, at age 33, and to date, the killer is unknown. In 2002, the man who was charged with Janie Pang’s murder admitted in court that he engaged in money laundering on behalf of Pang. The man was later found not guilty of killing Janie Pang.
Our tally of red flags identified for Pang so far include allegations of money laundering, theft, forgery, abuse, and deceit. This is all before the former employees of PEMG disclosed that Pang used investor money to buy a Gulfstream jet, and was even so bold as to tell some of his employees that he was engaged in a Ponzi scheme. Knowing all of this, would you have given Pang any of your money?
Remember Bayou?
Bayou Hedge Fund Group was a hedge fund founded by Sam Israel III, who pled guilty to defrauding investors of $450 million in 2005. As with Bernie Madoff and Robert Allen Stanford, investors quickly handed over money to Bayou with the hopes of unrealistic returns and overlooked the basic due diligence steps that would have given them plenty of information to suggest that investing with Mr. Israel was not a wise decision. When we researched Mr. Israel’s background to find any clues that would predict the debacle that unfolded for investors in Bayou, we found was that Sam Israel significantly overstated his credentials regarding his tenure and his responsibilities at a prior employer. Of course, the lies and mismanagement do not end there.
Two former employees had sued Bayou, Mr. Israel, and Dan Marino (CFO) in March 2003 in Louisiana, two years before the fiasco. In reviewing the complaint filed in the case, we determined the former employees alleged that Bayou engaged in potential violations of both SEC and NASD (now known as FINRA) regulations. The complaint also mentions an inexplicable depletion of $7 million of company funds in December 2002. When the plaintiffs raised the issue of the missing monies to Mr. Israel, they were quickly fired from Bayou, according to the complaint.
Also, Dan Marino, the Bayou CFO, (not the famous Miami Dolphin quarterback of the same name) was the registered agent for the allegedly independent accounting firm used by Bayou. And in March 2005, Bayou hired a new Director of Investments. Well, this newly appointed director filed for Chapter 7 bankruptcy protection in May 1993 and then again filed for Chapter 13 bankruptcy protection in California in April 2002. Would you hire him to direct your investments if he clearly cannot direct his own?
Last, we found Dan Marino had sued a fund in the Isle of Man in March 2003, alleging the principals of the fund had engaged in fraud and misrepresentation. A review of the complaint in the case determined Mr. Marino had given $2 million to this fund. Had investors known about this case, they would have immediately questioned the origin of the $2 million investment and would have wanted to know more about Dan Marino and Bayou’s connections to a fund that allegedly engaged in fraud.
The public record information available on Stanford Group Company, Danny Pang, and Bayou is much more abundant and blatantly damaging than for Bernie Madoff. However, the commonalities between Robert Allen Stanford, Danny Pang, and Bernie Madoff are that they each used their reputations, whether fabricated or true, to keep investors in the dark. We call this “flock funding.” Investors relied on reputation and not research when they invested: They followed the flock. Bernie’s reputation was supported and echoed by a vast network of friends and family; Stanford’s reputation was established through tight friendships with influential government heads both offshore and on; and Pang’s reputation was built from his connections to his homeland in Taiwan. Another shared and critical trait: The information and warning signs were out there to be found, had anyone been interested in looking.
And the Moral of the Story Is...
In 2008 and 2009, as the economy faltered and once-revered financial institutions crumbled, instances of corporate fraud were being announced on a weekly basis. In this chapter, we discussed some of the largest frauds that were revealed during this time period: Madoff, Stanford, and Pang. But it is important to know that defrauding investors is not and probably will not be limited to this time frame. An article in Time magazine, dated June 10, 1985, entitled “Crime in the Suites,” stated
The way things are going, Fortune may soon have to publish a 500 Most Wanted list. During the past few months the news has been filled with tales of business schemes and scandals, of corporate intrigue and downright crime. The offenses make up a catalog of chicanery: cheating on government defense contracts, check-writing fraud, bogus securities dealing, tax dodges, insider trading and money laundering... But rarely have so many big-name businessmen and corporations been accused of so much wrongdoing in so short a time. Several business trends, including financial deregulation, the growth of huge conglomerates and the rise of electronic funds transfers, seem to be multiplying the opportunities and temptations for businessmen to stray outside the law.
All you have to do is change a few of the types of crime named in this paragraph, and the statements apply today. The 1985 article discussed the corporate crime that was prevalent in the 1980s. Most of these crimes, such as insider trading and money laundering, remain issues of concern. And while state and federal regulators scramble to implement revamped rules to accommodate the most recent waves of corporate fraud, there are always loopholes. Within weeks of the implementation of the 2008 Troubled Asset Relief Program (TARP), a special inspector general was appointed to monitor potential fraud in the program. By April 2009, there were 20 investigations being pursued involving alleged TARP fraud, and in March 2010, the CEO of Park Avenue Bank, located in New York City, was arrested for engaging in such fraud. This was the first time criminal charges were brought against an executive for violations of TARP rules. The CEO allegedly lied about his bank’s financial status in order to illegally get a piece of the TARP bailout money.
Creative corporate criminals will continue to find ways to permeate the system in their desperate journeys for wealth, power, or whatever drives them. To avoid becoming a victim, the answer does not lie in fear or apathy; paranoia is as helpful as ignorance. Rather, your survival rests in your awareness. Information is your advocate.
The cases discussed in this book have one common theme: disclosure. When information was withheld, the success of a deal or investment was compromised. From Bernie Madoff’s billion-dollar Ponzi scheme to a slight exaggeration on a resume, when information is not properly disclosed, the balance of power is shifted to those in the know and those being duped. The end result is always that reputations and bank accounts are greatly sacrificed. Transparency is vital in every transaction, whether in the United States or overseas.
The purpose of telling these stories from our arsenal of investigations is certainly not to instill fear, but rather to impart caution. The objective of the background check is to confirm someone’s good name and to bring to your attention any discrepancies, controversies, reputational issues, or potential problems that may impact the prosperity of your deal. We are relieved when we conduct a background check and find the person has a clean slate and accurately represented himself. Background checks should always be used and assessed in conjunction with your legal and financial due diligence. The intelligence we gather is designed to protect you and give you the confidence and knowledge to move forward with your transaction, whatever that may be. Background checks give you intelligence, which in turn gives you the power to act judiciously.