Federal Bullion & Coin, Ltd. (FBC) was a precious-metal dealer in Pensa-cola, Florida. FBC sold silver, palladium, gold and platinum, in both ingot form and investment-grade coins (such as the American Eagle or the South African Krugerrand). FBC offered direct delivery to the customer or, for an additional fee, arranged storage of the metal at a secure vault. There the customer's bullion would be commingled with other customers' metals, but, as each ingot and sealed coin bore a logged serial number, each customer's metal would be organized. One page on the Web site explained the process:

FBC offered just the kind of alternative investment Cris sought. As the company's Web site assured, this was not some kind of abstract purchase in a mining company or a futures contract. With FBC, Cris was buying actual metal. Unlike art or other collectibles, metals had a ready market with quoted prices available from a wide variety of sources on the Internet. Cris understood that, as with any investment, he was taking risks on the fluctuation of the market price of the metal, but unlike collectible coins, the value was unrelated to the particular coin in his possession.

Aware that the Internet is rife with frauds and fly-by-night operations, Cris initially established his account with a $2,000 deposit through PayPal, which prevented FBC from obtaining his credit card information. Cris's first outlay was a small one. He purchased one "unit" of U.S. Silver Eagles, consisting of five sleeves of twenty coins. The U.S. Silver Eagle has a face value of one dollar, is approximately 1.5 inches in diameter, and contains one ounce of silver. As a result, the value of these coins fluctuates with the market value of silver and, generally, is substantially more than the face value of the coin.

FBC charged a 5 percent commission on the total value of the transaction as well as delivery charges to ship the product to either the customer or the secure storage facility (storage charges were a separate fee if the customer elected that service). Cris, still cautious, elected to have the metal delivered to him, and two weeks later he received his package. Over the next several weeks, Cris monitored metal prices and by the end of the month, he had recovered most of the commission and delivery charges. Confident that FBC was legitimate, Cris began investing in earnest.

When Cris transferred $50,000 to his FBC account, the metals broker paid attention. Before the funds cleared his bank account, Cris received a call on his cell phone. "Mr. Marino, I'd like to introduce myself," said a deep voice with a distinct drawl. "My name is Carmichael J. Fredrick, and I'm your account executive at Federal Bullion & Coin, Ltd. I'd like to welcome you to the FBC family of investors."

During that first conversation, Fredrick spoke with Cris for nearly twenty minutes without once soliciting an order for metal. They discussed Cris's background, his computer consulting company, and the death of his parents and subsequent sale of their business. At the end of the call, Fredrick promised to e-mail Cris some recent research on anticipated demand in precious metals and to call him back early the following week after the funds cleared the bank and were available for investment.

As promised, Fredrick was on the phone the following Tuesday, "Y'all get a chance to look over the research?" he asked.

"Yes, Mr. Fredrick, I did, and I'm intrigued by the potential shortages in palladium from restrictions on mining in Russia and increased demand from growth in cell phone manufacturing," Cris answered.

"Well, first, please call me Mike. Mr. Fredrick was my daddy. And I think palladium is a great choice. I'd also like to see you take a position in gold. It is an essential element in the production of semiconductors and other electronic devices. Everywhere you turn, there are more and more computers and electronics. As there's only so much gold available in the world, there's nowhere else to turn, and if the economy slows down, it's a great hedge against declines in other investments like stocks and currency."

So Cris placed his order, and Fredrick transferred him to a compliance officer to complete the transaction.

"Good morning, Mr. Marino, my name is Austin Goodwin. I'm a compliance officer with FBC. I have in front of me a purchase order that Mike Fredrick prepared and it's my job to confirm the terms of the transaction with you and make sure we've got your order correct. It says here that you wish to purchase 20 ounces of gold and 100 ounces of palladium." Cris agreed.

"You understand that FBC charges a 5 percent commission on the total price of your metal and a combined delivery charge on this order of $150 for insured, secure handling to its final destination?" Goodwin continued. Again, Marino agreed; Fredrick had already discussed these transaction fees with him.

Goodwin went on, "Now, I see that you have decided to have FBC arrange vault storage for you . . . a wise decision with this quantity of metal. It's very expensive to try to arrange adequate security on your own. I assume that Mike explained to you that we place customer metal with an entirely independent vault company called FundEx, which is located in Texas. We do so much business with FundEx that they have agreed to provide vault space to us free of charge. The only fee associated with secure metal storage is a handling charge of $75, which you will pay every time you deposit or withdraw metal from the vault. Now for your convenience, we will advance the FundEx handling fee from your FBC account, and FundEx will send you a depository receipt via overnight delivery confirming the metal and serial numbers of the ingots it is holding in storage for you. Is that all right with you?" Again, Fredrick had already explained the storage terms to Cris and he readily confirmed the transaction with Goodwin, who thanked him for being such an enthusiastic customer and welcomed him again to the FBC family.

Over the next three months or so, Cris's relationship with FBC flourished. He would hear from Fredrick at least once a week. They discussed a wide variety of topics from activity in the precious metals markets to the general economy. Cris was in and out of several different metals as prices fluctuated. Silver dipped before he could ship the coins from his original purchase back to FBC to sell them, so he took a bath on that investment. Palladium, however, rose steadily as Russia — true to expectations — curtailed production of the metal to push up the price.

About four months after his initial contact with FBC, Fredrick had him on the phone. Palladium had experienced a particularly sharp price spike, and Fredrick said, "It's a shame you're a cash investor. With leverage, you could have quadrupled your profit."

Cris had no idea what he was talking about. Fredrick explained further, "FBC is a metals broker. We arrange the purchase and sale of precious metals for our customers on a commission basis. To customers like you, who understand the true potential in the precious metals markets, we offer a program that is actually provided by the vault company we deal with, Fund-Ex. They offer financing using the metal they're storing for you as collateral for the loan. You can borrow up to 80 percent of the value of the metal using the equity in your account for the other 20 percent."

Cris was interested, but also concerned about the risk of borrowing, which he raised with Fredrick.

"That's the best part," Fredrick responded. "Since they hold the physical metal as collateral, and they are heavily involved in precious metal investing themselves, FundEx is able to offer the loans at very favorable rates. Unlike buying stock on margin from a brokerage firm, FundEx will advance funds to you at a half point over prime. You're not likely to get that kind of rate anywhere else." Flush with the success of his precious metals investments thus far, the thought of using somebody else's money for profit was appealing. Cris signed up for the leveraged investment program.

During the next two years, Cris steadily built on his initial cash. He tentatively used the equity in his account to leverage his metals positions at first. But before long, Cris had more than a quarter of a million dollars worth of metal in storage at the FundEx vault. Cris traded in and out of various metals on the basis of news reports of global events and Mike Fredrick's knowledge of the likely reactions of the markets to these events. Certainly, there had been some losses, but these were minor compared to the gains he had enjoyed in the majority of his trades. As a result, Cris was surprised to receive an e-mail from FundEx requiring him to remit $6,400 to meet his margin requirements.

Cris had been so focused on the investment side of his metals portfolio, he hadn't noticed the accumulation of storage and handling charges each time he bought or sold a position in a metal. Rereading the customer agreement, he realized that the storage charges had only been waived for his first six months as a customer, and had been steadily building ever since. Cris discussed the margin e-mail with Fredrick, who encouraged him to pay the $6,400 because inflation expectations would push the value of his metal up in the next few months, and he would recover the additional investment several times over. Cris sent the payment.

Six months later, and two years into FBC's leveraged-investment program, Cris realized that the inflation wasn't coming. Looking deeper, he recognized that his losses were mounting and the interest, transaction and storage fees had effectively eliminated any equity in his account. When he added in the margin calls he had satisfied, he realized that he had lost substantially more than his initial investment. Cris called Mike Fredrick and instructed him to liquidate the remaining positions. Fredrick encouraged him to wait — a recovery in the metal markets was around the corner. Cris, however, would not be deterred. Fredrick agreed to close the account and send a check for the balance. Cris anxiously awaited receipt of the funds. A week later, when he had still not received the money, he checked his account online. There had been no change. FBC had sold none of Cris's metal and the FundEx loan remained, accumulating interest day to day.

Cris called FBC again, but Fredrick wasn't in the office. Cris called the next day; Fredrick couldn't take the call because he was on the phone with another client. He didn't return the call. Frustrated, Cris called again and asked to speak with Austin Goodwin. Goodwin claimed to know nothing of Cris's request to close the account and assured Cris that he would get to the bottom of the problem, "I promise you, sir, if Mike Fredrick dropped the ball, we will cover any losses that might have accrued over the last week. I'll get back to you by tomorrow."

Goodwin did not call back the following day, or the next, or even the next one after that. Once again, Cris logged into the FBC Web site to check the status, but the system showed the account as "Unavailable." Fearing he was the victim of an investment fraud, Cris contacted counsel.

When Cris described his experience to me, I initially believed that he had been the victim of high-pressure, incomplete-disclosure sales tactics common in boiler-room operations. Although Cris was locked out of his online trading account, he had printed copies of all trade confirmations and loan renewals.

We analyzed the transactions, comparing the purchase and sale prices to historic pricing information available on the Internet, and discovered that Cris's purchases were, routinely, 8 to 10 percent above the spot price of the related metal and his sale prices were always 5 percent below. These premiums and discounts were in addition to the commission FBC charged on the sale. Our analysis of the loan renewals showed that, contrary to the representations in the compliance interviews, the loans did not renew "bi-yearly," or every two years, but rather every six months. FundEx charged a 1.5 percent origination fee with each renewal, increasing the annual interest rate 3 percent. Further research revealed that Austin Goodwin was not merely the FBC compliance officer; he owned the company. While the FBC promotional materials and Web site claimed FBC and FundEx were independent, Goodwin owned the financing entity also. Armed with these misrepresentations, we filed a class-action claim for fraud in federal court in Florida on behalf of Cris and all other similarly situated FBC customers.

Through the discovery process, we requested financial statements and tax returns for both FBC and FundEx, as well as a number of other accounting records, but the defendants and their attorneys stonewalled. Eventually, through a subpoena to the companies' accounting firm, we obtained copies of the tax returns and other FBC and FundEx financial records that the accountants had in their files.

Reviewing these documents, we discovered a curious thing. During the three-year period that the court had allowed us to investigate, FBC had generated approximately $10 million in sales. At the same time, the company recorded $2.7 million in metal purchases. Similarly, FundEx had recorded millions in interest and fee income, which was consistent with the millions in lending it would have done to support FBC's sales of metal. However, FundEx was supposed to be holding depository receipts from a secure storage facility as collateral for the loans, but the company did not show any expense for it.

After obtaining and analyzing this documentation, we managed to locate Carmichael Fredrick. When Cris filed his lawsuit, Fredrick left FBC and moved to New Mexico, where we found him telemarketing penny-stock investments. No longer tied to Goodwin or FBC/FundEx, and fearing the appearance of a process server with a subpoena at his new job, he agreed to meet with us voluntarily at a bar after work. At the meeting, Fredrick acknowledged what we had already come to suspect: There had never been any actual precious metal.

FBC account executives would take orders from customers, using varying premiums and commission rates as incentives to decide quickly on the purchase. The account executive would pass the customer to Goodwin, who acted as a compliance officer to provide an air of formality to the transaction. Goodwin would then enter the "order" into a tracking program he'd developed himself. The tracking program would generate applicable "loan" documentation that Goodwin's sister would print and mail to the customer from her home in Houston. When customers like Cris logged into the FBC Web site, they were actually accessing the tracking program.

"What about the metal?" I asked him.

Fredrick took another swallow of beer, "There really wasn't any. Oh, Austin had a safe in his office where he kept a few thousand dollars worth of coins and bullion. Once in a while, we'd get a call from somebody who needed immediate delivery for some reason — like Cris's first order, or the crazy old lady from Boston who was giving her grandkids gold American Eagles as bar mitzvah presents. Other than that handful of coins and ingots, he would only buy metal when somebody actually settled an account and requested delivery of metal."

Further conversation revealed that Goodwin managed a portfolio of precious metals futures based on the total metal "held" by FBC customers. He used these futures contracts as a hedge against sudden, unfavorable movements in the market price. "Like," Fredrick explained, "if there was a huge mine disaster in Russia, the price of palladium might spike, and we could get a whole bunch of people wanting to close out their positions." The value of the futures contracts would track the price movement of the metal and allowed Goodwin to satisfy a demand to produce actual metal if needed. Goodwin recorded the futures contracts as "purchases" of metal in the accounting records, which proved to be the basis for most of the $2.7 million in purchases on the books.

In the meantime, it was the account executives' job to try to convince customers to maintain their leveraged positions so that the interest accumulation and renewal fees would consume whatever "equity" appeared in the account, and to reinvest "profits" to generate more commissions. Goodwin rewarded the account executives with lavish parties, deep-sea fishing trips in the Gulf, and substantial cash bonuses.

About three months after our meeting with Fredrick in New Mexico, the court ordered a conference on our renewed motion to compel FBC and FundEx to produce detailed financial records. The judge was very angry when defense counsel appeared with no representative of the defendants. After several minutes of being berated, defense counsel acknowledged that he had been unable to reach his client for some time. We later learned that Goodwin had cleared out the bank accounts and fled when he discovered the accountant was producing documents in response to the subpoena.

FBC's landlord had sold the abandoned furniture and computer equipment before we found out that Goodwin had absconded with the remaining cash but the landlord had saved several boxes of old files, which he gave to us. From these documents we identified more than 700 other FBC/FundEx investors who had lost about $15 million.

With no defendant in sight and no funds to pursue, the civil litigation floundered, and the court ultimately dismissed the action. We tried to interest government regulators in pursuing criminal action against Goodwin in the hope that it might lead to some degree of restitution, but we discovered an unfortunate gap in the then-applicable regulatory structures. The Securities and Exchange Commission (SEC) lacked jurisdiction because the transactions did not involve the purchase or sale of a security. Similarly, the Commodities Futures Trading Commission (CFTC) could not pursue the matter because Cris and the other FBC customers had expressly purchased actual metal, and the CFTC's jurisdiction was limited to policing contracts for the future delivery of a commodity, not an obligation to deliver the product currently. Finally, we spoke to state and local criminal prosecutors. While they sympathized with the situation, there was no perpetrator around to arrest and limited evidence with a dubious chain of custody. Further complicating the matter was the issue of jurisdiction, as Cris and the vast majority of other FBC customers were neither Florida nor Texas residents. In the end, there was no prosecution or restitution to satisfy FBC's defrauded investors.

Michael J. Molder, J.D., CFE, CPA, CVA, CFF, is a senior manager in the Business Advisory Services group of Marcum, LLP. Throughout his career, he has litigated, or aided counsel in, more than a hundred cases involving alleged fraud and financial manipulation. Mr. Molder has helped recover hundreds of millions of dollars for victims of fraud.