by James Walsh
Since many legitimate developers use this formula, it provides credibility for Ponzi perps who either collect the investments and don’t actually develop anything or sell dozens of 25 percent shares in a single project.
project.
count indictment charging him with mail fraud and money laundering related to a Ponzi scheme that bilked more than 200 southern California investors out of more than $13 million between 1990 and 1993. The indictment resulted from a cooperative investigation performed by the FBI and the IRS Criminal Investigation Division.
Murphy promised phenomenal returns to investors from across the United States if they invested their money in one of several commercial real estate projects being developed by his company, American Capital Investments Inc. (ACI). He invited people to invest in dozens of limited partnerships managed by ACI. The self-proclaimed real estate investment expert had advertised heavily on television and in magazines. He’d also co-written a book called One Up on Trump.
According to the U.S. Attorney’s office in Los Angeles, Murphy commingled money from various limited partnerships and improperly diverted a large portion of that money to pay ACI’s operating expenses and his own personal expenses. Murphy also used funds from later investors to pay supposed profits to earlier investors. The indictment charged that Murphy lied to obtain his investors’ money and continued to hide the truth to avoid having to repay principal and promised profits. (The Securities and Exchange Commission had begun a civil investigation of Murphy and ACI for fraudulent practices in early 1993. Murphy did not tell investors about this investigation, as required by law.)
As many Ponzi perps do, Murphy persuaded investors to roll their supposed profits into new funds rather than cashing out. Those who demanded their money were paid with funds from later investors. Unfortunately, only a few investors demanded their money back. Of more than $18 million that Murphy collected from investors, he returned less than $5 million.
About the time that the SEC was opening its investigation into Murphy’s limited partnership Ponzi, it was closing the lid on another.
In September 1993, the SEC filed a lawsuit against Atlanta real estate developer H. Ellis Ragland. The Feds asked U.S. District Court Judge J. Owen Forrester to make Ragland return $670,042 in “ill-gotten gains” derived from a Ponzi scheme.
Between July 1985 and December 1987, Ragland’s company, Guaranty Financial Corp., raised more than $4 million from 165 investors in three limited partnerships and two blind pools. (Blind pools are investment vehicles in which investors don’t know exactly how or where their money will be used.)
In each limited partnership, Ragland was the general partner or manager, in charge of scouting out real estate in metropolitan Atlanta. Investors who assumed they were putting their money in shopping centers, auto malls and undeveloped commercial land were instead supporting Ragland’s social-climbing lifestyle, including a taste for fine wines, payments on his house, country club dues and a MercedesBenz, according to the SEC.
The SEC lawsuit had come too late to save Ragland’s investors. A few weeks earlier, a group of investors who’d asked repeatedly to withdraw their money form Ragland’s limited partnerships had forced him and Guaranty Financial into involuntary bankruptcy.
A court-appointed trustee investigating the assets of both Ragland and his wife didn’t find much. He finally agreed to a settlement of only $10,000. This might seem like a surprisingly small settlement— considering the large sums of money Ragland collected from his investors—but very little is ever recovered in the wake of a Ponzi scheme.
The “Zero-Down” Ponzi
Beginning in the recession of the late 1980s, a number of real estate Ponzi specialists moved from the commercial market to the so-called “zero-down” residential market. They filled the deregulated television airwaves with infomercials promising big profits from investments in distressed properties.
Zero-down Ponzi schemes can be complicated. The perp will offer information and support that helps investors find residential real estate owned by people who are late in paying property taxes, mortgage payments or both. (Some schemes focus, instead, on real estate tied up in probate or other estate disputes. But the ultimate point is the same.)
Just before a bank repossession or tax sale, the zero-down investor steps in and offers to take over the payments on the property—sometimes on an accelerated schedule—in exchange for taking the title. Usually, some heated negotiating follows. If the existing owner and lender or tax assessor are desperate enough, they will agree to easy terms.
Anyone with decent credit and strong nerves can do this. Where does the Ponzi perp come in? He’s been “coaching” the zero-down investor through the process. If it goes well for the investor, she can end up owning a piece of real estate with some—though usually not much—positive equity value. That’s what the Ponzi perp wants. Saddled with the right kind of second mortgage, it becomes cash in his hand.
Part of the Ponzi perp’s coaching will be to convince the successful zero-down investor to borrow against equity in the newly acquired property and join the perp in other real estate deals. “It’s a neat trick,” says a veteran real estate Ponzi perp from the New York area. “You use other people’s good credit, stupidity and greed to squeeze the last few drops of cash out of property that was already in trouble. And they’re actually coming to you asking what to do next! Give me the money is what to do next.”
Second Mortgages and Trust Deeds
In many cases, the zero-down investing strategy is really a funding mechanism for getting money into a Ponzi scheme. Once there, it will often disappear in a flurry of real estate-related transactions. And these will have something to do with second mortgages.
Second mortgages are a shadowy sideline to traditional real estate lending. In many states, they are regulated less carefully than primary loans. And, since traditional lenders shy away from them, second mortgages are often made by non-bank financing companies and entrepreneurial mortgage brokers placing money for people who want higher returns or more secrecy than traditional investments offer.
One FBI special agent puts it bluntly: “There’s a lot of dirty money in the second-mortgage business. Stolen money. Drug money. Mob money. Money from con schemes.”
In 1985, Guy Scarpaci started a mortgage brokerage called U.S. Funding in suburban Boston. The company advertised aggressively that it could get mortgages for anybody, regardless of financial status or credit history.
As a result of the ads, U.S. Funding attracted large numbers of low and moderate income borrowers, people with poor credit or who were otherwise in dire financial straights. In order to sell these loans in the secondary market, U.S. Funding manipulated the records of the motley borrowers to make them appear more creditworthy than they really were.
U.S. Funding also prepared phony appraisals and, in some cases, created phony title histories. As a result, loans were granted based upon the security of properties which the borrower did not own or which were already encumbered.
U.S. Funding often told borrowers and investors that the proceeds of loans would be used to pay off prior indebtedness on the mortgaged property. But the company would divert the money to other uses. As a result of these diversions, U.S. Funding was often in a deficit situation. It had to use the proceeds from later loans to pay off indebtedness associated with earlier borrowers. In effect, U.S. Funding operated as a massive Ponzi scheme.
By the fall of 1989, the company wasn’t able to write enough new second mortgages to keep its pyramid standing. U.S. Funding employees prepared for the inevitable collapse by destroying some of the documents that showed how the company had inflated borrowers’ creditworthiness and properties’ value. But there were so many incriminating documents, they couldn’t destroy them all.
The company collapsed in late 1989. A federal investigation followed.
Beginning in 1991, the U.S. Attorney’s office in Boston reached plea bargains with various former U.S. Funding employees an
d people related to the company. In the end, they’d diverted more than $10 million through the scheme.
There are several signs that should warn an investor that a second mortgage operation is actually a Ponzi scheme.
First, very high interest rates are always suspect. When standard first mortgages are charging seven to nine percent annual interest, legitimate second mortgages should be charging between 12 and 15 percent. Promised interest earnings of 18 percent or higher could mean the company is in trouble and desperate to attract money.
Second, in most states, mortgage brokers must have a realtor’s license, a special broker’s license or both. An investor should ask to see these licenses and make a call to the government agency that issues them to ask about any complaints made against the broker. If a broker can’t produce the licenses, he or she may be a crook.
Third, legitimate second mortgage brokers will record their loans or trust deeds at the county recorder’s office (or with an equivalent agency). A broker who claims he’s experienced but can’t show any paper trail with the county may be a Ponzi perp.
Fourth, mortgage brokers who lend money without title insurance are immediately suspect. Among other things, title insurance makes sure the owners are real and the property doesn’t have six or 10 other mortgages already.
A final note: Lenders in the second mortgage market often “warehouse” mortgages. In a typical warehouse arrangement, a party lends against a large number of mortgages for a short period of time. Warehousing provides interim funding to the originator of the mortgage until the mortgage can find a permanent investor, and it is used to cover various other delays between origination and ultimate resale on the secondary mortgage market. While warehousing is legal, it makes keeping track of money difficult.
Case Study: Financial Concepts
The biggest factor that makes real estate a rich ground for running Ponzi schemes is the illusion many people have that it’s somehow different from other kinds of business. “People think they understand real estate. They think it’s a safer bet because you can go and see it,” says one California law enforcement official who has prosecuted several Ponzi schemes. “That’s not true. The land and the building may be concrete. But ownership and loans can be hidden and manipulated in a hundred different ways.”
In the mid-1970s, Earl Dean Gordon and Kenneth Boula founded a real estate investment syndicate called Financial Concepts, consisting of dozens of limited and general partnerships, which were in turn comprised of hundreds of individual investors. The operation was headquartered in Barrington, Illinois, a conservative Chicago suburb. The low key environment was a cover for a far-reaching real estate Ponzi scheme.
Billing themselves as investment advisors, Gordon and Boula ran folksy ads on radio and TV offering free “estate planning seminars” with euphemistic names like “Operation Snowbird” and “Life After Work, A New Beginning.” The workshops purportedly offered a “psychological adjustment program, a physical adjustment program, and a financial program for retirees.” Most were clearly directed at older investors with retirement concerns—and money.
The real aim of the seminars had little to do with estate planning; the sharpies used them to sell investments in Financial Concepts. Some 3,000 investors—many of them elderly—bit.
Among other things, Gordon and Boula used investors’ money to buy expensive toys: 22 automobiles, eight motorcycles, four airplanes, and an aircraft hangar. They ran up $10,000 monthly charges on their credit cards, paying the bills with investors’ funds.
Gordon and Boula offered limited income partnerships yielding annual interest of up to 15 percent. They also promised investors that their money would be used to develop a particular property. They didn’t usually do that. Instead, they’d use newly acquired money to finance other partnerships whose properties had not produced promised cash.
And this was a major problem. Few Financial Concepts partnerships generated any income. As one court later noted: “Whether by criminal malice or poor business acumen, properties Gordon and Boula relied on to solicit investors did not yield the promised returns, and the two began to pay earlier partnerships with money garnered from more recent ones.”
The high-risk nature of the partnerships and some of the conflicts of interest were spelled out in the prospectuses for the partnerships, which warned that Gordon and Boula were permitted to enter into “potentially adversarial relationships” with investors regarding construction, financing, management and virtually every other aspect related to the projects.
The problem for many investors, according to one salesman who sold investment programs for Financial Concepts, was that they frequently didn’t have access to prospectuses. He recalled:
We were told to do everything we could to avoid letting them see a prospectus until after we had their money in hand. Sometimes we even would tell people that we had run out of copies and our word processor was down when there would be a pile of 40 or so on a nearby table. Generally, we’d mail them out a month or two after we had the money.
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.
