Sunday, February 17, 2013

What it’s like to uncover a $1 billion fraud

This is in response to the article: "Gangster Bankers: Too Big to Jail" and ensuing conversation on Hacker News.

Disclaimer: Due to the nature of this story, I had to omit certain details for legal and security reasons. I am not a lawyer, and my interpretation of these events and legal ramifications may have changed since they occurred.

For context, this story takes place primarily between 2004 and 2008; before Bernie Madoff and the collapse of Lehman Brothers. The US had recently been attacked on 9/11, President Bush was in office, and the national priority was the war in Iraq/Afghanistan. Newsrooms weren't covering financial markets as investigative journalism was being cut from budgets, the FBI was spending their time on terror hunts, and right under our noses billions of dollars were being funneled illegally overseas. “White collar crime,” and the attention it receives today, did not exist.

I was 20 years old at the time this happened. I had founded my first company one year prior. Things were going well and I had 8 seed stage investors supporting the company. Our largest investor, a great guy and farmer from Oregon, had the ability to appoint a Board member to the company. He introduced me to an individual whom he had invested in previously as a possible selection for the board seat. Little did we know, the individual he introduced me to was a professional con artist. My investor would later lose his investments to this person. Here is my account of the story and some of the things I learned.

 1) Trust your gut

The first thing that gave me a weird feeling was how many things in common the con artist and I had. He grew up in the same area, had the same background and said all the right things. However when recounting the conversation afterwards I realized I couldn't tell you a specific thing about him, what exact school did he go to, what exact city did he live in, what was the exact name of his previous company? A good con artist can empathize enough to get close to you, but not enough to get themselves stuck in a corner.

2) Pay attention to legal names and details

I ultimately found the information leading to the con artist’s discovery by doing a reverse phone number/address look-up which showed him having a slightly different last name. This led me to search his old name, and realized he was using an alias.  It is common in fraud for individuals and companies to use slight variations of their name. e.g. “Brian” instead of “Bryan” or "Simms" instead of "Sims," or variations of company names such as, “ABC International,” “ABC International Group.” This is easier to lose in the paper shuffle and is easier to blame on a “clerical error.”

3) State to state laws are a joke

It turned out the con artist had changed his name and was hopping from state to state committing securities fraud. His former state of Idaho knew him as Person A, but California knew him as Person B. I contacted the Department of Corporations in each state after learning Idaho had sued him for securities fraud. Bottom line, when someone leaves your state and crosses state lines, the previous state doesn't care. You could do this seven or eight times before it popped up on a federal level.

4) Pump and dumps happen a lot

If you've seen the movie Boiler Room, it isn't far from the truth. The way the con artist would make money was by acquiring stock in young, often real, companies using a different name, with other people’s money, eventually claiming it as his own. What start-up company wouldn't want an investor’s money, right? Wrong. The con artist would then “help” the company execute a Reverse Merger, often referred to as a “Backdoor IPO.” Reverse mergers allow a shell company to acquire a real company and become an instantly tradable stock so investors have the ability to sell the stock on the open market which is how the con artist could get quick liquidity. Usually there is a lock-up period, but the insiders ultimately dumped their stock prematurely or used insider information to sell off. This ultimately caused the stock to crash and the public market to be stuck with the loss. Meanwhile you, the unknowing founder, probably end up in jail.

5) Isn't it somebody's job to be regulating all this?

Yes, and they’re really bad at it. A 20 year old was able to uncover something multiple government agencies could not. Here are some examples:

a) I contacted the states to notify them that the individual was committing tax evasion and owed back taxes. They said call the IRS.

b) I called the IRS and informed them I had legal proof, his name, aliases, address and even his bank and routing information obtain from my investor. Their response: "I'm sorry sir, unless you have his legal identity and Social Security Number there is nothing we can do." Wait, so if someone changes their name you don’t pursue them? This seems a little self-defeating.

c) The con artist was foreign to the United States, so in the height of the national security scare I figured a foreign person in the US changing his identity might be of interest to Homeland Security. Nope, they don’t deal with stock related issues. That is the SEC's job (Securities and Exchange Commission).

d) I contacted the SEC with the information, which they ignored. I would find out years later that there were three different SEC offices (New York, SF, and Philadelphia) that were all investigating the same case but didn't know it.

e) I used the FBI's online form to submit information the fraud to their white collar crime group. Never heard back. Years later I read an article talking about how 20,000 agents from the FBI were reassigned to fight terrorism and away from financial crimes. And we wonder how the banking meltdown happened?

6) Death of the investigative journalist

With the government not investigating the fraud, I went to the media. I contacted people at the Wall Street Journal, New York Times and even had an in person meeting with someone at the offices of Fortune. Here were a few reasons why it didn't get covered:

a) Young college drop-out/entrepreneur is not a credible source
b) Too difficult to prove
c) Legal ramifications and costs were too high for the media outlets
d) Not enough readership interest
e) News rooms had cut most investigative journalists

7) Follow the money

It turned out the con artist was only one fraction of a much bigger puzzle. Through exhaustive investigation of public financial documents and research on, I realized that there was not just one pump and dump, but a whole series of pump and dumps organized by an international holding company, in excess of $1 billion. Each pump and dump ranged from $100mm to $300mm and there were about six to seven of them over a four to five year period. The international holding company was actually an organized crime group, with offices in Barbados and the Cayman islands committing fraud in the US.

8) Pump and dumps have a number of similar things in common

Some of the consistent things that were done in each pump and dump were:

a) Have some type of product an average investor might not understand, typically technology or medical related
b) Create products in a long development cycle. e.g. "Waiting for FDA approval"
c) Have general traction overseas, which is harder for investors to vet
d) Get "big name" people behind the companies to get social acceptance

9) Too big to be scammed

Two years into this search, I found that a separate group of wealthy investors, out of another state, had filed a class action lawsuit against one of the portfolio company pump and dumps. The group included a descendant of an unnamed, multi-generational billionaire family and a former Deputy Director of the CIA. I called them up to share the information I had uncovered. I’ll never forget when someone walked to my office and said, "ABC is on the phone for you." I proceeded to share my information and what I had uncovered. 

His response, "And you found all of this information just by looking on the internet? Incredible." Let me repeat that, this is the former Deputy Director of the CIA. While you would think his contacts could help push the investigation along, it turns out losing a little bit of personal money is a whole lot less important than everyone finding out a Former Deputy Director of the CIA and prominent investor was conned.

10) Too little, too late

Finally, after several years of notifying the SEC of the pump and dumps, they launched an official investigation. Since I notified them the stock lost over 90% of its value.

11) News began disappearing

With all of the attention being paid, the organized crime group started erasing their trails. Websites started coming down. Press releases began disappearing. And even scarier, the few news stories actually written about the investigations were removed from media websites. I had to take screen captures to be able to actually prove what I was saying to be correct.

12) Bankruptcy and settlement

In order to silence the class action lawsuit from Texas, the fraud portfolio company ultimately filed for bankruptcy and settled with the investors. As part of the terms, investors with insider information were required to not discuss details of the case. These same investors who were on the verge of bankruptcy after losing all of their money had to take the deal. The organized crime group effectively severed one of its companies for the rest to survive.

13) Fraud and terrorism

This is the point where you start to feel like a raving lunatic claiming there are organized crime groups tied to terrorism…but it's true. When I started this crazy investigation, I knew nothing about reverse mergers, SEC filings or fraud. So do you think it is ironic that more than three differing circumstances had people or organizations linked indirectly to terrorism? Probably not. At this point, if an idea seems too crazy to be true, it probably is.

In reality the United States would be much better off if it focused on the funding sources for terrorism as opposed to terrorism or drug trafficking itself.

14) End result

The portfolio company shut down. The class action investors settled. The SEC stopped investigating because they had nothing left to pursue. The organized crime group slowed down their deal flow, probably due to too much attention. The man behind the fraud bought a  20 bedroom mansion in Barbados with a private beach. 
Ultimately my investor has never been paid back, and the individual I met as a possible board member is alive and well, wheeling and dealing in the San Francisco Bay Area.

So I guess the moral of the story is watch your ass out there and don't be afraid to ask questions.