by James Walsh
Some residents were surprised by how many community leaders were in the scheme. Among the people indicted were: the president of the area’s only higher education institution, the College of the Desert; the superintendent of the Desert Sands Unified School District; and the executive director of the McCallum Theatre—the region’s performing arts venue.
An internal investigation by the College of the Desert had found that at least 20 employees put in money, though there was no evidence that anyone had been pressured to take part. Still, it accepted President David George’s resignation.
It whad been a College of the Desert employee—Joyce Moore, president of the local college employees union—who’d first brought the scheme to public attention. When she heard that George was involved, Moore had confronted him and then complained to the local newspaper and television station.
Deputy D.A. Edward Kotkin, who was prosecuting the criminal cases, said the area’s tight-knit social and business circles provided the perfect environment in which the scheme could incubate. “My office is most concerned about people who may have used their influence or positions of public trust to bring others into the scheme,” he said.
But the argument that the investors were as greedy as perps resonated with many people who lived in the Coachella Valley. One teacher at the College of the Desert noted that the area’s country club set bred a lot of “country-club wannabees” who tried to act the part but didn’t really have the financial resources to keep up.
Social climbing—which one loser called “the greed for recognition”— certainly was a major factor. With so many of the local swells involved, the social element of the scheme was important. One local society columnist explained:
A friend said...the pyramid party was the damnedest thing he ever saw. So I went two nights later. There were 150 people there—people who own art galleries, charity chairpersons, real estate people, members of the Daughters of the American Revolution—very respectable people. And people were turning over money and hugging one another, like a spiritual revival. And it was the damnedest thing I ever saw.
Moore—the original whistle-blower—offered her explanation to a national newspaper: “We think we’re sophisticated, but we’re an isolated community. Greed was what did it.”
Case Study: Michael Scott Douglas
Like most compulsive behavior, the greedy rush for money makes little sense to outside observers. Michael Scott Douglas was a twice-convicted felon who used a little bit of computer knowledge to build a Ponzi scheme that bilked investors out of more than $20 million. His effectiveness is a testament to greed—his own and his investors’.
From August 1987 through November 1989, Douglas operated a bogus investment firm through which he induced investors to purchase limited partnership interests in four entities: D&S Trading Group, Ltd., Analytic Trading Systems, Inc., Analytic Trading Service, Inc. and Market Systems, Inc.
The companies were headquartered in a single fancy, computerequipped office suite on LaSalle Street—the heart of Chicago’s banking and financial district. The pitch was simple. Douglas claimed he’d developed a proprietary system for exploiting price differences between stocks and related stock options or various kinds of commodities futures. He promised returns of 10 percent to 20 percent per month on investments.
As a federal court later explained:
Although some trading of commodities was done, most of the money raised from the sale of the limited-partner interests was used simply to pay the promised return. These payments gave the scheme credibility, enabling Douglas to sell additional limited-partner interests.
In a little more than two years, Douglas raised $30 million from the sale of limited-partnership interests and paid back less than $10 million in phony profits. During the same period, Douglas paid himself $3 million in salary. He bought 19 cars, two condominiums near Palm Springs, and homes, commercial property and vacant land all around metropolitan Chicago.
Despite the ostentatious spending, Douglas hadn’t come from poverty. He was born and raised in the suburbs around Milwaukee. His father owned a successful company that made plastic containers for household use. The future Ponzi perp went to good private schools— but he wasn’t a keen intellect. He fumbled his way through several colleges, finally dropping out and marrying his high school sweetheart.
The newlyweds moved to Chicago, where Douglas worked in several local banks while attending night school. He had his first brush with financial trouble in 1980 when, as a commercial loan officer at a community bank, he was fired by supervisors who accused him of stealing a $2,000 cash deposit a customer had left on his desk. The charge was never proved.
Later that year, a grand jury indicted Douglas on charges of theft by deception. In a crude confidence swindle, he’d written two bad checks totaling $99,000 to a former Chicago Bears football player. He pleaded guilty and served 18 months in prison.
On his release from jail in 1983, Douglas took a job as a sales manager for a retail outfit called Lake Shore Computers in yet another Chicago suburb. The job was a chance for Douglas to go straight. But his greed got the better of him. Within a few months, he was running another crude con scam—stealing customers’ credit card numbers and using them to buy computer equipment which he would sell on the black market. Again, the scheme wasn’t particularly smart. Douglas was back in prison for two years in 1985.
A few months after his release from prison in 1987, Douglas landed a job writing software programs for a trading firm that was a member of the Chicago Board Options Exchange. The programs that Douglas was hired to write tracked the firm’s trades and generated client statements. This was considered basic back-office administrative work by the firm; but it was a revelation to the felon. It taught him the operational details of how stock option trading worked.
Though Douglas hadn’t been much of a student at school, he learned enough in six months to embark on a new level of criminal activity. He left the trading company, teamed up with a veteran con man he’d met in prison and started D&S Trading.
Douglas refined his pitch with D&S Trading. He offered investors huge returns through an arbitrage strategy exploiting differences between prices in blue-chip stocks and options on those stocks. He’d learned enough about computer programs and options trading to sound expert. And as one family friend put it, “[Douglas] is brilliant with numbers, so options would really be his niche, and that’s partially why he was so convincing....He really dazzled people because of his command of numbers.”
What sold D&S Trading even more than the technical jargon were the guarantees Douglas made. The firm would receive a management fee equal to 25 percent of monthly profits, which was high by industry standards. The trade-off: Douglas personally guaranteed to cover any losses.
This was a hollow promise, since his net worth was only a few thousand dollars. But it worked. By the middle of 1988, less than a year after he’d started D&S Trading, Douglas had taken in about $6 million from more than 100 investors. Instead of segregating customer funds, as required by law, Douglas kept all of the money in just two bank accounts—a D&S Trading account and one under his name. (This is a common sign that an investment firm is running a Ponzi scheme.)
Like many Ponzi perps, Douglas made great claims of religious piety. Though he was raised a Roman Catholic, he had become an evangelical Christian during one of his prison stays. He used the connections he made through church donations to lure ministers and members of their congregations to invest in D&S Trading and ATS. “He used the cloak of Christianity to lure these investors to their financial slaughter,” one lawyer representing investors would later say.
Almost from the beginning, D&S Trading had problems making its dividend payments as promised. Douglas didn’t have the mental discipline that some Ponzi perps use to keep things running smoothly. Instead, he talked about investment strategy and vision—explaining to investors that he was an idea person rather than a detail person. But his vision was no more reliable than his
command of details. Within a year of starting D&S Trading, Douglas had abandoned his arbitrage strategy for a series of high-risk investments in stocks the firm had “carefully researched.”
Although D&S Trading was a long way from collapsing, some investors made complaints to the SEC and state regulators in Illinois and Wisconsin. The SEC sent letters to D&S Trading, seeking information on its investment program and principals. In September 1988, under the auspices of Illinois securities regulators, Douglas agreed to be barred permanently from selling securities in the state and made a full refund to all his clients.
But Douglas would not be sidetracked. In an astounding act of brashness, he asked the D&S Trading investors to put their refund checks into Analytic Trading Systems (ATS), a new company he was starting. Many of them were still happy with the performance of their investments with Douglas, so they agreed.
ATS continued to operate the Ponzi scheme started by D&S Trading. Early winners spread the word that Douglas was an investment wunderkind. More money flowed in.
Douglas did make some investments. He boasted to anyone who would listen about a $4.2 million profit he made on 42,000 shares of RJR Reynolds Inc. stock he bought and sold during a three-week period in February 1989. “He probably did make that money because he was so impressed with himself about it,” recalls one investor. “It should have been a sign. He was too excited. It’s like [college football coach] Joe Paterno says: ‘When you get in the end zone, you should act like you’ve been there before.’”
Douglas didn’t. And, still, more money kept flowing in. By September 1989, ATS had raised almost $40 million from more than 300 investors spread across seven states.
The SEC and the local authorities weren’t far behind. The SEC made a series of requests for information about ATS and the money it was managing. In late October, Douglas supplied the SEC with a document showing that ATS investors had $35 million deposited in segregated trading accounts. The document was a fake, though. It was based on a single trading account which actually contained less than $28,000.
In November 1989, the Feds arrested Douglas and charged him with stealing about $12 million from his investors. The SEC ordered all of Douglas’s operations closed. A federal court appointed Chicago lawyer Steven Scholes as receiver of ATS to untangle its finances and recover as much money as possible for its investors.
Douglas had divorced his first wife and married a second time. The second marriage collapsed after his arrest. Douglas—who often spoke about himself with a strange detatchment—said, “When my wife found out about all this, she simply could not fathom how I was able to commit such a huge fraud and keep it hidden from her.”
More family shocks followed. Four months later, Douglas’s father was accused in a civil racketeering lawsuit of illegally pocketing more than $800,000 in “finder’s fees” from the scam.
Scholes argued that Douglas pere was paid the finder’s fees for acting as a middleman who solicited investors by phone and at meetings. “David Douglas knowingly joined, combined and conspired with Michael S. Douglas and others in schemes to defraud investors in connection with the sale of interests in investment partnerships,” the suit charged.
The father reached a quick, quiet settlement with Scholes. The settlement limited his ability to help his son.
In October 1990, Douglas fils pleaded guilty to three counts of mail fraud and one count of lying to the Securities and Exchange Commission. At his sentencing hearing a few months later, Michael Douglas offered a tearful explanation for his actions:
The investor money was coming in too fast—so fast, in fact, that I couldn’t find a place to invest it.... I could see the handwriting on the wall, but I did not want the train to stop. The money’s coming in at $2 million a month, and I’m stretched nine ways to Sunday, $15 million in the hole at one point.
People want to know how I slept nights. It was easy, because I am a winner. I’m goal oriented, and in my mind I’m saying, “One more trade. I can make up the difference. I can be all things to all people.” I tried to trade my way out of my losses.
That statement could be part of a psychological profile (egocentrism, insecurity) as easily as a legal tactic. In any case, it didn’t have the intended effect. Douglas was sentenced to 12 years in prison by U.S. District Judge William Hart, who called the fraud “a cruel crime.”
By early 1995, Scholes had recovered $12 million, consisting mainly of real estate that Douglas had bought with stolen money. Scholes was also trying to recover about $2 million in charitable donations, another $1 million in undocumented personal loans that Douglas had made (including money he’d given his first wife) and some money early investors had taken out of the scheme.
Citing fraudulent conveyance laws that bar giving stolen money to someone else, a federal district court and an appeals court both said the charitable groups had to turn over the contributions. One lawyer involved in the case called the charities to whom Douglas bestowed donations “the real victims,” because they ultimately were “the ones that had to pay the money back.”
But the court ruling was a fitting close to the Douglas story. His greed overwhelmed and obliterated his charitable acts.
CHAPTER 11
Chapter 11: Family Ties
One of the most surprising—but most telling—factors that control the size and shape of pyramids and Ponzi schemes is the involvement of family members. Many pyramid schemes actively encourage investors to recruit family members. This recruitment serves several purposes. It provides an easy source of new investors. But, in a more Machiavellian sense, it co-opts the most likely critics of someone pouring hard-earned money into a scatter-brained scheme.
On the flip side of the family structure, a consistent theme among Ponzi perps is to divorce long-time spouses as the stolen money begins to roll in. A spouse who’s been around long enough often falls into the thankless role of the conscience to his or her significant other. A perp who’s decided to throw morals to the wind will often decide to throw the potentially most incriminating witness out with the morals.
Finally, and most perversely, some families actually seem to cultivate scams as a common activity. These people usually share a cynical view of money and business—passed from a parent or spouse to other family members.
It’s a cliché of the 1990s that many families are dysfunctional. Ponzi schemes offer some of these families the chance to project their eccentricity—and, sometimes, malevolence—on the wider population.
Father-and-Son Ponzi Perps
Sidney and Stuart Schwartz were father and son—but they were also partners in Schwartz & Topper Co., an accounting firm in Nassau County, New York. They also ran STS Acquisition Corp., which set up bridge loans for small businesses and financiers in the midst of mergers, acquisitions or other transactions.
Bridge loans are short-term financing mechanisms that most traditional lenders find too risky to make. For this reason, lenders who are willing to make the loans—most often Wall Street investment banks— make a lot of money from them.
The father and son used their social setting to create a sense of legitimacy in potential STS Acquisition investors. The Schwartzes were regarded as pillars of the community in their section of Long Island; the focal point of their business and social circles was The Old Westbury Club. Sidney was the club officer in charge of membership and former president of his synagogue. (Old Westbury was a “Jewish club,” opened in reaction to other country clubs that excluded Jews as members.) Stuart, with his good looks, wit and gregarious personality, flirted with the women and made friends easily with the men at the club.
Of course, the appearance of legitimacy was only part of the equation. As is often the case, some investors were motivated by simple greed. The Schwartzes offered high interest rates on money invested in STS Acquisition, as much as 18 percent plus bonuses on 90-day loans. These numbers meant annual interest rates ranging between 64 and 216 percent.
Bridge loans are profitable—but they’r
e not that profitable. Despite the impression Sidney and Stuart cultivated with their neighbors and friends, they were crooks. STS Acquisition was a Ponzi scheme. And the father and son used Old Westbury as a proving ground for investors. “I gave them money because I felt, how could a family so involved with the temple and their country club...steal from me,” said one.
For at least four years, from 1988 to 1992, the Schwartzes sloshed investors’ money through a series of pyramid transactions. As their bogus empire was reaching its limits, the Schwartzes claimed a joint net worth of $5.7 million. In truth, their companies were running in the red.
Like many Ponzi perps, the Schwartzes had some problems which they managed to resolve but which pointed to the bigger collapse ahead. The crisis came in early 1992 when the Schwartzes defaulted on interest payments to their biggest client—who would eventually lose $2.4 million in the scheme. Stuart used his personal relationship with the big investor to plead for more time. His story was that STS Acquisition was growing so fast that all of its money was out working. Better to be cash-poor and collecting big interest than just sitting on the money.
The big investor would later say: “[Stuart] came to weddings and birthdays. He was like a son to me. When he asked for money, I said, ‘What’s the collateral?’ He said, ‘Collateral? I’m dealing with millions of dollars and bank presidents.’ So I gave a series of loans, and he gave me promissory notes. But now there is not a day I get up that I don’t wonder how could I be so stupid.”
By late 1992, the Schwartzes couldn’t charm investors fast enough to prevent the collapse. Dozens of STS Acquisition interest checks were bouncing. Sidney and Stuart were suddenly hard to reach. Panicky investors got together and demanded a meeting.
The first meeting took place in Florida, where many STS Acquisition investors had either winter or full-time residences. Because the Schwartzes had been receiving physical threats, they hired a security guard to keep order. At one point Stuart put his head against the wall of the conference room and cried, one investor who attended the Florida meeting recalled. Another investor said: “One man was so agitated, saying, ‘This is not just my money, it’s my son’s money, and he can’t afford to lose this.’ He leapt across the table and tried to strangle Stuart.”