Why should you care about a story of investors getting fleeced? Because there is more to this story than just the initial fraud. There has been a trend in recent years concerning the law, a trend that should alarm you. No longer are the courts, and the law, your unquestionable protectors. With today’s forfeiture and seizure statutes, along with the courts self interest, it is no longer all about justice, its all about who can grab the money. And your money may be next.
Part One: The Initial Scam
It has been almost 3 years since the September 2008 FBI raids of the homes and offices of Tom Petters, a once prominent Minnesota businessman. Petters and a group of accomplices had orchestrated a massive ponzi scheme, which had run successfully between the years 1995-2008, through his company Petters Companies, Incorporated (PCI). The ponzi scheme, which went all but unnoticed for more than a decade, was eventually pointed out by the vice president of operations for PCI, Deanna Coleman. Coleman, herself a participant in the scheme, decided to go to the FBI in early September, 2008, when the scheme became unsustainable and investors began asking too many questions. Coleman, along with Robert Dean White, a PCI accomplice who had long forged financial documents which worked to substantiate the ponzi scheme, agreed to wear wired recording devices while meeting with Petters. Coleman’s allegations of an illegal ponzi scheme, along with the recordings that she and White obtained, lead to the September FBI raids of PCI and the personal residences of Petters. Materials obtained during the FBI raids lead to the arrest of Tom Petters on October 3, 2008. Numerous accomplices to Petters were arrest soon afterward, including Deanna Coleman and Robert Dean White. Today, investigations are still underway to uncover who the remaining players in this massive financial scam were and how a fraudulent operation this large went unnoticed for so long. So how did this $3.65 billion scam manage to operate successfully for so long?
Before the FBI raids in September, 2008, Tom Petters was a prominent figure in the Minnesota business community. He owned three successful companies: Petters Group Worldwide (PGW), Thomas Petters, Inc. (TPI), and Petters Companies, Inc. (PCI). PGW was a holding company for a portfolio of name-brand businesses that Petters had acquired, including Fingerhut and, most prominently, Polaroid. TPI was a holding company for Petters Aviation and it’s main asset, Sun Country Airlines. PGW was a self-sustaining empire of legitimate businesses, which were highly profitable. TPI was a newer business that was not yet profitable, but showed great potential because Sun Country Airlines had grown to become the second largest commercial airline in Minnesota and Petters Aviation was also moving into jet sales and leasing. Further, Sun Country had begun to show profitability after securing government contracts to operate military charter flights. In early 2008, Petters was personally estimated to be worth just more than a $1 billion dollars. He had built an empire from scratch and, for his efforts, was among the wealthiest men in the world. With PGW showing legitimate profits and TPI showing tremendous future potential, the operations at Tom Petters’ third company, PCI, are hard to believe.
In 1988, Petters began marketing bulk electronics to big-name retailers like WalMart, Best Buy, and Costco, through PCI and its subsidiaries. This was an extremely lucrative business model, which Petters operated with great success for almost a decade. Big-name retailers prefer to keep as low of an inventory as possible and only buy merchandise as they have a need to sell it; this saves money on warehouse space and insures they will not end up with merchandise that no one wants to buy. In the retail industry, this is called “just-in-time retailing”. Just-in-time retailing seems like an intelligent way to do business, because retailers cut their costs and also ensure that very little of their operating capital will be tied up in surplus merchandise. However, this tactic poses one very substantial problem: how do retailers operate this way, while still paying bottom dollar for merchandise, so that they can pass competitive pricing on to the consumer? This at first seems impossible, because someone is going to have to buy the merchandise in bulk so that the big-name retailers can still afford to charge less for their merchandise than smaller retailers do.
Tom Petters and PCI offered a solution to this problem and ensured that big-name retailers could have their cake and eat it too. PCI was a middle man to these retailers and conducted supply chain management, known as diverting. PCI would find investors to finance deals, in which they would purchase electronics merchandise in bulk. The money raised, by PCI, would be housed in a lock-box account for safe keeping. PCI would use their investors’ money to purchase electronics merchandise from stores which were going out of business, known as “close-outs”, and eventually from the manufacturers themselves. PCI would then ship this merchandise to their warehouses until one of it’s subsidiaries, Nationwide International Resources, could broker a deal with a big-name retailer to sell the goods at a profit. Nationwide would transfer the big-name retailer’s purchase money back to PCI. PCI would pay their investors their money plus interest, while keeping a portion of the profits for themselves. Petters was a master diverter and found great success in this practice. His investors were happy because they made a profit. The big-name retailers were happy because they still saved money by going through PCI instead of purchasing merchandise in bulk themselves. Most of all, Petters was happy because this was an extremely profitable business model. So one can’t help but wonder: with a business this mutually beneficial, how did things go so wrong?
Sometime in 1995, Petters decided that his diverting business was not as profitable as it could be. He made a few drastic changes. First, he stopped buying merchandise from close-outs and manufacturers. In fact, he stopped buying any merchandise at all. Then he emptied his warehouses. Finally, he stopped selling merchandise to big-name retailers, small-name retailers, or any other type of retailer. To a less-savvy businessman, it would appear that Petters had essentially ceased operations on what had been a very lucrative business. Remember, though, that Petters was not just any businessman, he was among the best: he stopped buying merchandise, stopped selling merchandise, and stopped warehousing merchandise but he kept the profits rolling in. How?
Petters realized that as long as his investors continued receiving a return on their money, the actual transactions between PCI and big-name retailers were irrelevant. As long as Petters and his accomplices could raise more new investment capital than they were paying out to current investors, they could keep taking their cut off the top and drastically reduce any real work involved. Wasn’t this unethical? Wasn’t this illegal? Sure, but no one, including investors, seemed to care. With billions of dollars of new investment capital flowing through PCI, over the next 13 years, these questions seem to have fallen by the wayside, in favor of one simple fact: everyone involved was getting rich. Those on the inside of operations at PCI didn’t care that this was illegal. Investors who didn’t know what was really going on at PCI had no reason to ask because they were making a good return on their money.
Of course, the last 4 years have left us all very aware of this type of operation: it’s called a Ponzi Scheme… and we all know how they end. This type of financial fraud is extremely dangerous to investors because, for a long time, it can pay out attractive rates and appear, on the surface, to be a sound place to invest your money. However, historically almost all ponzi schemes reach a point when there is not enough new investment capital coming in to continue making payments to current investors. At this point, a ponzi scheme will begin to collapse and anyone still invested in this operation will find that their money is gone. PCI operated for almost 13 years as a very lucrative ponzi scheme, and nothing more. Investors made money. Investment advisers made money. PCI employees made money. Tom Petters made money. Everyone was happy, because money buys happiness… right?
When news of the Petters ponzi scheme and the Bernard Madoff ponzi scheme, which was discovered only months later in December 2008, became public, investors couldn’t help but wonder how these multi-billion dollar financial frauds were allowed to operate for so many years, unnoticed. Weren’t there any signs that this fraud was happening? Wasn’t there some way we could have avoided this? If the answer were no, then investing anywhere would seem extremely dangerous: how could investors trust that returns on their money today wouldn’t mean financial ruins tomorrow? Luckily, in the case of PCI, there were plenty of signs that this fraud was taking place… they were just ignored, that’s all.
As early as 1990, Petters began to show what would eventually become this true colors. He was charged, in Colorado, with forgery and passing bad checks. A charge like this would surely have made investors think twice about giving Petters their money, right? Absolutely… except investors never had a chance to consider Petters’ misdeeds because a Hennepin County judge had them expunged from his record in 1994. A year later, in 1995, his ponzi scheme was up and running and his public record showed only that Petters was an upstanding citizen, a philanthropist, and a strong supporter of political campaigns. On paper, PCI was a good investment and paid healthy returns. The investment dollars poured in.
Again, in 1999, flags should have been raised on the business dealings of PCI and Tom Petters. Mahtomedi attorney Garret M. Vail was hired by a Minnesota bank in a bankruptcy litigation in which a borrower had defaulted. After investigating the case, Vail suspected that the debtor and a second accomplice debtor were simply fronts for Petters and PCI because Petters’ name showed up all over the loan documents. Vail scheduled Petters to make a sworn statement, which is routine in such cases, yet Petters never showed up for his appointment. Further, the presiding bankruptcy judge declined to make Petters give a statement at all. This seemed suspicious, so Vail took it upon himself to present his findings to the FBI, but was met with what may be described as a total lack of concern or understanding. In one last effort, Vail took his concerns about Petters to the newly elected Hennepin County Attorney, Amy Klobuchar. Klobuchar found no reason to press charges against Petters, though she did put one of the debtors named on the loan, in jail and called him a swindler. It may be worth noting that Petters went on to be one of Klobuchar’s major contributors in her successful campaign for state senate.
Finally, in 2002, Petters was sued by one of his investors for allegedly owing money that he had not paid. Richard Hettler, a PCI investor, brought a suit against Petters and PCI but Judge Anne Montgomery threw out the law suit. Montgomery then barred Hettler from filing any further suits against Petters for the alleged amounts owed.
So, clearly there were opportunities to question the integrity of Tom Petters and PCI. Did our elected legal and political officials simply not find Tom Petters’ alleged indiscretions alarming? Or were the opinions of our elected officials swayed by the money that Petters contributed to their campaigns? We may never know why these signs were ignored. We also may not have known the true extent of the PCI ponzi scheme, if Deanna Coleman hadn’t decided the scam had run its course and it was time to tell the FBI what PCI and Tom Petters were really up to.
Early in 2008, investors, from multiple states, had brought law suits against PCI for failure to liquidate there investment and return their money. In a ponzi scheme, its one thing to continue paying investors a return on their investment and fully another to completely liquidate their investment. As the financial climate began worsened in 2007 and 2008, investors began pulling out of the market in greater numbers. This, it would appear, was the straw that broke PCI’s back. PCI was still scrambling to find new investors so that they could pay returns on old investors’ money. They had also begun working with investment firms to fix the books so that investors believed their PCI portfolios were growing, when in fact they were not, so that they would be swayed not to liquidate their investments. Firms would transfer money to PCI, who would then transfer it back to the firm minutes later, in an attempt to create the appearance that PCI was paying its investors. Firms that were not aware that this was occurring had begun asking too many questions and Coleman became nervous that the law suits, the fake financial transactions, and inquiring minds signaled the end of the scam. She did what any self-preservationist would do: she told on everyone before someone else had the chance to look like the good guy.
When the PCI ponzi scheme came to a crashing halt, in October of 2008, investors in PCI began to wonder where their money was. The simple answer is this: it was gone. PCI was completely and utterly broke. Billions of dollars, invested in PCI promissory notes, became worthless overnight. Among the investors, were at least ten church pastors, three missionaries, dozens upon dozens of retirees, and even half a dozen nursing home residents. More than 500 individuals, along with hedge funds comprised of honest people’s money, were the victims of what turned out to be the largest financial fraud in Minnesota history.
One such victim, Janet Leck, is a long-time Minnesota resident who lost her husband a few years ago. She and her late husband had lived in the same condo for more than 30 years and had paid it off. When they heard about the returns people were making on their investments in PCI, Janet and her husband decided that they should mortgage their home and put their money into PCI too. Soon after the PCI ponzi scheme and the arrest of Tom Petters became news, Janet was faced with a very harsh reality: everything she had was gone. She has since lost her condo to foreclosure.
In the months and years that have followed, several indictments have been brought against not only Tom Petters, but also many of his employees and business partners. As more and more indictments are served, it becomes clear that the Petters ponzi scheme was only allowed to exist for as long as it did because Petters had a lot of help. But who were these accomplices and how did they manage to hide such a massive financial fraud for so many years?
To be Continued in Part 2 – “The First Act Players”
