Investment Fraud: Due Diligence in a Deceptive Environment

1. Investment Fraud: Due Diligence in a Deceptive Environment Oregon Association of Certified Fraud Examiners Annual Seminar May 14, 2010, Portland, Oregon Sean B. Hoar Assistant United States Attorney

2. Overview • Case study of U.S v. Pac Equities, Inc. • Case background • Evidence seizure, organization & analysis • Asset seizure and preservation • Trial presentation • Opening statement/case in chief/closing argument • Sentencing presentation/results • Appellate process/results • Lessons learned

3. Case study: U.S. v. Pac Equities • Complex case involving real estate development and lending company • Driven by investor money • Investors solicited with promise of first trust deed security and 10% return on investment • Plausible explanation of profits • Representation of substantial development and lending experience

4. Case study: U.S. v. Pac Equities • Unfortunately, representations about CEO’s experience and security of investments were false • Over 300 people invested over $19 million, and lost over $16 million • Company and CEO were charged in 27 count indictment with securities fraud, wire fraud, mail fraud, bank fraud, tax fraud, money laundering, and obstruction of justice

5. Case study: U.S. v. Pac Equities • Background • CEO represented he was in business of real estate development and mortgage lending • Purported to manage profitable real estate development projects and make profitable loans • Represented over 30 years of successful experience in real estate development and lending and no loss of investor principal • Promised 10% annual return, paid monthly, on investments in real estate projects and loans

6. Case study: U.S. v. Pac Equities • Background • Represented that all investments were safe because • Secured by real estate • Which always had at least 30% of its value in equity • On property used to secure loans, there was never more than a 70% loan to value ratio.

7. Case study: U.S. v. Pac Equities • Background • Regarding how Pac Equities made money, CEO represented that • They were hard money lenders to those who could not obtain conventional financing, and loaned money at a higher rate than the 10% paid to investors • The difference in what they were paid by those to whom they loaned money, and the money they paid investors, was what paid their costs and fees

8. Seasoned executives They looked like seasoned executives, and easily developed trust with retirees and those who had substantial wealth to invest . . . If you simply did like they said they did, and invested in first trust deeds, secured by real estate with substantial equity, you could consistently earn 10% monthly on your investment . . .

9. Trust Deeds to Securities • Pac Equities originally offered trust deeds to secure investments • Later persuaded investors to assign their interests to Pac Equities in exchange for securities in one of three funds • Pac Equities Funds 1, 2 or 3 • Funds were purportedly operated to earn income for the investors

10. Conventional Marketing • In soliciting investors, Pac Equities used all conventional means • The Internet via a web site located at www.pacequities.com • Newspapers • Direct mail - newsletters

11. They developed professional marketing materials which fostered trust with potential investors . . . April 2004 Equity News

12. They said all the right things . . . May 2004 Equity News

13. They developed a tremendous corporate volunteer presence in their community . . . May 2004 Equity News

14. They used the technology of the day to reach potential investors . . .

15. They developed professional promotional materials which appealed to the most astute investors . . . Portion of Michael Rich resume from Pac Equities’ promotional materials

16. They created a physical environment which mirrored their representations of success . . . and which anchored trust with investors . . . Well appointed offices in Bend, Oregon – compared by investors to the nicest offices one might find in Manhattan . . .

17. And they established an office in a metropolitan corporate center to attract investment traffic from competitors . . .

18. New Investor Packet • Prospective investors received “new investor packets” • History and management of Pac Equities • Type and security of investments • Résumés of CEO & COO • List of references • CD with representations about CEO Michael Rich and Pac Equities

19. Private Placement Memo • Prospective investors for any of the three Pac Equities funds were provided private placement memoranda which included • Representations about various properties secured by the funds • valuations, equity, and loans secured by the properties • Résumés of CEO & COO

20. But former employees alleged it may be a facade . . . • In November of 2003, former employees of Pac Equities brought potential problems to the attention of state authorities (Oregon Division of Finance & Corporate Securities – DFCS) • personal expenses paid with investor funds • commingling of investment accounts • apparent aliases used by CEO • appeared to be real estate/securities fraud

21. Initial investigative results • Preliminary investigation by DFCS revealed over a million dollars invested by persons in multiple states. Given potential complexity of case, FBI was contacted in early 2004, and federal investigation initiated. • grand jury subpoenas were issued for certain corporate bank accounts • early subpoena returns showed investor funds were used to pay off personal mortgage of CEO and COO

22. Preliminary financial questions • Although a bank account appeared to show a personal expenditure with investor money, a number of questions emerged: • Was it an authorized “draw?” • Was it a loan from investors or an LLC? • Was it otherwise done with the knowledge and consent of investors? • Was the home a corporate asset? • Were there other plausible explanations?

23. Preliminary property questions • During this same period of time, title searches were underway to determine whether the corporation owned real estate • Where were the parcels located? • Were ownership interests consistent with representations? • Were actual values consistent with represented appraised values? • Were loan to value representations accurate? • Were there loans/liens against the properties?

24. Preliminary property questions • The title searches also attempted to determine whether the corporation properly recorded the trust deeds • Were there unrecorded deeds? • How would investigators know? • Was percentage of investments in trust deeds consistent with value of properties? • How would investigators know?

25. But who was the CEO? • Approximately one year into the investigation, little more is known • the financials were tremendously complicated • the real estate transactions were a quagmire • Absent an understanding of the financials or the real estate transactions, was there another question to be asked to determine whether a prosecutable fraud occurred? • Was the CEO who he said he was?

26. Preliminary personal questions • The CEO represented that he “studied law and accounting” at the University of Washington • Was it a material representation? • How could we verify the claim? • Obtain the transcripts . . .

27. The transcript

28. The transcript • Rather than “study law and accounting,” he completed only one semester at the University of Washington and then flunked out • obtained a “D” grade point average of only 1.88 his first semester • enrolled in fundamentals of accounting during the second semester but failed and received no credit for the course • ultimately flunked out during his freshman year and received no credit for any courses enrolled in during the second semester of his freshman year • Bottom line: he did not study law or accounting . . . Well, he may have “studied” accounting, but not what the investors expected . . . • Fraudulent representation confirmed.

29. Preliminary personal questions • The CEO represented that he helped to develop Lake Limerick, a destination resort in northwest Washington • Was it a material representation? • How could we verify the claim? • Obtain any promotional or legal records . . .

30. The Lake Limerick records The sales brochure The plot map

31. The Lake Limerick records The news release • The developers were Mark Antoncich and Ken Engel . . . not Michael Rich • He had nothing to do with the development of the site • He did not invest any money in the development • He was merely employed as one of 12-15 lot salesmen • Bottom line: he did not assist with or in any way help to develop the Lake Limerick destination resort • Fraudulent representation confirmed.

32. Formation of investigative team • Case appeared to involve numerous bank accounts (ultimately over 130 were discovered) yet there existed no expertise to analyze the financials • IRS was requested to participate and take responsibility for acquisition and analysis of all financial records

33. Formation of investigative team • Case appeared to involve numerous parcels of real estate and preliminary investigation indicated substantial title issues, yet there existed no expertise to adequately assess the issues • DFCS was requested to provide real estate expert to assess the title issues and document all transactional information

34. The lemon . . . • By May of 2005, investigation was probably one third complete • still trying to find and trace money • still trying to find involved real estate and understand title issues • still trying to determine “who” CEO was . . • A reporter called DFCS about the investigation. The question then became how to turn a lemon into lemonade . . .

35. The plan . . . • Once the DFCS investigator spoke with reporter (and confirmed the existence of an investigation . . .), he quickly informed me of the call • I suggested that reporter be referred to me • I would issue a “no comment” which implied existence of investigation, prompting call from CEO’s attorney

36. And then the house of cards collapsed . . .

37. The lemonade . . . • Day after article was published, received call from CEO’s attorney • Scheduled debriefing days later • During debriefing, “confirmed” CEO was engaged in fraud (he denied things we knew were true) • Obtained consent to search business and home days later • seized over 70 boxes of evidence and imaged 24 computer hard drives

38. What was learned? Pervasive deception • False representations about • Résumé of CEO • Education • Experience • Property value • Engaged in “strawman” purchases of Pac Equities’ own property to inflate the value of the properties • Used over two dozen LLCs and other entities to complicate matters, some of which were used in the transactions • Created fictitious appraisals • Created fictitious financials

39. Pervasive deception • False representations about • Existing loans • Most “income producing” loans did not exist • Loan to value ratio • Non-existent loans + inflated values = complete fabrications • Existence of trust deeds • Many were not recorded, or the assigned interest was more than the value of the property • Amount invested in certain holdings • CEO & COO invested none of their own $$

40. Pervasive deception • Facade of successful business created by using investor principal to make monthly interest payments to investors • new money paid old obligations – Ponzi-like • Represented that payments constituted interest earned from profitable investment and loan activity • Facade used to recruit additional investors and retain existing investors

41. Pervasive deception • Only sources of income for Pac Equities were from a few projects and loans • These amounts were insufficient to meet monthly interest obligations which Pac Equities owed its investors • The misrepresentations and material omissions caused over 300 people to part with over $19,000,000

42. The “voluntary settlement” . . . • Between June and December of 2005, negotiations ensued for what was believed to be voluntary settlement • Acceptance of criminal responsibility • Agreed to not take new investments • Agreed to preserve assets • Primary purpose of agreement was to return all assets to investors • During this time, CEO assured investors assets were safe . . .

43. The “voluntary settlement” . . . • Unfortunately, between August and November, assets were dissipated • On December 9, 2005, CEO fired his attorneys and wrote letter to all investors • declared innocence • claimed prosecutor attempting to increase conviction rate • claimed prosecutor attempting to drive company into bankruptcy . . .

44. Initial indictment • Once December 9, 2005 letter received, case was immediately prepared for grand jury • Indictment alleged securities fraud and the forfeiture of 36 parcels of real estate, 16 known bank accounts, and other assets that were proceeds of fraud

45. Search warrants • On December 21, 2005, search warrants were served on two condos in Maui, Hawaii, and an office in Bend, Oregon • $40,000 in cashier’s checks seized • After seizure of cashier’s checks, CEO requested issuing bank to reissue two of the checks (two $10,000 cashier’s checks), claiming that they had been put through the laundry and destroyed. The bank refused to do so without further proof. • One of the bank fraud counts . . . • Another 20 banker’s boxes seized

46. Seizure warrants • Between December 21st and 27th, seizure warrants were issued for over 30 parcels of real estate, 16 bank accounts, and $1,382,925 in seized currency and cashier’s checks

47. Initial arraignment • On December 27, 2005, CEO and COO arraigned on initial indictments • Released pending trial on condition that not engage in any financial transaction over $1,000 without the prior approval of the Court

48. Appointment of Receiver • Seized real estate needed management, foreclosures needed response, and substantial title and other issues needed focused attention • Primary purpose to preserve assets so they could be returned to investors • Stipulated motion and order appointing Receiver filed on March 16, 2006

49. Pretrial release violation • Between December 27th and April 28th, CEO engaged in over $6,000,000 in financial transactions, most in violation of his pretrial release condition • deposit and withdrawal of hundreds of thousands of dollars at casinos in Las Vegas • While this was occurring, various loans incurred by him for Pac Equities were in default and bills were left unpaid

50. Pretrial release violation • CEO arrested on May 3, 2006, for violation of pretrial release conditions • search warrant served on his home in Palm Desert, California • over $51,000 in currency and traveler’s checks were seized