You Can't Cheat an Honest Man (41 page)

Mullens spent some of the fraudulently acquired money on symbols of success: a million-dollar home, an airplane, country club memberships, glossy brochures full of empty boasts about Omni Capital, and elegantly detailed offices.

The scheme began to totter in 1991. First, the SEC began an investigation based on promises Mullens was making. In the course of that investigation, a group of Omni Capital employees learned that Mullens was a twice-convicted felon who’d spent three years in prison in the 1970s for operating a pyramid scheme in New Jersey.

Some of these employees had invested money with Omni Capital. They demanded refunds and Mullens paid them about $1 million, buying himself a little more time. But the collapse came quickly in April 1992 when word of the SEC investigation leaked to the local press—and investors rushed to liquidate their holdings. Omni Capital repaid about $4 million and then filed bankruptcy in May.

Using Omni Capital’s books and bank records, the bankruptcy trustee was able to trace all but about $7 million of the funds invested with Mullens. Of course, this didn’t mean the trustee could
recover
the money. About $15 million was lost.

In October 1992, federal prosecutors charged Mullens with dozens of counts of conducting financial transactions to promote a fraud, conducting monetary transactions with its proceeds and criminal conspiracy. A few months later, Mullens pleaded guilty to 47 criminal counts of defrauding investors and admitted that Omni Capital was a pyramid scheme with no tangible operations. A federal court in Miami sentenced Mullens to 35 years of in prison and ordered him to pay $27 million in restitution.

Many investors suspected that Mullens had diverted several million dollars to foreign bank accounts, but these suspicions couldn’t be supported by facts. So, investors had to look elsewhere.

Mullens said that believed the people who sold partnerhsip units had known that he’d run pyramid schemes in the past. That testimony set the stage for suits against the salesmen, including stockbrokers who referred clients to Omni Capital—in exchange for cash payments.

In April 1993, three Miami-area Prudential Securities stockbrokers were accused of taking money from Mullens to steer their clients into Omni Capital. Two separate suits filed in federal court claimed that the Prudential stockbrokers helped Mullens raise at least $15 million. (Both suits named Prudential—with its deep pockets—as a co-defendant.) Burned investors said they were told that Omni Capital was a conservative investment that Prudential employees bought for their own families.

One of the brokers had boasted that he’d raised $8 million for Omni Capital—for which he received more than $500,000 in commissions— during the 18 months prior to the scheme’s collapse.

To connect Prudential to the misdeeds, the suits claimed that Prudential supervisors were aware the brokers were selling Omni Capital to clients and that neither Prudential nor its brokers did any due diligence to verify claims Mullens made in a prospectus. One lawyer for the burned investors said Prudential should be held responsible for allowing brokers to recommend investments that were not screened by management and to accept money from an outside source.

Prudential Securities spokesman William Ahearn insisted his firm never had a relationship with Omni Capital. “Anyone who invested with Omni did so directly with that company,” he said. “They made the check out to Omni, there was no solicitation by us formally.”

Ahearn said that the stockbrokers who took money from Omni Capital did so only after leaving Prudential. Still, Prudential settled with the shareholders for a small amount.

“The main lesson in the [Omni Capital] case is that some deals are just so sleazy the bankers and brokers will pay money so that they aren’t associated with them,” says one lawyer familiar with the Prudential case. “And you might think that these deals are rare. But every office of every brokerage in the country has at least one that it’s peddling right now.”

Financial institutions get involved in Ponzi schemes because of two weaknesses which they share with many investors. First, they are drawn to strong profit-and-loss statements, which—in the early stages and with some manipulation—Ponzi schemes can have. Second, they operate in competitive arenas, so their decision-makers are often nervous about missing opportunities.

Together, these traits lead many insitutions to reach what one banker calls “false positives.” Sometimes these miscues are foreign countries; sometimes they’re local Ponzi schemes. All financial institutions have their share.

Case Study: Towers Financial Uses Duff & Phelps

Steven Hoffenberg’s Towers Financial was a false positive. Hoffenberg dropped out of the City College of New York in the late 1960s to go into business. While he had no particular passion for any one line of work, he was a good negotiator. In a few years, he was buying small businesses in the New York area and reselling them to bigger competitors at decent profits.
In the early 1980s, Hoffenberg stumbled onto the business that suited him best: debt collection. He started a company that specialized in collections, receivables purchasing and factoring. These are activities that make most people—even most business people—flinch. They’re the hardest, ugliest part of commerce.

Hoffenberg, with his facile knowledge of financial terms and aggressive, Brooklyn-bred personality
seemed
like the perfect person to handle the ugly work. Within a few years, Towers Financial operated through a number of subsidiaries, the largest of which were:

•
Towers Credit Corporation, which purchased commercial accounts receivable and tried to collect them for its own account;

•
Towers Collection Services, which collected past-due accounts receivable for third parties on a contingency basis; and

•
Towers Healthcare Receivables Funding Corporation, which engaged in factoring health care receivables.

The last subsidiary was the most promising. In the late 1980s, Hoffenberg had gotten into lending money against accounts receivable of financially strapped health care providers. Towers would purchase the receivables—bills owed to hospitals and nursing homes by Medicare, Medicaid and private insurance companies—at a discount from face value.

The genius of the business was that Hoffenberg convinced the cashstrapped hospitals to give him financing (though they may not have realized this was what they were doing). He’d pay half the cash right away and the another 40 percent or 45 percent after he’d collected the receivables.

The collection cycle usually took 30 to 90 days, so Towers was earning an annual return on its money of anywhere from 20 percent to 60 percent. Many of the hospitals paid the premium without complaint. One former finance executive at a New Jersey hospital said, “I needed the cash, and I didn’t care what I paid.”

Hoffenberg ran into some trouble in 1988, when the Securities Exchange Commission discovered that Towers had violated federal securities law by selling $37 million worth of unregistered bonds. But the SEC agreed to close its investigation in exchange for a consent decree which required, among other things, that Towers make a refund offer to the holders of the bonds.

Towers made the offer—but couched it in such vague terms that only a small percentage of the bondholders took advantage of the chance to get their money back. The company only refunded $440,000 of more than $30 million it had received from the notes in question. As one court would later observe:

Had a substantial majority of these noteholders reclaimed their investments, Towers, thus being deprived of funds to pay interest on its other notes, would have been forced to default. The Ponzi scheme would then have been over.

But they didn’t...and it wasn’t.

Hoffenberg treated his own employees in much the same way he treated investors. He compartmentalized his company, assigning narrow duties to each manager so that only a few people—and maybe only Hoffenberg himself—knew how Towers really worked.

And there was a lot of expensive bluster. Towers Financial’s corporate offices in Manhattan were decorated with tasteful furniture, plush carpeting and oil paintings. It looked like a prestigious old-line law firm. The image of respectability helped Hoffenberg carry out his fiveyear growth plan, fueled by repeated note and bond offerings.

Most of the notes were distributed by some 240 small regional brokerdealers, while the bonds were privately placed by Towers itself. In its Offering Memoranda, which paved the way for the various bond offerings, Towers stated that it had developed a remarkably profitable operation. The fat profits allowed it to pay fantastic interest rates.

Between February 1989 and March 1993, Towers sold over $245 million of bonds to more than 3,500 investors in 40 states. The money raised from these offerings was supposed to go to buying high-quality accounts receivable that the company could collect easily. Hoffenberg didn’t buy many accounts receivable. And, when he did, he bough low-quality, uncollectable ones for pennies on the dollar. He’d then claim this crap was worth 95 percent of face value.

Another trick he used was to sign deals with corporate clients under which Towers would collect bills which remained the client’s property. He’d then enter these bills on Towers Financial’s books like accounts receivable his company had purchased.

Towers’ Annual Reports for 1988, 1989 and 1990 stated that the company expected to collect 30 percent of all collection receivables as “fees.” It never kept anything like that amount.

From 1988 through March 1993, Towers generated almost $400 million in losses—though these losses didn’t show up in any of the company’s financial reports. Hoffenberg was keeping the company operating by misallocating the infusions of cash provided by the bond offerings. He papered over the losses with phony financial reports presenting an upward trend in earnings. Between 1988 and 1992 profits appeared to rise dramatically, from around $4 million to $17 million; in fact, losses were more than tripling in this period, to almost $96 million in 1992.

Overstating receivables resulted in a reported $25.5 million in shareholders’ equity in 1992; in reality, equity was negative $242.4 million. Reinforcing the illusion of prosperity were slickly produced annual reports. People believed the lies.

Hoffenberg lived in a Long Island mansion—complete with a pool, tennis court and private beach. For weekends, he kept a home in Boca Raton. When he needed to drive somewhere, he hopped in one of three Mercedes. In 1993, he tried to buy the
New York Post
. But trouble was looming. When SEC investigators learned about Hoffenberg’s efforts to buy the
Post
, they accelerated their inquiry.

In early 1993, bondholder trustee Shawmut Bank began making noises. It had just received the company’s fiscal 1992 annual report (six months after the end of the fiscal year) and found what seemed to be indications that Towers had violated the terms of its various loans. Worse still, Towers wasn’t forthcoming about whether the “possible events of default had been cured.”

Shawmut declared the health care bonds in default and refused to release any more of the bond-issue proceeds for lending to health care providers. That created a huge problem for Towers: It had already sent money to health care providers after purchasing the receivables backing the bond proceeds at Shawmut.

Once the money from Towers stopped coming, many providers simply kept the insurance payments. As a result, Towers Financial’s cash flow slowed to a trickle. Realizing his time was running out, Hoffenberg tried to cover his tracks. One attorney would later discover a $6,400 claim against Towers from the Mobile Shredding Corp. of New York that covered work during the last months of 1992. Mobile had shredded ten tons of Towers documents.

In February 1993, the SEC filed a lawsuit in New York federal court, charging Hoffenberg with securities fraud and demanding the appointment of an SEC trustee to run the company. Towers filed for bankruptcy protection a few days later.

In March 1993, Alan Cohen—a New York-based workout consultant—was appointed trustee. When he arrived at Towers Financial’s offices, Cohen found Hoffenberg there, still trying to hang on to his control of the company. “I suggested to him that it would probably be better if he didn’t come around anymore,” said Cohen.

The federal lawsuit charged that Hoffenberg never intended to do anything with money taken from gullible investors except “apply it to [his] own purposes and use it for the payment of interest owing to other investors.” According the U.S. attorney, “Unbeknownst to the investors, the source of the interest they received on the Notes was the principal paid by later Note investors.”

That’s as succinct a definition of
Ponzi scheme
as any.

During its heyday, Towers had referred skeptical investors to Duff & Phelps, a financial credit rating agency which “would provide independent verification and corroboration regarding the creditworthiness of [Towers Financial] and... confirm the positive statements [it] had made.” Duff & Phelps claimed it used what it called a “shadow rating” of Towers Financial. Its staff told a number of investors that it “had conducted extensive due diligence investigations prior to assigning ratings to the bonds.”

Burned investors eventually sued Duff & Phelps, claiming that it had known that the false information would be used in investment decisions. They said: “At all times Duff & Phelps knew that the false assurances and information it was providing would be... used by the brokers and their clients... to evaluate whether to purchase and/or maintain investments in [Towers Financial].”

The January 1996 federal court decision
Shain v. Duff & Phelps Credit Rating Company
considered the complaints against the rating company. The case had been brought by Myron Shain, who’d invested $200,000 in Towers notes, on behalf of himself and a class of similarly situated suckers.

The gist of Shain’s complaint was that “Duff & Phelps actively foisted a uniform and consistent set of misrepresentations and omissions on the Duff & Phelps Class via the Class Brokers who reiterated them to, or relied on them for, the Class.”