Financial intermediaries could be left holding the bag in the unraveling of what is being characterized as possibly the longest-running Ponzi scheme in U.S. history.
DETROIT — Financial intermediaries could be left holding the bag in the unraveling of what is being characterized as possibly the longest-running Ponzi scheme in U.S. history.
The alleged scam, centered in Tampa, Fla., and involving former boy-band manager Louis J. Pearlman, is believed to have snared more than 1,400 victims in 41 states, investing an estimated $317 million over a 15-year period.
Mr. Pearlman, who managed such groups as *NSYNC, O-Town and the Backstreet Boys, is believed to have fled the country, but his Orlando, Fla., home and business, Trans Continental Airlines Inc., were raided by FBI agents Feb. 15.
Trans Continental, which also owes $150 million worth of bank loans, according to court documents, was placed in court-ordered receivership Feb. 2,
following a yearlong investigation by Florida’s Bureau of Financial Regulations.
At the time the business was placed in receivership, court records state that Trans Continental had less than $15,000 in four checking accounts.
“It’s an extremely bad situation, and I don’t see much in the way of [asset] recovery,” said Gerald McHale, the Fort Myers, Fla.-based forensic accountant appointed as the receiver responsible for sorting out the alleged scam and the recovery of assets.
Restitution blues
Mr. McHale said that the average asset recovery in a Ponzi scheme is about 15 cents on the dollar, but he doesn’t think this one will reach the average.
One potential source of assets he plans to pursue is the $7 million worth of commissions and referral fees paid out to insurance brokers, lawyers and financial advisers.
Even those intermediaries who were duped into believing it was a legitimate investment and who did not receive any compensation for directing investors toward the scheme could become entangled in the anticipated flood of lawsuits, Mr. McHale said.
“If investors came in through a third-party adviser, people will go after those advisers,” he said.
The Financial Services Institute Inc. in Atlanta acknowledged that with the investigation unfolding, it is too early to speculate on how financial advisers might be affected.
“Guys like that can do irreparable harm to the financial advice business,” said David Bellaire, FSI’s general counsel and director of government affairs.
The Financial Planning Association in Denver echoed the perspective of hindsight, advising, “If it sounds too good to be true, it probably is,” said Brad White, the FPA’s Washington-based director of public affairs. He said he was not familiar enough with the case to comment on how or whether such an elaborate scheme would affect the reputation of the financial planning profession.
According to the complaint filed in circuit court in Florida’s Orange County, the scheme involved word-of-mouth marketing of a Trans Continental employee investment savings account program that was promoted as offering FDIC-insured interest rates of between 6% and 8% up to $100,000.
Beyond $100,000, the EISA program was promoted as being insured by American International Group Inc. in New York and the British insurance market Lloyds of London.
None of that was true, despite the promotion literature often openly flaunted by Mr. Pearlman and other Trans Continental representatives, according to sources familiar with the case.
“It was promoted as a secure banking product,” said Jack Kiefner, a St. Petersburg, Fla., attorney who is representing three dozen people that invested in the EISA program.
“There were some salesmen who signed independent-contractor agreements,” he added. “But [Mr.] Pearlman and others in the area were relatively easy to reach if you wanted to invest in this.”
One adviser, who asked not to be identified, said he earned one-time referral fees for nearly a decade for directing investors toward Trans Continental’s EISA program.
Other sources recalled Trans Continental representatives’ showing up at investment club meetings and promoting the EISA program.
“There were probably several dozen people from our group that invested with them,” said Preston Bailey, a leader in the Tampa-area SuperTraders investment club.
Like a lot of people familiar with the way Mr. Pearlman’s alleged scheme operated in plain view for 15 years, Mr. Bailey wants to know why the regulators took so long to figure it out.
“A lot of us are mad at the state,” he said. “People in our club are upset that something like this could happen in Florida, and nothing was done years ago.”
According to sources familiar with the investigation, the scheme started to unravel in early 2006 when some investors were having difficulty withdrawing money from their accounts.
Meanwhile, according to court records, at least one investment for $1 million was made into the EISA program as recently as Jan. 25, 2007.
At this point, the Florida Office of Financial Regulation is working with the FBI, the Internal Revenue Service and the office of the U.S. attorney for the middle district of Florida in parallel criminal and civil investigations into both the whereabouts of Mr. Pearlman and the recovery of assets.
“This has the makings of a long-term investigative effort, because we have to prove where the money came from, where it went and who is liable,” said Bob Rosenau, chief of Florida’s Bureau of Financial Investigations.
“This case clearly illustrates the dangers of making investment decisions without adequately researching the legitimacy of the investment,” he added. “When doing your due diligence, don’t trust your friends and neighbors.”
