fimmtudagur, febrúar 18, 2010

ponzi two

My second article of two appeared a few days back in Fréttablaðið. Here it is in English.

Part II: Stanford International Bank

As I discussed in the first part of this two-part series, a Ponzi scheme is any fraud or scam that must continually bring in new investors in order to pay returns to existing investors: the arrival of new money is the only way to keep the scheme afloat.

In this article I will describe a Ponzi scheme that has not been discussed much here in Iceland (hér heima), but was nonetheless a giant fraud that came crashing down last year: Stanford International Bank. This Bank had its headquarters in Antigua, a Caribbean island nation, but was started by two Americans. Stanford International Bank turned out to be an 8 billion dollar conspiracy and a giant Ponzi scheme.

The scheme ran for at least 10 years, and maybe as long as 20 years. It centered on taking savings deposits from individuals in the form of CDs – Certificates of Deposit. These savings deposits are “locked up” for a given time period, 6 months, one year, or longer. Stanford International Bank was paying high interest rates on these CDs – double the rate of other banks and as high as 15% (in US dollars). The CDs were purchased by 28 000 investors world-wide, in 130 countries, through an international web of marketing companies connected to Stanford. Not being able to earn these high returns through legitimate investments, Stanford resorted to paying old investors with the money of new investors. Nonetheless, for 20 years every investor in Stanford got his money back.

Perhaps Stanford had started its life as a legitimate bank, but developed into a Ponzi scheme as it was unable to make good on its promises. Any unsustainable business model whereby an investment company continually takes in new money is in effect a Ponzi scheme: it doesn’t have to originate that way, but under pressure to perform as advertised can become one.
There were four personalities who were central to the perpetration of the Stanford Bank Ponzi scheme. The main player was Allen Stanford, the founder of the bank. In the words of one fraud investigator from the SEC, “This guy knew how to spend other people’s money.” Allen Stanford lived lavishly on his adopted home of Antigua and built the headquarters of his bank to match his lifestyle. It was a beautiful building with the façade of a giant mansion, a lush path of palm trees and tropical flowers leading to the main entrance.

Allen Stanford was knighted by Antigua in 2006, and preferred to be called “Sir Allen”. As I alluded to in the first section of this article, many Ponzi schemers use public promotions of sports and charities to build their profile and believability, and Sir Allen was no exception. He was a leading charitable benefactor in Antigua and established a $20 million prize for an international cricket championship that was held in Antigua. (When the local team won, he encouraged them to “invest” their prize money in CDs from Stanford International Bank.)

Sir Allen invested time and effort in his public image, and the efforts paid off. In February 2009, the Houston Chronicle described him as, “the leading benefactor, promoter, employer and public persona” of Antigua. He maintained powerful friendships in the U.S. and worldwide and was listed the 605th wealthiest man in the world by Forbes Magazine in 2008. In a glowing article, he was also named Man of the Year by World Finance magazine for 2008.

The number two man at Stanford International Bank was Sir Allen’s college roommate, James M. Davis, who acted as the bank’s CFO (Chief Financial Officer). Mr. Davis and Sir Allen were the only two individuals with access to view the actual holdings of the investment portfolio of Stanford International Bank and thus the ones with innermost knowledge and control of the scheme.

In a Ponzi scheme, every participant plays a role in keeping the façade of legitimacy, and the two men needed a believable “public face” for the Bank. That person was Laura Pendergest-Holt, whom James Davis had met when she was 16 and he was her Sunday School teacher at the church he had founded in Mississippi. When Ms. Pendergest graduated from university, she went to work for her old teacher and in her mid-20s and with no previous education or experience in finance was made CIO (Chief Investment Officer) of Stanford International Bank. She and her team were based in the United States, with an office in Tennessee. Ms. Pendergest-Holt was in charge of a small fraction of the bank’s investments but claimed that she controlled the whole portfolio. She was then free to make public statements about how risk-free were the assets in the investment portfolio. But the bulk of the assets were of course managed by the two college roommates.

And according to SEC investigators, that portfolio of valuable investments – the asset side of the balance sheet of Stanford International Bank – was “missing”. Billions had been invested in illiquid private equity deals, something that was never disclosed to investors in the bank’s CDs. There were also large investments in real estate, something Stanford had claimed publicly not to have done. In some cases, parcels of real estate were purchased and then “flipped” back and forth between shell companies controlled by the bank, in order to increase their stated value on the books of the bank. In addition, Sir Allen withdrew $1,6 billion dollars from the bank for his own use, against IOUs he wrote the bank. Publicly, he claimed that he never took a dime out of the bank and reinvested every penny into the enterprise.

The fourth colorful character from the saga, and perhaps the chief enabler of the Ponzi scheme, was Leroy King. He was the head of the bank supervision agency of Antigua. He and Sir Allen maintained an “unusually close” relationship, with Sir Allen paying regular bribes to King’s Swiss bank account to keep the regulator from looking at the books of the bank. Not believing the money to be enough to keep King loyal, in 2003 Sir Allen encouraged his regulator to take a “blood oath” where their wrists were cut and the blood mixed together. After the oath, Leroy King referred to Sir Allen as “Big Brother” and was showered with Super Bowl tickets and trips in the Stanford private jet for him and his girlfriend.

Leroy King was worth the money. When foreign regulators came around, he stated that Stanford International Bank was the cleanest bank in Antigua. And when the U.S. SEC began asking questions about the bank’s investments in 2006, he refused to cooperate with his foreign counterparts, citing “bank secrecy”. He also forwarded the confidential SEC letter to Sir Allen’s lawyers to have them draft an acceptable response for Mr. King to sign and return.

The Stanford scheme began to unwind in 2008, along with many other Ponzi schemes. 2008 was a “trigger year” for such schemes to fail, as falling stock markets worldwide led investors in Stanford CDs to require some of their money back. With the news of the Madoff scheme, some of the compartmentalized employees of Stanford who had been suspicious about their own bank’s business model began to wonder if they, too, worked for a Ponzi scheme. Some of them confronted Laura Pendergest-Holt and she told them the truth about some of the real estate and private equity investments. About this time the American investigations of Stanford kicked into high gear, and it was these investigations that sealed the fate of the bank.
In February 2009, the SEC charged Ms. Pendergest-Holt with fraud (lying to investors about where their money was invested), obstructing an investigation, and conspiracy to obstruct justice, and she is currently awaiting trial. In June 2009, confronted with the evidence against him, James Davis pled guilty to conspiracy to commit fraud, mail fraud, and conspiracy to obstruct an SEC investigation in a plea deal that was the final straw for his old roommate. He faces up to 30 years in prison as the result of his plea.

Davis’ plea triggered the arrest of Allen Stanford for “massive ongoing fraud” in June 2009. Mr. Stanford was stripped of his Antiguan knighthood late last year and is currently awaiting trial in a Texas prison. That same month, Leroy King lost his job and is currently awaiting an extradition hearing in Antigua. U.S. prosecutors are requesting that he be removed to the U.S. to stand trial there as a member of Allen Stanford’s massive Ponzi conspiracy.

[Disclaimer: Some of the statements made in this article are according to SEC sources or US Attorney prosecutors and have not been proven in a court of law.]