PhiliP r. Murray
The Investment
Consider the following investment opportunity circa the 1980s. Stephen L.
Smith, a businessman in the small town of Winter Haven, Florida, runs a company called SH Oil and Gas Exploration. ἀ e nature of the business is locating oil and gas underground, drilling wells, and selling the gas and oil in the energy market. ἀ e returns are remarkable. You show an interest in investing in SH Oil and Smith agrees to meet you in his offices at 505 Avenue A, Northwest.
ἀ e office is clean and organized. A framed picture of his wife and a duck decoy decorate the desk. An appointment book is in the center of the desk and a large contour map marked with push pins is on the wall behind. ἀ e preppy-looking, 30-something Smith invites you to sit down and begins talk-ing about business.Business is good. Smith owns more than three hundred oil wells. ἀ e map shows where he intends to drill next. He is on the cutting edge of energy prospecting. ἀ ere is a technology, he explains, a “black box”
that sits aboard a plane in order to identify underground reservoirs of oil and natural gas. ἀ e technology is so reliable that Smith can boast of striking oil in 114 of his last 120 attempts. He shows you checks written by the Amoco Company in the amount of approximately $1 million to pay for purchases of oil and gas (Sills, October 12, 1991; Calonius 1990; Cardinale, June 3, 1989).
ἀ ere is no stock prospectus outlining SH Oil’s assets, liabilities, net income, and risks. Instead, Smith hands you a pamphlet titled “Background
15
Contents
ἀ e Investment ...161
ἀ e Profile ... 162
Doubts about SH Oil ... 163
ἀ e Letter ... 164
ἀ e Sentence ... 170
Parallel Controversies ... 171
Foreign Intrigue ...174
New Developments ...176
References ... 178
of SH Oil and Gas Exploration.” According to the pamphlet, Smith has been around the oil industry since 1973. SH Oil has wells where you would expect, in places such as Texas and Oklahoma, and where you might not expect, such as Pennsylvania, New Mexico, and three other states. Smith does not sell stocks or bonds to finance SH Oil. He sells investments in “projects” and a
“production pool.” Investing in a project involves “the partial assignment of leases to oil or gas wells.” Your income from a project flows from the sale of oil or gas from the well. ἀ e production pool is “like a small bank.” Your income from the production pool is similar to interest. Rates of return on projects range from 60 to almost 100 percent a year. Returns on the less risky produc-tion pool are about 20 percent a year. In addiproduc-tion to those impressive returns, there is a possibility of an investment tax credit for what you invest in SH Oil.
Actually, Smith does not invite you to become an “investor.” He conveys a dif-ferent mindset. He views you as a “customer.” ἀ e pamphlet states: “Based on objectivity, the Company will always deal fairly with any and all of its custom-ers” (Calonius 1990; Winter Haven News Chief, January 20, 1988; Cuthbertson and Sills, February 4, 1988, January 20, 1988; Sills, October 12, 1991).
ἀ ere are hundreds of delighted investors in the SH Oil Gas and Explo-ration company. One describes Smith’s character: “He said he works harder than three men.” Everyone seems to be making money; losers are unheard of. ἀ e only unhappy investors are those Smith rejected. ἀ e word around town is positive, which is why you are interested in the first place. But there is another reason to support investing in SH Oil. Barnett Bank of Polk County evidently approves the business plan. According to some investors, represen-tatives of Barnett describe SH Oil as a “squeaky clean” organization. Other investors say that John Dunn, a vice president of Barnett, personally testifies to Smith’s business acumen. Dunn reportedly authorized a geological study of SH Oil’s properties. Smith took other Barnett officials on a helicopter tour over SH Oil’s wells in Pennsylvania. Barnett lends directly to Smith and, in an indirect way, lends to investors who then buy SH Oil securities. One inves-tor says a loan officer at Barnett goes so far as to claim that SH Oil is “better than sliced bread” (Sills, October 12, 1991; Cuthbertson and Sills, January 7, 1988; Cuthbertson, March 9, 1988; Calonius 1990).
It all sounds so good, especially the high rates of return. But those returns are so high and sustained for so many years you wonder if they are too good to be true. You wonder what kind of character Steve Smith really is.
The Profile
Stephen L. Smith is not an outsider who raises one’s natural suspicions.
He is the third generation of an accomplished Winter Haven family. Smith graduated from Winter Haven High School in 1969. ἀ ere, he was an honor
student, president of the Spanish club, class treasurer, and member of the Interact service club—an organization of future business leaders. Classmate Steve Baker describes Smith: “He was friendly and very courteous; extremely well groomed—Steve was a person who always did everything right.” ἀ e promising high school graduate earned a bachelor’s degree from Stetson Uni-versity in Deland, Florida, and a master’s degree in business administration from the University of Georgia. He worked in Texas, where he became famil-iar with the oil business and learned the industry jargon. He sold stocks and bonds for Merrill Lynch during the latter half of the 1970s. Smith parlayed what he knew about oil and finance to create the SH Oil and Gas Exploration Company as a sole proprietorship in the late 1970s. One experience from the past is perhaps significant: A Netherlands Antilles company led Smith to believe it was going to lend him $18 million to invest in orange groves and oil wells. Instead, the company bilked him out of $40,000 (Leach 1988; Sills, March 3, 1989; Cuthbertson and Sills, January 6, 1988; Calonius 1990).
ἀ e “S” stands for Stephen; the “H” for his wife Heather. Heather was Steve’s high school sweetheart, from an “upper middle class” Winter Haven family. ἀ e couple’s primary residence is a house with pool and tennis court on Lake Hamilton in Winter Haven. ἀ ey also own real estate in Ocala, Florida; South Carolina; and posh Sea Island, Georgia. Steve collects cars, four Aston Martins among them. He bought a Rolls Royce for Heather. ἀ e couple literally lives the jet-set lifestyle, flying up and down the East Coast in their $500,000 Rockwell Saberliner. Although work consumes much of his time, Steve enjoys hunting at his leisure. Heather rides horses and collects jewelry. All this wealth is real and you can see the Smiths living in luxury year after year (Loftus 1991; Sills, January 20, 1988).
Doubts about Sh oil
ἀ e SH Oil and Gas Exploration business model appears to work well. ἀ e company sells securities in its well-drilling projects, accepts deposits into its production pool, and makes payments to investors on a monthly basis.
Barnett Bank officials apparently endorse SH Oil and put the bank’s money where its officials’ mouths are with loans of its own. Various other banks, including Bankers Trust and Citibank of New York as well as Mellon Bank of Pittsburgh, also lend money to SH Oil’s operations. ἀ e only nagging sus-picion, however, is that even though investors have been earning substan-tial returns on SH Oil for years, the returns are far above those available on alternative investments. Investors in the stock market, for example, expect to earn about ten percent a year on average, which seems mediocre compared to returns ranging from 20 to 100 percent annually on SH Oil.
Smith tells investors, “If you are the least bit uncomfortable in the way I do business, we’ll be happy to refund your capital.” Mitchell Kalogridis grew uncomfortable with the way SH Oil did business. He was the brother of Peter Kalogridis, the lawyer for SH Oil. Mitchell traveled to Pennsylvania in order to confirm SH Oil’s ownership of assets in that state but was unable to do so.
Upon his return he revealed what he learned to Smith who agreed, as he said he would, to refund Mitchell’s investment. Other business-minded members of the community voiced their concerns that the emperor might not be wear-ing clothes. Ron Brown, a certified public accountant, made a similar fact-finding trip to Texas in 1984. He could not verify that Smith owned any oil wells there. When Brown shared his findings (or lack thereof) with Peter Kalogridis, the latter mollified him with the point that Smith listed proper-ties in “nominee names” to protect his privacy. (A “nominee name” is a legal term for agent or trustee.) ἀ e Briggs family was a group of wary investors.
Sometime during 1985 Dr. Deane Briggs of Winter Haven shared his res-ervations about SH Oil with his father, Colver Briggs of Connecticut. ἀ e father employed a land assessor who reported back that he could not verify the existence of any oil wells in Texas owned by Smith or SH Oil. ἀ e land assessor also doubted Smith’s success rate in drilling wells and striking oil.
He dubbed the business “a very shady deal.” Ed Rooney, of Rooney Invest-ments, likewise could not verify that SH Oil owned any wells in Pennsylvania and informed John Dunn of Barnett Bank. In early 1986 businessmen Bill Herndon and Mark Bostick told Larry J. Pitts of Sun First National Bank in Winter Haven that the high rates of return Smith was paying implied that
“there must be something either illegal or immoral with his business.” Pitts consulted other bankers who rejected Herndon and Bostick’s suspicions.
Despite these doubts about the veracity of Smith and his ability to pay spec-tacular rates of return through SH Oil, investor sentiment remained for the most part optimistic (Sills, August 25, 1991, October 12, 1991, January 8, 1992, March 13, 1992; Calonius 1991).
ἀ e SH Oil money machine came to an abrupt halt in December 1987 due to “the letter.”
The letter
An anonymous tipster mailed a letter from Lakeland, Florida to the state comptroller’s office in August 1987. ἀ e letter alleged that the SH Oil and Gas Exploration Company was a Ponzi scheme. In such a scheme, named after conman Charles Ponzi, the perpetrator solicits an initial group of investors, then recruits another group of investors and pays the first group attention-getting returns with funds put up by the second group. ἀ e chief character-istic of a Ponzi scheme is that the perpetrator pays the last round of investors
with investments made by the next round of investors. In this way the pyra-mid of investments and payouts grows unless or until investors demand the return of their principal. ἀ e whistleblower on SH Oil wrote: “ἀ ese returns are not being produced by the earnings of the company, but rather, are com-ing from the capital becom-ing invested in the company. ἀ e returns are so good that the investors cannot resist reinvesting their earnings with the company.”
He or she also alleged that “most of the investors have an idea of what is going on, but the returns are too great for them to stop.” ἀ e public appar-ently never learned the true identity of the letter’s author, who type-signed it
“Florida citizen” (Sills, October 12, 1991).
Whoever wrote the letter and prompted the government intervention shook the foundation of the SH Oil pyramid like no one else. ἀ e author’s skepticism, coupled with a government investigation, finally exposed a fraud that lasted about a decade. ἀ e state comptroller began the investiga-tion in October 1987. Lawrence H. Fuchs, a deputy comptroller in Tallahas-see, assigned the Orlando office to conduct the investigation along with the Florida Department of Law Enforcement. ἀ ree and a half months of inves-tigation were enough to stop Stephen Smith from perpetuating the fraud (Cuthbertson, January 1, 1988; Sills, October 12, 1991).
An investigator doing research at the Polk County courthouse stumbled across an SH Oil “partial assignment of lease” security. Another investigator contacted the owner of the security for information. ἀ e owner informed Smith, who then contacted the comptroller’s office and agreed to meet with investigators as if he had nothing to hide. Smith and his lawyer, Peter Kalogridis, told investigators of a “secret agreement” between SH Oil and Amoco Corporation. News reports left it to one’s imagination why, according to Smith and Kalogridis, secrecy was necessary. In a later meeting, Kalogridis attempted to convince investigators of SH Oil’s legitimacy by showing them checks written by Amoco in the amount of several million dollars. Represen-tatives of Amoco inspected the checks and concluded that they were forged.
Amoco officials also denied the existence of any secret agreement with SH Oil. Shortly thereafter, Polk County Judge Dennis P. Maloney ordered that SH Oil be closed. It was December, 30 1987 (Sills, October 12, 1991).
Investors resisted the idea that their King Midas was a fraud. Nick Pund said, “It’s impossible for it to be what they say it is. I believe in Steve Smith.”
Twila Rhodes said, “Steve just wouldn’t do a thing like that. Bless his heart, he just can’t be in trouble.” “I’ve known him all my life,” claimed Steve Owen,
“and I’m confident that what he told me is true.” Some investors defended Smith and expressed resentment toward the government’s actions. Twila Rhodes said, “ἀ e papers are crucifying him…but I still think I’m going to get my money back. It isn’t a case of him running away.” Nick Pund asked, “If [Smith] was running a scheme that needed money, a ‘Ponzi’ scheme, then why did he turn down potential investors?” Investor W. N. Scarborough predicted
that “if [state authorities] don’t stick their noses in it, I think it will all work out.” Deputy Comptroller Fuchs offered sobering commentary. He stated, “In cases of this type, a recovery of 10 cents on the dollar would be optimistic.” In response to investor Nick Pund’s question as to why Smith would reject some investors, Fuchs answered, “ἀ at is fairly common in these kinds of schemes.
If you make it something exclusive, then people think that, somehow, it is a privilege to get involved” (Cuthbertson and Bygrave 1988; Cuthbertson and Sills, January 7, 1988; Cuthbertson, December 31, 1987; Winter Haven News Chief, January 9, 1988).
Judge Maloney’s court designated William H. McBride, Jr., as “receiver,”
responsible for seizing Smith’s assets and investigating the financial operation of SH Oil. McBride delivered his first report in late January 1988. He reported that “contrary to the expressed perceptions of those who allege investment interests in the businesses, Smith and SH Oil do not have identifiable, prov-able, or perfected interests in oil and gas projects (except a few limited inter-ests of small value).” By his estimate, 591 investors had put $109.1 million into the “projects” and the “production pool.” He documented a “typical pattern” of the financial transactions between Smith and his investors. ἀ e following passage illustrates the “meticulous” nature of Smith, which is one way he deceived investors:
ἀe investor would indicate to Smith that the investor had a desire to par-ticipate in a particular Project. Smith would mail the investor an invoice that listed the Project, the amount of the investor’s investment in the Project, and the investor’s purported percentage interest in the Project.…ἀe inves-tor would mail Smith a check in the amount of the invoice. Smith would then mail the investor an invoice evidencing that the investor had paid in full for the investor’s interest in the Project.…In addition, Smith would mail the investor two duplicate partial assignments of leases which specified the investor’s interest in the Project and lease.…ἀe investor would then execute both duplicate partial assignments of leases and return one of the duplicates to Smith. Investors in Projects would receive checks on a monthly basis that listed the amount paid to the investor for the previous month with respect to the various Projects.…Investors that deposited monies in the production pool would follow a similar procedure except that Smith would mail the investor duplicate participation agreements rather than duplicate partial assignments of leases.…Persons who invested in the production pool received a check each month from Smith which purportedly paid interest on their investments.
(Winter Haven News Chief, January 20, 1988; Cuthbertson and Sills, January 20, 1988)
McBride noted that “smart, tough business people” fell for the scam. In fact Smith fooled a wide variety of people. One reporter made a list of vic-tims: “elderly widows, small businessmen, entire families, and some of the
community’s most powerful and influential people.” Another reporter made this list: “Smith’s grandmother, prominent Winter Haven doctors and lawyers, and a former Winter Haven mayor.” A journalist writing for Fortune maga-zine put it this way: “Smith took checks from grandmothers and pensioners;
from the people who took him swimming as a child, who double-dated with him at Winter Haven High. He defrauded citrus managers, bankers, small-business executives, wealthy retirees, dentists, lawyers, an Episcopal priest, and an otolaryngologist.” ἀ is perpetrator, in other words, did not just vic-timize strangers and unsophisticated investors. He betrayed family members, long-term friends, and educated professionals (Cuthbertson and Sills, January 15, 1988; Sills, March 3, 1989; Cardinale, May 30, 1989; Calonius 1990).
When investigators searched SH Oil offices, they discovered a balance sheet prepared December 31, 1987, and signed by Smith, which listed SH Oil’s net worth at $8.5 million and Smith’s net worth at $78.2 million. McBride prepared “a rough estimate of the potential assets and liabilities of Smith and SH Oil,” which gave a completely different picture than the one Smith por-trayed. McBride pegged the assets of Smith and SH Oil at approximately $12 million compared to liabilities of about $116 million. Certain participants in the scheme fared well. McBride determined that a few recovered up to six times the principal they invested. Others lost everything. McBride asked,
“Should those investors who profited be treated the same as those who didn’t profit?” ἀ at question would take years for the courts to decide. McBride also recommended that the authorities pursue “aiders and abettors” who helped Smith build his pyramid (Winter Haven News Chief, January 20, 1988; Cuth-bertson and Sills, January 20, 1988).
In his next report, released in February 1988, receiver McBride revised his figures to show that there were 717 accounts with investments totaling
$138 million in SH Oil. ἀ e owners of those accounts collected “refunds, withdrawals, and income distribution” in the amount of $119 million. Recall that some individuals invested in “projects” involving partial assignments of leases. Table 15.1 is the result of a forensic accounting investigation com-missioned by the receiver and released to the public in March 1988. It shows investments in projects, payouts to investors in projects, and the difference, which Smith kept for SH Oil and himself, over time. ἀ e table illustrates the nature of a Ponzi scheme whereby the perpetrator diverts investments in the company toward the previous group of investors, not toward the purchase of plant or equipment to produce goods and services. ἀ e table also illus-trates the construction of a financial pyramid. Investments in the projects rose every year to a total of $106,987,866 by the end of 1987. Returns from the projects rose every year to a total of $88,658,124. ἀ e overall net gain to SH Oil and Smith from projects amounted to $18,324,842 (Cuthbertson and Sills, February 27, 1988; Sills, October 12, 1991; Winter Haven News Chief, March 24, 1988).
McBride reported that some investors in projects made money. Specifi-cally, he wrote that “240 accounts received refunds and income distribution
McBride reported that some investors in projects made money. Specifi-cally, he wrote that “240 accounts received refunds and income distribution