Savvy investors must act less like pigeons

This is an update of a “Street Sweeper” column that originally ran on May 4, 2012.

On November 17, 2010, a federal grand jury in the Northern District of Illinois indicted Francis X. Sanchez, then 49, of Woodstock, IL, and James D. Bourassa, then 53, of Gilberts, IL, with 20 counts of mail fraud and wire fraud. The Indictment charges Sanchez and Bourassa with operating various businesses that were used to defraud investors out of more than $7,000,000.  Mail fraud carries a maximum penalty of 20 years in prison and a $250,000 fine, or a fine totaling twice the loss to any victim or twice the gain to the defendant, whichever is greater, as well as restitution to the victims.

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To sort of cut to the chase here, Bourassa pled guilty to mail fraud on February 27, 2012; and on May 3, 2012, Sanchez pled guilty to mail fraud. Sanchez admitted that, during the course of the scheme, he and co-defendant Bourassa fraudulently obtained approximately $7,238,506.40 from the investors. Of this amount, approximately $1,711,711.18 was paid back to the investors through Ponzi-type payments.

Okay, so, in a nutshell these two entrepreneurs have admitted to a $7 million fraud and are likely headed to prison and will be hit with a substantial fine; of course, as to whether the likely resetitution will ever put much if any dollars back into the now-fleeced pockets of investors, who knows.

What truly interested me in this case were the elements of the scam: What was said and what was believed.  Frankly, I often shake me head over such blatant nonsense as was exhibited in this case. It’s hard for me to really apportion the blame as between the fraudsters and their victims.  As I have often noted, sometimes this nation might benefit from enforcing a form of eugenics on investors. See, “Wall Street Eugenics : SEC Charges Microcap Fraud . . . again” (“Street Sweeper” January 27, 2012). Sadly, let’s go through this litany of nonsense and blind acceptance, yet again.

Fibs, Lies, and Half-Truths

As part of his plea agreement, Sanchez admitted that he, Bourassa, and their employees solicited people to invest in InvestForClosures, which was presented as a business that bought distressed houses, rehabilitated those houses, and sold the houses for a profit. Among the bald-faced lies that Sanchez admitted that he and his employees made to their potential investors, was the following:

1. their investments would be safe because they would be backed by real estate;
2. InvestForClosures used the majority of their investors’ funds to purchase real estate; and
3. because of the business’ efficient cash flow from buying and selling houses, InvestForClosures Financial had never failed to make an interest payment on time or return an investor’s principal when requested.

Contrary to those pie-in-the-sky promises, Sanchez now admits that the following is the truth:

1. the business did not own sufficient real estate to secure all of the investments;
2. the business did not use the majority of investor funds to purchase real estate, but instead used most of the investors’ funds to pay other expenses, including the salaries of the defendants, and to pay Ponzi-type interest to prior investors; and
3. InvestForClosures was not making enough money from property sales to pay the interest owed to the investors, but was instead using cash received from new investors to pay the prior investors with Ponzi type payments.

Keeping Your Guard Up

Okay, stand back and give me some room here – watch my swinging elbows and roundhouse punches.

Some con artist tells you that your investments are safe because they are backed by real estate. You think that you might insist upon proof?  And, by the way, I can fabricate all sorts of official looking documents on my computer in a few seconds.  Don’t tell me that someone sent you a piece of paper. Did you go to the source yourself and confirm the legitimacy of the deeds and titles?  Did you pay someone to verify the asserted holdings?

Next, you’re assured that your money is going to be used to buy real estate.  How do you know that the funds are going to be used as earmarked?  Did you demand the right of access to the corporate bank accounts?  Was an independent auditor retained to monitor the investments and issue reports to investors?

You were likely happy to see that the check came in the mail as promised.  However, did you ever demand audited financials or bank statements to show the actual cashflow of this business?  You know that we’re in the Age of the Ponzi – did you seek to implement any safeguards against that? And puhlease don’t give me the crap that the cost of such verification was prohibitive.  These two scam artists bilked investors out of over $7 million!  I’m sure that for a pittance of that amount someone could have done some homework and some competent lawyer retained by an investor(s) could have drawn up a contract preserving the investor’s rights of audit and direct verification.

What do audited financials for real estate deals look like?  What kinds of representations should you require? For starters, how about you look at some publicly traded real estate companies and get an idea how they are required to document their businesses. For starters, go visit Hovananian Enterprises, Beazer Homes, Toll Brothers, KB Homes, or Lennar — look at the detailed financial reports that they are required to prepare.  Perhaps some of the victims in this case might have used those materials as guidelines when insisting upon audited disclosures prior to making an investment and, thereafter, as the business progressed.  Keep in mind that even regulated publicly traded companies have legal problems, get sued for fraud, and have difficulty realizing profits — particularly in recent years. Still, at least with publicly traded companies there is a system of state and federal securities regulation — as ineffective as that may often be.  What do you have when two clowns approach you with extravagant claims about real estate flips and deals, and are asking for millions of dollars from investors?

Sands of Gold . . . umm, maybe foolsgold?

As with too many of these Ponzi schemes, it gets worse.  When Sanchez apparently began to fear his scheme could be uncovered or was beginning to unravel,  he told investors that he was developing an exclusive, luxury, residential community in Mexico known as the “Sands of Gold,” for which Sanchez and Bourassa solicited their investors to purchase lots at Sands of Gold and to invest additional monies with InvestForclosures. And what, pray tell, did the clever Sanchez tell his new pigeons?  How about the following:

1. the government of Mexico had promised to invest millions of dollars in infrastructure necessary for the development of the Sands of Gold;
2. efforts to obtain financing for the project were going well and a financing deal was imminent; and
3. they were finishing negotiations with a major hotel chain for the construction of a hotel at Sands of Gold.

Of course, the cold, harsh truth was that the Mexican government made no such promise; the fundraising was not destined for anything bona fide; and good luck finding the major hotel chain.

UPDATE

On June 11,  2012, Bourassa was sentenced to 51 months in federal prison.

On September 24, 2012, Sanchez was sentenced to 136 months in federal prison and ordered to pay $7.8 million in restitution to the victims of his crime.