Ponzecase.pdf

105
CASE STUDY 13:

Ponzi Scheme or Accounting
Malpractice: Beware of Cowboys Wearing the White Hats
D. Larry Crumbley, Ph.D., CPA, CFF, Cr.FA
Louisiana State University

Nicholas G. Apostolou, DBA, MBA, CPA

West Virginia University

LEARNING OBJECTIVES

After completing and discussing this case, you should be able to
Recognize signs of a Ponzi scheme.
Learn a number of expert witness concepts.
See that there are two or more different sides to a legal dispute. Learn the various stages of a courtroom battle.

INTRODUCTION

An external auditor is required to perform an assessment in accordance with
generally accepted auditing standards for the purpose of rendering an opinion
that the financial statements have been prepared in accordance with general
accounting principles applied on a consistent basis. The audit is essentially
intended to uncover significant deviations from standards and to verify that
acceptable accounting and auditing practices have been used in the preparation
of financial statements.

A forensic accountant takes a more proactive, skeptical approach to examin-
gthe books of a company. This specialist makes no assumption ot manage

egrity and brings to the evaluation process
less concern than an auditor

wtn whether the reports conform to GAAP and more interest in exposing any

pOssibility of fraud. Since a forensic accountant often faces legal issues, an ac

tant practicing in the forensic area needs to
have an understanding of the

vironment in which businesses operate.
For example, the evidence

the

CCountant derives from an investigation may require his/her
testimony

ing

6
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attorneys oftenuse forens
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eal-w
orld situatio, nt that expert

This case
h

e b
asic

ru
le

s
of accounting SEC
aining

orders
aw

o
n

. Its principal place of busi
managing

A
s the M

anaging

JU
S

T
T

H
E

F
A

C
T

S
, M

A
A

M

general p
a
r
tn

e
r
fa

n
u

m
b

e
rof oil a

n
d

g
a
s
o

ffe
rin

g
s. A

s th
e
M

a
n

a
c
a
n

a
g

i
n

Sands,

W
ilso

n
E

nergy R
e
s
o

u
r
c
e
s
w

a
s
a

N
e
v

a
d

a
c
o

r
p

o
r
a
t
i
o

n
.
lts

p
rin

c
ip

a
l

n
e
s
s
w

a
s
lo

c
a
te

d
in

W
o

o
d

l
a
n

d
H

ills,
C

a
l
i
f
o

r
n

i
a
.
W

ils
o

n
E

n
e
e

General
A

n
d

ers a
n

d
M

r. R
o

b
er

P
a
rtn

e
r, W

ilso
n

through its o
w

n
e
r
s
,
M

r. Ja
m

e
s

A
n

d
e
r
s

vells an
d

properties in which
Vhich

e
x

e
rc

is
e
d

e
x

c
lu

s
iv

e
au

th
o

rity
o

v
e
r
th

e
o

p
e
ra

tio
n

o
f w

e
l
l
s
a
n

d
p

r
o

p
e
r
tie

s
in

M
r. R

obert S
ands

w
a
s
th

e
c
o

–
o

w
n

e
r
of M

&
M

C
o

m
p

a
n

y
.

A
s o

n
e
o

f th
.

o
w

n
e
r
s
of M

&
M

, M
r. S

andsoperated a
n

d
controlled the offerings m

ade h

M
&

M
C

om
pany

a
n

d
c

o
n

tro
lle

d
th

e
o

p
e
ra

tio
n

s
, bank

a
c
c
o

u
n

ts
, and

other

day-to-day operations o
f th

e com
panies.

F
o

r ex
am

p
le, M

r. S
an

d
s

w
a
s the

signatory o
n

m
o

s
t o

f the M
&

M
b

a
n

k
a

c
c
o

u
n

t
s
in

to
w

h
ic

h
in

v
e
sto

r m
onies

w
ere deposited as w

ell as o
n

th
e acco

u
n

ts fro
m

w
h

ic
h

d

istrib
u

tio
n

s w
ere

in
te

re
s
ts

w
e
re

o
ffe

re
d

.

m
ad

e to in
v

esto
rs.

TEM
PO

R
A

R
Y

R
E

ST
R

A
IN

IN
G

O
R

D
E

R

On Septem
ber 22, 1997,Judge

D
ick T

rain,
the Judge

o
f the U

.S.
D

istrict
C

ourt of the C
entral D

istrict of C
alifornia in

the E
astern

D
ivision, issued

a remporary restraining order (TRO) w
hereby the

a
s
s
e
ts

o
f the defendants

and principals w
e
re

frozen.
A

receiver, Jay Lane,
w

a
s
em

pow
ered and directed

to
conduct

a
n

investigation
to

locate
and a

c
c
o

u
n

t
for all o

f the assets
o

f tn
companies-afourteen-year

business.
H

e
w

a
s

to

take custody
a
n

d
co

of these assets, and take all actions necessary and appropriate
P

n
tro

l
these assets.

The TR
O

w

as based upon
a declaration of leanne

Neighbors,
a cer

publicaccountant employed
by the Securities and Exchange

Comn
SEC). She was the senioraccountant in the Pacific Regional O

ffice lo

Los Angeles,
California.

rtified
ission

n

OFFSETTING CHECKS
The defendant, W

ilson Energy, offered and sold securities
to

inves roperti

form of joint ventures and generalpartnership interests in oil ana
ompany

Mountain Petroleum, Inc. served
a: the operator, on

the
to

in
v

e
s
to

rs
in

rests

in oil and gas
erties.

ator,
o

n
behalf of

M
Com

pany

Ponzi
Schem

e
o

r Accounting Malpractice
107

uells
in N

orth
D

akota
in

which
they h

ad

a
n

interest. M
ountin’s

o
f
m

o
s
t o

i
l

p
r
i
m

a
r
y

prim
athe oil an

d
gas properties. O

ver
a period of about

tw
o

years, how

ary duties w
ere to present properties for acquisition to the defendants and

ever, M
ountain d

id

e
n

u
e
s
.
I

n
s
t
e
c
a
d

,
M

o
u

n
ta

in
m

erely
M

ountain
in

cu
rred

in
th

e
o

il a
n

d
g

as fields.
T

h
e am

o
u

n
t

o
f expenditures that

to
o

p

o o
p

eain
did n

o
t send W

ilson approximately S2,234,824 of oil and gas
o

w

offset
this moneyagainstexpenditures that

w
as in

dispute,:
M

o
u

n
t
a
i
n

i
n

c
u

r
r
e
d

s
h

o
u

l
d

h
a
v

e
r
e
c
e
i
v

e
d

.

w
ell

a
s
the a

m
o

u
n

t
that the defendants

T
hese offsets w

ere m
em

orialized by M
ountain

w
ith voided

checks
in the

(M
o

u
n

tain
)

o
n

A
ugust 14, 1997, and

M
r. C

ole clearly
told the SE

C
about

e
n

u
e

a
c
c
o

u
n

t
a
n

t
,
d

e
sc

rib
e
d

hese m

assive
offsets

in
his deposition

o
n

M
arch

c
o

r
r
e
c
t

a
m

o
u

n
t
.
T

h
e
S

E

m
o

u
n

t.
T

h
e
SE

C
s

a
c
c
o

u
n

ta
n

t knew
aho.

v
O

Id
e
d

checks
in

th
e

SEC’s
acco

u
n

tan
t knew

about
the

m
o

re
than

tw
o

m
il-

io
n

d
o

lla
r

ffse
ts to cash

receip
ts an

d
revenues before she prepared

her initial

which
resulred

in the TR
O

. She was at the deposition of Keith Cole
rep

o
rt w

h
ic

h
re

s
u

lte
d

(M
ounta

offsets of cash receipts and revenues. Larry
Luke,W

ilson
Energy’srev

huge

12,
1

9
9

7
,

a
s
did B

arbara M
clean

(M
ountain)

in her deposition
o

n
A

ugust
1

9
9

7
,
T

h
e
d

e
fe

n
d

a
n

ts

th

e
m

s
e
lv

e
s

w

e
re

e
v

e
n

fo

rc
e
d

la

te
r to

a
c
q

u
ire

th
e
se

v
o

id
ed

checks tr
o

m
th

e
S

E
C

.

n
her first

declaration
file

d
in

su
p

p
o

rt of th
e S

E
C

‘s
m

o
tio

n
for

a T
R

O

and appointm
ent o

f a
receiv

er, Jeanne N
eighbors com

pared
cash receipts

o
f

120.004.39 (w
ithout a

b
o

u
t 5

1
,2

5
3

,2
8

6
o

f offsets)
to

the cash distributions
c
I
3

3
.9

2
5

. T
h

e S
E

C
acco

u
n

tan
t then m

ade the inflam
m

atory statem
ent

th
at less th

a
n

1
0

%
o

f
in

v
e
s
to

r d
is

trib
u

tio
n

s

w

e
r
e
d

e
riv

e
d

from
oil and gas

operatic
based

o
n

d
is

trib
u

tio
n

c
h

e
c
k

sissued
during

th
e
re

le
v

a
n

t period.

In other w
ords,

th
e S

E
C

argued
th

a
t

W
ils

o
n

E
nergy

w
a
s
operating a

P
o

n
zi-

lik
e s

c
h

e
m

.

W
hereD

id The M
oney

C
om

e From
?(R

eceipts)

W
h

ere D
id th

e M
oney G

o
?
(D

isbursem
ents/E

xpenses)

B
eg

in
n

in
g

B
a
la

n
c
e

S
2

6
8

,4
3

9

M
oney D

istrib
u

ted
to

In
v

e
sto

rs
$2,281,255

M
oney

R
aised

F
rom

in
v

e
s
to

rs

6
,7

0
4

3
2

0

E
m

ployees/ P
rincipals/

O
v

e
rh

e
a
d

$
2

,3
3

2
,0

6
6

a
n

d

C
as P

roduction
394,575

O
il Field O

perations
$1,616,000

194,575
A

tto
m

e
y

‘s
F

e
e
s

1
,0

2
7

.9
8

4

O
th

er

1
5

8
.6

2
6

E
n

d
in

g
C

a
s
h

B
a
la

n
c
e

$145,978

F
rau

d
A

u
d

itin

C
a
s
e
S

t
u

d
i
e
s

in
F

o
r
e
n

s
i
c

A
c
c
o

u
n

t
i
n

g
a

n
d

108

F
o

re
n

s
ic

A
c
c
o

u
n

t
i
n

g
a

n
d

f
r
a
u

d
A

u
d

itin
g

h
e

r
e
c
e
i
v

e
r
,
Jay L

a
n

e
, h

ire
d

a
C

P
A

, J
im

:
.
.

r
e
c
e
i
v

e
r
s

N
o

v
e
m

b
e
r
6

, 1
9

9
7

c
a
s
h

r
e
c
e
ip

t

a
p

p
e
a
r
e
d

a
s
f
o

l
l
o

w
s
:

hired
a C

P
A

, Jim
F

in
n

,
from

San

9
7

“cash re
c
e
ip

t s
t
a
t
e
m

e
n

t
”
prepared by M

Diego.” The

Mr. Finn
T

he

during
1

9
9

6
a

n
d

1
9

9
7

, d
e
f
e
n

d
a
n

t
s
u

se
d

nificant portions o

f in
v

e
e
n

tha

distributions to investors o
f $

8
1

9
,7

4
0

in
ex

cess
o

f th
e
p

ro
fits

actu
allv

.

the defendants apparently failed
to pay th

e up
-fro

n
t expenses related to

.n
e

C
A

S
H

R

E
C

E
I
P

T
S

S

T
A

T
E

M
E

N
T

rt th
e
conclusion

r
o

m
ake distributions o

n
p

rio
r unrelated i

n
v

e
s
t
m

e
n

t
s
ra

th
e
r th

an

C
S

tor

1996, the def vestor mone
T

h
e
R

e
c
e
iv

e
r
stared

th
a
t th

e
fin

d
in

g
s o

f
th

e
C

P
A

S

the purpose
nts made

described in the offering
m

em
o

ran
d

a. F
o

r
e

x
a
m

p
le

,
in

1
9

9
6

r

the derive

p

to
Jay Lane,

from
the oil and gas operations. l

o
m

ake m
a
tte

r
s

w
o

rs
e
,

a
c
c
o

rd
in

e
.

cess of $430,000. T
hus, even the funds ch

aracterized
by d

e
fe

n
d

n
e
well

incom
e

w
ere illusory.

R
eceiver L

ane argued that by m
aking d

istrib
u

tio
n

s to
investors, the

pres
sion w

a
s created that m

any w
ells w

e
re

profitable w
hen

a
s
a resu

lt
o

f the expens

fendants as “net

for reworking and maintaining the w
ells, th

ere w
e
r
e
n

o
profits.

M
oreover,

ac.
cording

to
the offering m

em
oranda, th

e expenses fo
r rew

orking the w
ells and

the purchase
of m

ineral rights
w

e
re

to

be paid
o

u
t o

f th
e initial

investm
ent,

n
o

t from
incom

e
from

operations. Thus,
by im

plication, th
e defendants

w
ere

operating a Ponzi schem
e.There

w
e
re

about33
n

e
w

investors o
v

e
r th

e two-year
tim

e period.

UDGE’S ESCAPADES
In

a hearingon November21, 1997,and November
25, 1997, aat

defendants to have the receiverremoved,JudgeTrain
stated

thatu

the worst
set of books

vem
ber

25, 1997,
a
t th

e request
of

te
d

th
a
t th

is w
a
s one of

ng the judgestressedthar b Ver seen kept by a
n

accountant.”
[During

and he knew accounting.) However,he seemed obsessed
a

cash flow from investors w
as commingled into one singe

b

ne had previously w
orked for A

rthur Andet
n

ta
n

t.”
[D

u
rin

r
s
e
n

,

ssed
about the fact

th
e

o
r

counting
M

alpractic
109

Q
U

E
S

T
IO

O

N
S

A
N

D
R

E
Q

U
IR

E
M

E
N

T
S

a
r

a
r
e
so

m
e characteristics

o
f

a
Ponzi schem

e? W
hy

is
it called

a
1.

P
o

n
z
i

s
c
h

e
m

e
?

h
i
s
situation

a P
onzischeme?

U
se th

e Internet
to

learn
m

o
re

about
otherPonzischem

es.
Is this like B

ernie M
adoff’s schem

e?

W
as there

any im
properprofessional conduct

involved
in this

c
a
se

study?
R

ead S
E

C
R

u
l. 102(e)(1).

3

If v
o

u
w

e
re

th
e
expert w

itn
e
sS

fo
r

th
e
defendant, w

hat w
ould be y

o
u

r
a
rg

u
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5.