You Can't Cheat an Honest Man - James Walsh [32]
Federal courts have relied on a number of factors—the legal term is indicia—to determine that tax fraud exists in an investment scheme. Although no single factor is necessarily sufficient to establish fraud, the existence of several can be persuasive. These factors include:
• understatement of income,
• maintenance of inadequate records,
• failure to file tax returns,
• implausible or inconsistent explanations of behavior,
• concealment of assets, and
• failure to cooperate with tax authorities.
As you can see, all of these factors can apply to a pyramid or Ponzi scheme at the same time. As a result, the IRS will often have identified a Ponzi scheme as suspicious before it collapses.
Unfortunately, the Feds have a hard time moving on a scheme before it crashes. This is partly because federal regulators have so much ground to cover that they move slowly on any one case; but it’s also partly because Ponzi schemes tend to collapse quickly—often in less than two years.
To help the regulators—and, in turn, investors—some federal courts have added other warning flags to identify illegal schemes. The U.S. Ninth Circuit Court of Appeals (which includes Ponzi-heavy states like California and Nevada) has been active in this regard. Indicia that it has offered include:
• a history of illegal activity on the part of principals,
• a preference for cash transactions of less than $10,000,
• failure to make estimated tax payments, and
• offering any “guarantee” of tax-advantaged status.
Case Study: Home-Stake Mining
Despite the IRS’ efforts to identify the characteristics of an illegal tax scheme, tax-advantage Ponzi schemes have continued to flourish.
In late December 1996, a federal judge in Tulsa, Oklahoma, approved a settlement in a case that had started in 1973. It involved one of the biggest and most protracted tax shelter Ponzi schemes in American history.
During the early 1950s, Robert Trippet organized Home-Stake Energy Co. to develop oil and gas properties. He raised money for socalled “wildcat” exploration by selling percentage interests or units of participation to investors through private placements.
Home-Stake organized separate annual programs, units which were registered with the SEC and sold to the public. Each of the programs was supposed to develop a particular oil and gas property or properties in the Midwest, California or Venezuela.
Home-Stake’s salespeople pushed the things hard. They told prospective investors that they would reap big profits from proven oil reserves and that the tax deductions for intangible drilling costs and oil depletion allowances were advantageous. An investor could shelter as much as $700,000 of $1 million in income in one of Home-Stake’s yearly programs.
The Home-Stake salespeople also tailored each pitch to each investor or prospect. Often, the salesperson would find out the details of an investor’s tax situation and then offer participation in a Home-Stake program as a perfect solution.
This customized tax planning was of dubious legality but had an outstanding effect on sales.
Home-Stake investors included the rich and the famous, such as entertainers Bob Dylan, Liza Minnelli, Barbra Streisand, and Walter Matthau. Also involved were some captains of industry, such as the entire board of General Electric Co.
Home-Stake salespeople closed their deals with written sales materials, which included unregistered “black books.” For all practical purposes, a black book served the same sales function as a prospectus. It provided a general description of the program, explained the nature of participating interests, and contained engineering reports for the properties, descriptions of the various tax advantages, and projections of substantial profits.
At first, Home-Stake’s operation seemed successful. Its quarterly progress reports indicated that substantial oil was being produced and early investors