You Can't Cheat an Honest Man - James Walsh [41]
In the end, only Donahue knows the path the money took. He kept no financial books, all of the accounts were commingled and only he saw the records of investment transactions.
Donahue pleaded guilty to securities fraud in August 1991, almost exactly a year after his investment scheme collapsed.
In January 1992, Donahue was sentenced to five years in prison. At his sentencing, federal prosecutors called Donahue’s scam the single largest securities fraud in U.S. history.
During questioning, Judge Jim Carrigan asked Donahue whether he’d committed the fraud. Donahue answered that he’d “technically” broken the law. But Carrigan pressed him, saying, “I’m not interested in technicalities. If you’re not guilty, this court will not accept your guilty plea.” Donahue muttered his confession.
In June 1992, as part of a civil settlement with the SEC, Donahue consented to a permanent ban from the securities business. The SEC had sought to seize nearly $1.5 million from Donahue—but the fine was waived because Donahue didn’t have the funds to pay it. Many investors complained that Donahue wasn’t cooperating sufficiently with the bankruptcy proceedings. His lawyer, Denver criminal defense specialist Robert Dill, sounded coy in response: “He’s attempting to cooperate in the case. He hasn’t given them specific information because they haven’t requested it.”
Frustrated, the burned investors realized they weren’t going to get much money from Donahue or the remaining pieces of Hedged Investments. So, they looked for deeper pockets.
In November 1994, Kidder Peabody & Co. and Morgan Stanley & Co. agreed to pay more than $40 million to Hedged Investments investors. The agreement topped a $5 million settlement recently made with Prudential Securities.
“It was a very fair settlement under the circumstances,” said Bob Hill, an attorney for the investors. Hill said that proving Kidder and Morgan committed wrongdoing would have been difficult because the two firms did not actively defraud investors. Instead, they permitted Donahue to trade recklessly. “Our view was, if they had followed their internal policies, they would have realized what was happening,” Hill said.
“The problem with Donahue was that on every measure of a money manager, he pushed the limits of credibility,” said another fund management analyst. “We have a number of tests that a manager should pass. In the case of Donahue, he didn’t pass any. He had none of his own money [invested]. He was still accepting an unbelievably low minimum of $100,000. And, he had no industry references. But the clincher was lack of an audit or any credible third-party verification that assets existed and the record was real.”
Again, the problem was one of suspicious consistency. All investment markets—and especially the options and commodities markets—are volatile. Good investment managers try to diversify their holdings and hedge this volatility—but not even the best ones can smooth out every spike.
CHAPTER 7
Chapter 7: Precious Metals, Currency and Commodities
While vaguely defined “investments” and elaborate loan programs will probably always be the favored pretenses for Ponzi schemes, commodities programs usually run a close second. These financial mechanisms—which, for the sake of our investigation, include currency investments, precious metals deals and true commodity goods—are complicated and volatile things from the start. They offer a Ponzi perp plenty of cover in which to hide.
Even when they are traded legitimately, precious metals, currency and commodities can sound like schemes. They trade in markets which rise and fall dramatically—often in short bursts of activity. Trading them successfully requires steel nerves and good timing. Many transactions are heavily margined, which means an account with a few thousand dollars can make—or lose—tens of thousands of dollars in a few hours.
This trading is usually regulated by a federal