You Can't Cheat an Honest Man - James Walsh [72]
The tax court ruled that Phyllis had reason to know that Jerome was underreporting the money he made on his real estate investments. She would be responsible for her share of that income—about $42,000. However, it ruled that she did not have reason to know that he was running a Ponzi scheme. So, she was not responsible for any part of that income—over $1 million.
It concluded with a useful observation about one spouse’s duty to investigate another:
We are cognizant of the marital relationship here and considered whether it would have been reasonable for Phyllis to check with [the IRS] as to whether Jerome had in fact filed [accurately]. Marital relationships are usually based upon mutual trust and such unprecipitated inquiries would not foster a trusting relationship.
Case Study: Bennett Funding Group
Bennett Funding Group (BFG) was born in 1977, when Edmund “Bud” Bennett started leasing office equipment out of a former gas station in upstate New York. He was the CEO and his wife, Kathleen, was the president. Their children, who were in high school and college, helped out.
BFG quickly dominated the business of originating, purchasing and selling commercial leases of copy machines and other office equipment in its part of the country. For several years during the 1980s, Inc. magazine listed BFG as one of America’s fastest growing firms.
The Bennetts were financially savvy. They organized groups of leases into portfolios, which they pledged as collateral for bank loans. Cash flow from the portfolios would easily cover principal and interest payments on the loans.
Because BFG made its payments in a timely manner, the banks were always willing to loan more money. Usually, a bank would draft a standard loan agreement and then take a file of documents as collateral. The documents included:
• a bill of sale;
• an assignment of contract from BFG of all of its interest in the equipment leases;
• a promissory note from BFG ; and
• copies of the original leases, including a description of the leased equipment, as well as the identification of the lessee and a schedule of payments to be made by the lessee.
Bankers were usually satisfied with this paper trail. As the business grew, though, the bankers started to demand more reporting and better performance standards. Most of the banks believed that the equipment-leasing business was so service-intensive that no company could expand beyond a regional base.
So, BFG looked beyond traditional bank financing. Modifying its package slightly, the company started offering the portfolios to individual investors. They were even more eager than the banks to get involved.
BFG would organize a portfolio of 30 photocopy machines leased to a city or federal agency. An investor would then buy a short-term note backed by the income BFG expected to receive on the leases. BFG would offer an interest rate of between 7 percent and 10 percent, depending on the portfolio’s size and risk factors. It would make monthly or quarterly distribution payments covering some combination of interest and principal.
Investors were invited to reinvest the distribution payments in new notes. Many did. “Retirees loved it,” said one Washington, D.C., stockbroker who sold BFG lease securities. “It was so in demand, there was a waiting list.... They would just keep buying and buying and buying.”
Bud Bennett’s son Patrick took over day-to-day management of BFG in the early 1990s. The father and son weren’t much alike. Bud had few pretenses, preferring to be low-key and cagey; Patrick was slick and aggressive. Bud seemed to have the hard-earned pride of a man who’d built a company from scratch. Patrick seemed to have contempt for BFG’s humble origins.
While his title was Chief Financial Officer, Patrick was clearly running the company. He talked about bringing in more professional management to raise BFG’s profile. What he actually accomplished