WexTrust's (Alleged) Fraud - What Are the Lessons For Investors?

As sophisticated as today's financial gurus claim to be, the old-fashion Ponzi scheme is still alive and well. Indeed, the SEC filed a major case against WexTrust Capital (a Chicago-based private equity firm), its partners and various investment affiliates, that allegedly ripped off an estimated 1,200 investors, mainly from the Jewish Orthodox community. In response, Zamansky & Associates has launched its own investigation in order to return funds back to investors.

It is estimated that WexTrust Capital, and one of its main partners, Joseph Shereshevsky, may have defrauded their investors by as much as $100 million, which the SEC alleges was diverted to cover personal expenses, among other expenditures. According to the SEC's complaint,

"Defendants have been fraudulently raising money in the various offerings, each of which purportedly is for a particular investment, without disclosing that funds raised were actually being used to pay prior investors in unrelated offerings and to make unauthorized payments to fund the operations of the Wextrust Entities, which were operating at a deficit. An internal Wextrust combined "balance sheet" shows that as of December 31, 2007, Wextrust Entities "borrowed" at least $74 million from the LLC entities and also "lent" at least $54 million to various LLC Entities. The Defendants are raising money and commingling funds in contravention of specific representations in private placement memoranda that investor funds will be used for specific investments in real estate or other assets identified in offering memoranda."

All together, the SEC alleges that WexTrust Capital conducted at least 60 private placement offerings and created approximately 150 entities in the form of limited liability companies or similar vehicles. Throughout the process, the SEC alleges, WexTrust Capital partners didn't disclose material information, never purchased properties it promised to investors and paid themselves profitably. WexTrust Capital allegedly committed a litany of violations of U.S. Securities laws.

Indeed, this is the classic Ponzi scheme strategy and eerily similar to Zamanky & Associates' pending case in Long Island court involving Peter Dawson, a now jailed investment advisor who ripped off dozens of retirees. Among the similarities between the Dawson case and that of WexTrust Capital are:

• Both situations are examples of affinity schemes: WexTrust Capital targeted members of the Jewish Orthodox community and specifically, those that attended the B'nai Israel Congregation. Mr. Shereshevsky was close with the Rabbi who vouched for him regularly, according to the Wall Street Journal. By the same token, Peter Dawson targeted members of the East Meadow Methodist Church, and had close ties with its Pastor.

• Investor borrowed against his home: According to the Journal, at least one investor, and potentially others, borrowed against his house in order to invest in WexTrust Capital.

• Managers of WexTrust Capital and its affiliates enjoyed lavish lifestyles, as did Mr. Dawson, by allegedly fraudulent means.

And basically both Mr. Dawson and Mr. Shereschevsky and WexCapital, commingled funds, which is a fancy way of robbing "Peter to pay Paul." For example, in the SEC's report under "The Block III Offering Fraud," WexTrust Capital did the following:

Block III Mines & Minerals, LLC ("Block III") is a Virginia limited liability company organized to make a loan to and acquire an interest in a Namibian company, Deva Investments (Pty), Ltd., which owns the exploration and mining rights in a group of diamond mines in Namibia known as Block III.

Block III Managers, LLC, a Virginia limited liability company, is the manager of Block III. Block III Managers is wholly-owned by Brandon Investments, and that Brandon Investments is a wholly-owned subsidiary of Wextrust.

Defendants Byers and Shereshevsky, together with Defendant Wextrust and Brandon Investments, controlled the issuer, Block III.

Block III issued a private placement memorandum dated March 22, 2007 (the "Block III PPM") seeking to raise $11 million from investors. The Block III PPM represents that the proceeds of the offering will be used as follows: (a) $4.5 million would be used for new equipment and operating capital, (b) $1.5 million would be used to fund a reserve for a purchase option on two other mines, (c) $1.75 million would fund an operating reserve, $300,000 would pay legal and operating expenses, and (d) approximately $2.95 million would be paid in fees to Wextrust and Wextrust Securities. Moreover, the operating agreement attached to the Block III PPM specifically limited the use of funds to expenses related to Block III.

These representations were false. Moreover, the Defendants knew, or were reckless in not knowing, the representations were false. Almost immediately after the money was raised, Defendants diverted the proceeds to unauthorized uses.

The Wextrust balance sheet shows that $3,990,910 of proceeds raised by Block III Mines & Minerals LLC was diverted to Wextrust Entities.

Defendants Wextrust Securities acted as a placement agent in the Block III offering.

The Block III PPM describes Shereshevsky as a "principal and integral part of Wextrust", and states that Shereshevsky was "instrumental in the founding of Wextrust Securities". The Block III PPM fails to disclose Shereshevsky's prior felony conviction. Defendants Byers and Shereshevsky knew, or were reckless in not knowing, of Shereshevsky's conviction.

Defendant Shereshevsky and his wife received transaction based compensation of $249,577, or approximately two percent of the funds raised by Wextrust Securities, in connection with the Block III offering. The Shereshevskys also received $750,000 in bonuses in connection with the Block III offering.

WexTrust Capital's Troubles

Its likely WexTrust Capital will attempt to defend itself by saying that investments simply went south and it's "buyer beware." But the SEC's evidence points otherwise. For example, Mr. Shereshevky emailed a business partner which showed they both were aware that their activities were fraudulent:

"Please remember one thing. That although I always take care of you and myself, my goal in this thing as I have always told you from day one, is to get [W]exTrust out of all the s---- before the end of 09 or 10 at the latest. that is my primary concern. We have faced it until we made it for long enough and now we must clean it up."

Mr. Dawson pleaded guilty and is serving a sentence of five to 15 years; a sentence provided to him only after helping investor recover their money. At least at this point, the SEC has only filed civil charges. Shereshevsky and his Chicago partner affiliated with WexTrust Capital were arrested earlier this week and face criminal charges. The WexTrust Capital partners could be looking at much longer sentences if they choose to fight the charges.

WexTrust Capital Investors: What's Next?

Naturally, the investors in WexTrust Capital are asking simply, "where's my money now and how do I get it back?" In the Peter Dawson case, most of the funds were squandered. It's unclear at this point whether any of WexTrust Capital assets are retrievable, but in all likelihood even the assets that are liquid won't amount to a full recovery for the allegedly defrauded investors.

The key in recovering money is to ferret out solvent firms that potentially aided and abetted the fraud, or at least were in the position to stop it. In the Dawson case, we are suing banks, mortgage brokers, mortgage lenders and other firms, which Mr. Dawson himself alleges were participants. This takes an extensive amount of research and investigation, but if you follow the money in all likelihood there are places that can be found were recoverable money exists.

Investors in the WexTrust Capital scheme are likely feeling a whole host of emotions. It's important to have hope, be patient, and communicate regularly with an attorney.

WexTrust Capital and Peter Dawson: What are the lessons for investors?

And then there is the age old adage: if something is too good to be true, it probably is. Perhaps the over arching lesson in these two cases is due diligence. According to the SEC's complain, Mr. Shereshevsky had a prior history of investment-related fraud:

"In March of 1993, Shereshevsky was arrested for bank fraud, among other things. In June 2003, Shereshevsky pleaded guilty in the Southern District of New York to one felony count of bank fraud. He was sentenced to time served, 24 months supervised release and ordered to pay restitution in the amount of $38,797.90, which judgment was satisfied on February 15, 2005.

Even if the investment advisor is a member in good standing at investor-affiliated organizations, such as a church, synagogue or rotary club, a full due diligence investigation should be conducted.

Comments

[irondoor91:]

You may be familiar with the similar case of the Maricopa Investment Fund(s) located in Naples, Florida in the late 1990's. The perpetrator of the Maricopa scheme, one David Mobley, said that he had a computerized program to trade the stock index futures market. He had been in "business" since the mid-1990's and had taken in more than $100 million from investors. His reported performance, which he sent to investors monthly, did not ever show a losing month. So that investors would be somewhat reluctant to withdraw money, Mobley told them that they did not directly own the investments, but owned shares of an offshore company that did not pay US taxes. As long as they held their investment, they owed no tax. However, if they did need a withdrawal in an emergency, money could be sent.

When questioned about an audited financial statement, Mobley declared that since his "system" was a secret, he would not allow any accounting firm to audit it, nor would he show brokerage statements. He claimed that if anyone saw his trading pattern, they could "reverse engineer" his system and steal his secret methods.

He had lavish offices in Naples where he had prominently displayed photos of himself with former Presidents, local politicians, ministers, etc. He was a large contributor to charities. Of course, he was also a golf course real estate developer too. Most of the local wealthy had invested with him.

His son and son-in-law (in their 20's) operated a large trading room with dozens of computer screens showing various graphs and positions. Visitors and prospective investors were invited to view the action. When asked what was being traded, the answer was that "Dad is trading from his home so that he won't be distracted". No actual trading was taking place at the office.

His brother, son, son-in-law, daughter, wife and ex-wife were all involved in the operation. His wife was CFO. When later asked where they got the information to compile monthly investor reports, they replied that Dave got the data from an administrator in the Cayman Islands and they got it from Dave. The back office people in Naples never actually saw the trades and account data. These people were all dependent on Mobley for their livelyhood.

Due diligence would have shown that Dave Mobley had been charged with fraud in Kentucky years before. Rather than having a successful track record, he had left Kentucky after bankruptcy. His previous work experience had been on an automobile assembly line.

Investors have recovered approximately 50% of their capital. The lesson learned is that due diligence is required, along with audited financial statements and the understanding that no matter how much you dig or audit, a really good psychopathic criminal is probably going to screw you anyway. They see other people as just pawns to be used to fill their empty lives, and somehow they deserve it.

Some common themes in these frauds:

. Affinity goups (wealthy, connected, charitably inclined, greedy).
. Some sort of "secret" or proprietary program.
. No audit by reputable accounting or law firms.
. Simple statements showing only the "value" of your investment.
. Non-professional family members involved in the operation.
. Some type of tax dodge or angle.
. Unusual reluctance to discuss the specific details of their investment strategy or results.

2008 Aug 18 11:04 AM

[irondoor91:]

One more comment on the above case. Dave Mobley was convicted of securities fraud, wire fraud, etc. He is serving a 17 year sentence in the federal system.

Several investors had put their entire life savings in the funds. Small recoveries have been slow. Any investors who received money from the Ponzi scheme have been labled as "profiteers" and have had to return the money received. Imagine that is not easily done, since several of them used the proceeds of their "winnings" to build homes, take vacations, pay bills, etc. Some of them have died and the receiver has sued their estates.

2008 Aug 18 11:12 AM

[advisor prof:]

It is really the advisors who placed investor money in Wextrust on behalf of clients who are guilty. Many of these advisors recieved 5% or more upfront sales commission on bringing in investors to a convicted fraudster, without doing due diligence

2008 Aug 18 02:09 PM

[HashemHates...:]

The best current coverage of this situation is with the Virginia-Pilot (local Norfolk, VA paper).

May Hashem forever bless FINRA, the SEC, and the DOJ.

2008 Aug 18 11:17 PM

[User 428073:]

Just so I get this straight:

4.5m - legitimate investment, Block III
1.5m - reserves, held by WexTrust
1.75m - operating reserves, held by WexTrust
0.3m - legal fees, managed by WexTrust
2.95m - commissions & fees to WexTrust

11m total goal - 4.8m to direct placement and legal, and 6.2m held by WexTrust, for fees and expenses, of which 3.99m was actually accounted for as being held by the company.

I don't know if the other 2.11 was already paid for legitimate expenses, was never raised or was mishandled. But there's a lot of explainable accounting being called fraud in this case.

Jun 09 12:03 AM