The Tom Petters fraud case

Sept. 30: Rich returns giving way to panic and fear

A nonprofit and a charity that invested in Tom Petters' unconventional investment plan are worried they will lose millions now that the CEO is the subject of a fraud probe.

Tom Petters

It was an unconventional investment proposal that, for a while, paid rich returns to those willing to believe in the success story that was Tom Petters.

One small Twin Cities nonprofit says it earned as much as 24 percent on 90-day loans that Petters Co. Inc. said were used to buy and resell electronics goods.

Then last week, federal authorities raided Petters' company, his home and several other locations. In court documents, the government describes a scheme that may have bilked investors out of as much as $2 billion. On Tuesday, the government charged one of the people identified as a participant in the scheme.

Two of the investors named in court papers, the Fidelis Foundation and Minnesota Teen Challenge, say they first noticed signs of trouble late last year, when Petters Co. asked to extend their loans to as long as six months. Now they are worried that they may not get any of their money back, a potentially devastating blow for the organizations.

Fidelis Foundation of Minneapolis holds $27.6 million in Petters Co. notes that may ultimately be worthless. Among them are five notes for $5.7 million to Teen Challenge, a nonprofit program that Petters personally supported.

"We are overwhelmed, shocked and saddened," said Joe Smith, president of Fidelis.

Fidelis is a public charity that also serves as an investment agent for other public charities and nonprofits, including Teen Challenge.

Richard Scherber, executive director of Teen Challenge, said its board of directors has scheduled an emergency meeting for Thursday to deal with fallout.

"It's hit us in the jugular," Scherber said.

Teen Challenge is a faith-based organization that annually serves about 400 teens and adults with hardcore addictions. "This thing is saving lives," Scherber said, and the potential loss of millions of dollars poses a serious threat to the program. "You can imagine financially how this has impacted us," he said.

After a prayer meeting Tuesday morning with 75 to 100 staff members, Scherber said he spent much of the day talking to other charities that also invested with Petters Co.

"Everybody's in the same boat," Scherber said. "People are panicking. People are scared."

Evolving investments

When Smith joined Fidelis as its president in 2003, he said the organization held one note from Petters worth about $4 million.

In the beginning, the notes provided double-digit returns, Smith said. Other ministries saw those returns and wanted to invest through Fidelis. Smith said the potential loss of funds it invested with Petters represents the lifeblood of those organizations.

"That's a lot of ministry money. That's a lot of dollars that goes to help people," Smith said.

He said Fidelis has hired an attorney "to try and protect our interests" and the interests of others who invested in the Petters funds through Fidelis.

At Teen Challenge, officials have been reassuring some contributors that their money didn't go to Petters Co. The money that Teen Challenge invested in Petters came from a single contributor, according to Ron Goodman, the nonprofit's finance director.

"It was money a donor gave who wanted it to go into ... Petters," Scherber said. That contributor -- whom he declined to identify -- knew Petters and had suggested the investment in 2002 as a way of building a reserve fund, he said. But Scherber stressed Teen Challenge's board, not the contributor, made the investment decision.

Frank Vennes Jr. was a member of the Teen Challenge board at the time and served on the finance committee that first reviewed the investment proposal, Scherber said. Authorities raided Vennes' home and business last week as part of the Petters investigation.

Scherber said Vennes never pushed the board to make the investment. The organization's board at the time included a banker, a former banker and a certified public accountant (CPA), and the entire board researched the proposal thoroughly, he said. The board had a major Twin Cities auditing firm review the investment proposal and it got an opinion from a major law firm.

"The letter from the legal firm, it advised caution," Goodman said. "And it gave some suggestions about what we should do in exercising our due diligence." But the law firm found no reason to balk at the investment or to suggest a breach of fiduciary duty, he said.

Suspicions emerge

The donor ultimately contributed $3.225 million toward the Petters investment, Goodman said. He said it paid returns of 24 percent on 90-day notes in 2002, then dropped 2 percent each year until it stabilized about four years ago at 18 percent.

"It was paying regularly until probably about a year ago and then it started paying a little slower -- but still paying," Goodman said.

Petters Co. sought authorization to extend payments to 180 days, if necessary, but promised the same interest accrual, Goodman said. "Toward the end it was getting longer and longer," he added.

All told, Goodman said, Teen Challenge collected about $4.3 million in interest payments from the Petters investment through about June of this year. It rolled over about $2.1 million in interest and withdrew $1.2 million to buy some property for an expansion.

Goodman said Teen Challenge believes it's still owed almost $5.8 million in principal and interest. He said the original investor seemed shocked by the accusations against Petters.

Other investors with Petters Co. said they grew skeptical early this year when the payback period stretched to 180 days, even though the alleged purchases of new merchandise for delivery to the likes of Costco and BJ's Wholesale Club continued at the same pace.

If retail sales were slowing down, they reasoned, why were retailers still building inventory?

Private investment firms told the Star Tribune that they conducted what they thought was serious due diligence of Petters Co. One hired a private investigative firm to look into the merchandise trades, and Petters came back clean. But investment managers, who spoke on the condition that they not be publicly identified, said they were never allowed to compare purchase orders to actual manufacturer numbers on the merchandise.

Goodman said Teen Challenge faced the same obstacles.

"We were handicapped because we weren't able to go in and audit Petters' inventory. And even people who did [try], I think ... were just shown a warehouse of inventory, you know, and told, 'This is it.' Well, you're kind of, kind of stuck there if you can't really verify it."

dbrowning@startribune.com • 612-673-4493 dphelps@startribune.com • 612-673-7269

  • about this series

  • The Star Tribune's coverage of the federal fraud case against entrepreneur Tom Petters and the struggles of Petters-owned Sun Country Airlines.

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