If Tom Petters and his cronies ran one of the largest Ponzi schemes in U.S. history, as alleged, how did they pull off the caper under the noses of lawyers, accountants, auditors, heavily regulated banks and supposedly sophisticated hedge fund managers?
Among the red flags that went unseen or unheeded: fake inventory statements, dummied invoices, millions of dollars wired to an office next to an Excelsior car wash, suspicious bank account activity and Petters himself, a flamboyant executive trailing decades of lawsuits over bad debts.
But apparently authorities suspected nothing until a Petters executive, Deanna Coleman, approached federal investigators in September to accuse her longtime boss of fraud and to cut herself a deal.
Petters, a prominent Twin Cities executive whose holdings include Sun Country Air Lines and Polaroid, denies the allegations and is in jail awaiting trial. Four others have already pleaded guilty to a variety of fraud charges.
The public may never get a full accounting of why the people who should have been in a position to raise questions about Petters' operations didn't. Nearly everyone involved has hired a lawyer and declined to comment.
Petters Company Inc., the investment arm central to the alleged fraud, was run by a small group operating separately from the Petters Group Worldwide holding company. But they shared the same building in Minnetonka, and Tom Petters was their sole director. Both companies were placed into a receivership last month after a federal judge found probable cause to believe that more than $3 billion had been bilked from investors.
The Petters companies wouldn't say whether Petters Company Inc. had its own legal team. The company magazine did not list one when it published an article about its in-house lawyers in 2006. David Baer, 35, headed Petters Group Worldwide's legal team. He joined Petters in 2003 after four years at the Minneapolis firm Leonard Street and Deinard. Minnesota Lawyer magazine named him one of the top 15 lawyers in the state in 2006. Another former Leonard Street lawyer, 38-year-old Michael Phelps, joined Petters in 2004, just six years out of law school.
Public court documents don't implicate either Baer or Phelps, and both men left the company after Petters was charged last month with crimes that could result in a lifetime prison sentence.
Citing rules of attorney-client confidentiality, Baer and Phelps declined to discuss their roles as in-house counsel for Petters.
In an e-mail, Phelps said he "had no knowledge or involvement in the alleged fraud." He has been retained by Doug Kelley, the court-appointed receiver now in charge of most of Petters' companies, to help the businesses restructure in bankruptcy.
Some outsiders question whether Baer and Phelps had the experience required for their jobs.
"My idea of a general counsel is a wizened old attorney who has been around and practiced law and then decides to become general counsel to protect businesses from doing what they shouldn't be doing," said Ron Rosenbaum, a St. Paul attorney and talk radio host whose program frequently features legal issues.
Being in-house counsel for a private company differs from the job at a publicly traded company that ultimately is responsible to a board of directors and shareholders.
"When you're in-house counsel, you represent the board, not the CEO. But that's difficult when it's one and the same person," said Joseph Daly, a professor at Hamline University School of Law. "Are you an advocate for the company or just a counselor?" For Daly, the answer is clear: "Corporate counsels really should act like gatekeepers."
A lawsuit filed last month by Interlachen Harriet Investments of Minneapolis, which invested $60 million through Petters, raises questions about both Baer and Phelps, as well as James Wehmhoff, Petters' head accountant. Interlachen contends that the terms of its $60 million investment with Petters Company Inc. were negotiated with Petters' legal team. Some of those same people and Wehmhoff were at an August meeting in which Interlachen said it was shown fictional invoices.
Wehmhoff is a certified public accountant who served as executive vice president for finance, tax and treasury issues at Petters Group Worldwide. The 67-year-old Plymouth resident joined Petters in 2005 out of retirement after a long career that included co-founding the Blanski Peter Kronlage & Zoch accounting firm in Golden Valley, which had done tax work and some auditing for Petters until 2004. An employee at the firm said its work for Petters was done properly.
Wehmhoff's attorney said he declined to comment. A company spokeswoman said Wehmhoff oversaw taxes at the Petters Group and accounting at several small subsidiaries. She said the investigation prevented her from saying anything about the operations of Petters Company Inc., specifically.
What is known is that key Petters companies appear to have been operating without the most basic of business documents -- the certified financial statement, or annual outside audit. A certified financial statement is prepared by an outside public accounting firm. It's considered a basic stamp of credibility. Privately owned businesses aren't required to have them, but financial professionals insist that no prudent investor or lender would do business with a company lacking them.
Kelley, who recently hired Price Waterhouse Coopers for a forensic accounting of Petters' books, said he has found no evidence that any audited financials exist for most of Petters' companies.
"I find it quite amazing that people didn't demand them before lending large amounts of money to the Petters companies," Kelley said.
The professional rules of conduct governing both in-house accountants and lawyers don't require them to go outside the company to report illegal activity if they see it. The rules simply require them to report wrongdoing up the internal chain of command. Nonetheless, Neil Hamilton, who teaches legal ethics at the University of St. Thomas law school, said accountants and lawyers have a fiduciary duty to the public.
"The story of Enron -- and possibly again with the whole financial disaster -- is that the public is expecting the gatekeeper professions to be substantially more proactive in protecting the public," Hamilton said.
No red flags
Lawyers and accountants aren't the only people facing oversight questions in the Petters case.
Carolyn Anderson, a Minneapolis attorney with Zimmerman Reed who has filed a federal racketeering lawsuit on behalf of more than 100 pastors and nonprofits that sank more than $20 million into Petters' companies, said she doesn't understand how bankers could have overlooked the large wire transfers that passed quickly through some accounts on their way to Petters for so many years.
"Those are the checks and balances that the smaller investor assumed were going to be there," Anderson said.
Financial institutions are required to help law enforcement spot and prevent money laundering, primarily by filing reports into a database maintained by the Financial Crimes Enforcement Network, or FinCEN, an arm of the U.S. Treasury. FinCEN records show that banks have triggered numerous successful investigations of Ponzi schemes.
But the system isn't perfect. Lenders are given broad discretion to determine what constitutes "suspicious" activity for wire transfers. Suspicious activity reports are secret, so it's nearly impossible to know whether anyone flagged the Petters transactions.
Tom Petters was among Edina-based Crown Bank's early customers after it opened in 2000, said Kevin Howk, the bank's president. Petters Co. Inc. also banked there. Howk said the bank had no reason to generate any suspicious activity reports for the Petters accounts. "There weren't any red flags," he said.
Court records indicate that two banks, one in the Twin Cities and one in Los Angeles, apparently did raise questions about some accounts that were used by Petters' business associates, allegedly to divert investment funds to Petters. But neither bank would discuss the accounts or say whether they raised suspicions.
Jennifer Bjorhus • 612-673-4683 David Phelps • 612-673-7269