Part 1: The collapse of the Petters empire

I t was a typical Tom Petters affair. Flamenco dancers swirled around the room. Actors dressed as matadors posed with Minnesota's rich and famous. Saturday Night Live alum Kevin Nealon told jokes, and NFL great Michael Strahan flew into town for the Aug. 9 party, a Petters fundraiser for his late son's foundation that cost almost $400,000.

A beaming Petters shmoozed and draped his arm around anyone who passed by. Corporate big hitters. Celebrities. Politicians.

A month later, one of Petters' closest associates betrayed him to federal authorities, accusing him of running a multibillion-dollar Ponzi scheme.

Petters, a high-profile Twin Cities entrepreneur whose holdings include Sun Country Airlines and Polaroid, was led from his Lake Minnetonka mansion to the Sherburne County jail. He faces federal charges of fraud, money laundering and obstruction of justice. Though Petters maintains he is innocent, four associates already have pleaded guilty for their roles in what may rank as one of the biggest investment fraud schemes in history.

Petters' stunning reversal of fortune has everyone who believed in him, from religious charities to international hedge fund managers, scrambling to assess the damage and wondering how they could have been fooled for so long. Joel Alsaker, Petters' boss in the 1970s when he was selling stereo equipment in St. Cloud, has one answer.

"He was so talented -- you can't overstate that fact," Alsaker said. "He could talk your wallet right out of your pocket."

Alsaker said he believed in Petters so much that, in 1989, he lent him $7,900. Petters had promised to repay the money in 19 days, but according to court documents gave multiple excuses for missing the payment, eventually claiming that he had filed for bankruptcy. When Alsaker discovered that the bankruptcy claim was a hoax, he reopened the case.

Court documents show that, before the next hearing, Petters called the court office and claimed the case was settled and should be removed from the court calendar. The ruse didn't work, though, so when Petters failed to show up in court, a judge found him in default.

Alsaker finally collected his money, but only after threatening to repossess Petters' car.

The shopkeeper's son

The Tom Petters who hobnobbed with the elite, drove a Bentley and reportedly dropped $10 million in gambling losses in Las Vegas contrasts sharply with his upbringing in St. Cloud.

Petters grew up with six siblings in a nice but hardly opulent cottage on the banks of the Mississippi River, just below "pill hill" where the doctors lived. The house was secluded behind a stand of trees and featured a domed greenhouse and gardens tended by his father, Fred, who owned a fur, fabric and tailoring shop downtown. The Petters Building had housed the family business for more than 100 years.

The Petterses live in Avon now, but still attend Catholic mass at the Newman Center on the campus of St. Cloud State and are active in peace and justice issues.

The Petterses are "very well respected for their integrity," said Michael D. Doyle, a friend of the family. "They are considerate, modest and gracious, and very much involved in the issues of the community."

In high school, Tom was gregarious, "a bit of a goofball, but nothing legendary," according to classmate Bill Kain.

"Tom was always very smart and very funny and very popular. He had lots of friends," said Jon Petters, Tom's older brother by four years.

While other teens wore letter jackets, Petters favored long car coats, like a budding businessman. One friend recalls how he would sweep into a room, his trench coat flowing.

He was not a particularly good student and loved to play practical jokes. He was the kind of kid, for example, who would offer to pay for your cup of coffee or lunch, then go to the cashier and pay for only his own, leaving friends to feel foolish when they got up to leave.

Two schoolmates who asked not to be identified said Petters' penchant for pranks sometimes got a little more devious. In ninth grade, he told them he knew someone who had printed counterfeit money. Give me $20, they remembered Petters saying, and I'll bring back $400 in fake bills.

When one of the friends asked to see the money, Petters took them to a downtown office and knocked on the door. No one was there. They gave Petters the $20 anyway, but never saw any counterfeit bills. After hounding him for weeks, he finally returned the money.

In the high school yearbook, Petters shows up only in class photos. He wasn't involved in sports or extra-curricular activities. Instead, he worked at his father's shop or selling stereos.

Even though Dick Schaak employed 850 people at his Schaak Electronics stores, he said the young Petters stood out. "He was an excellent salesman and was extremely well liked," Schaak said. "He always won the best-employee awards."

During an Aug. 5 speech at the University of Minnesota's Carlson School of Management, Petters told how he secretly leased space in downtown St. Cloud and began selling stereos to college students during his junior year in high school. He routinely skipped school to work, and got caught when his mother heard him doing a radio commercial during school hours.

"I was having a lot of fun until one day it came to a screeching halt when my report card came home," Petters said.

Two years after he graduated from high school, his father's business closed, a victim of "unfortunate changes in American taste," according to the St. Cloud Times.

In an article, Fred Petters ascribed the closure partly to the new trend toward mass merchandising and discount stores.

"Merchandising in this field has gotten very gimmicky, and it's gotten to a level where I don't care to operate," he said. "I don't think it's right to trick people."

The entrepreneur emerges

Petters dropped out of St. Cloud State University after one semester. In the 1980s, he found himself in Colorado with an opportunity to buy a small chain of consumer electronics stores. The business failed, and Petters was arrested on charges of fraud, forgery and larceny, according to a recent government recording of a Petters phone conversation.

The Colorado charges were apparently dropped, but the case has been sealed, leaving no public record of the outcome.

Petters' 13-year marriage to Jamie Lynne Hagan ended in divorce in 1990, with his ex-wife getting custody of their two children.

By then, Petters had his own business, Amicus Trade Group, and was making about $40,000 a year. He was a "liquidator" who made money by buying overstock, damaged, or unsold apparel, electronics and other goods from retailers and reselling it to other merchants.

In 1991, Hagen Foods and Bargain Bin, an Elk River discounter, sued Petters, claiming that he had failed to deliver the promised amount of electronic goods for an order the company had paid for.

In a move that would foreshadow the mammoth investment fraud scandal 17 years later, court documents say Petters told Hagen's attorney that the check was in the mail and sent a Federal Express air bill as proof. After waiting in vain for Petters' $3,325 check, Hagen's attorney learned from a Federal Express representative that the air-bill number was a phony, documents show. A judge eventually ordered Petters to pay up.

Jon Petters said his brother went on instinct when it came to business deals and sometimes his instincts failed him. "He'd get stung, get back on his feet and get stung again," Jon Petters said. "Tom trusted everyone, sometimes to an enormous fault."

By 1995, Petters had opened his own stores, Petters Warehouse Direct, to sell directly to consumers. George Wozniak, CEO of Hobbit Travel, first met Petters around then, when he tried to persuade Wozniak to try to open travel agencies inside Target and Cub stores -- before big-box retailers began putting franchises inside them.

"Petters was way ahead of the times," Wozniak said. "He was a sales guy's sales guy. He was always energized and thought the sky was the limit."

Less than a decade later, Petters seemed to be everywhere.

He invested with Ted Deikel in the purchase of Fingerhut, a consumer catalog company, and uBid.com, an online reseller. He paid $426 million for Polaroid in 2005, and an undisclosed sum for a major stake in Sun Country Airlines the next year. The media routinely portrayed him as a man willing to take on and turn around troubled businesses.

Ted Mondale, an executive vice president for Petters Worldwide from 1998 until 2003, said he made trips to Japan and Korea to set up buying arrangements with trading houses for surplus electronics equipment. The Mondale name was well known in Asia, where Ted's father, former Vice President Walter Mondale, had served as ambassador to Japan.

People generally liked Petters, Mondale said, "but it was like he had ADD [attention deficit disorder] and he would switch from topic to topic. He wasn't one to sit around and read the newspaper. It was go, go, go, go."

The trappings of Petters' apparent success mounted. He flew across country in a customized Boeing 727 and received complimentary rooms at the tony Bellagio casino in Las Vegas. He lived with his girlfriend and their two young children in a $2.3 million Wayzata home. And he had two properties in Florida, one of which is valued at nearly $9.2 million.

But his charisma, say those who knew him, came as much from his apparent lack of sophistication as his success. He frequently butchered the language and spewed malaprops, qualities some found endearing.

"He'd talk for 20 minutes and you'd get in maybe two-three words," said Andrew Redleaf of Whitebox Advisors, a Minneapolis-based hedge fund that initially invested with Petters in Sun Country. "And at the end of that 20 minutes you'd feel like the AFLAC duck in the Yogi Berra commercial."

Even the shocking 2004 murder of his 21-year-old son, John, while traveling in Italy, didn't seem to slow Petters much. When colleagues inquired about his well-being, he'd quickly turn the conversation back to them. He gave lavishly to charitable causes and never hesitated to help friends and relatives in times of need.

"He'd pay for drug treatment for a cousin," said brother Jon Petters. "If it was a family matter, he'd make the time [in his schedule]. If you were down in the dumps, Tom was always there."

Not everyone was charmed.

"He could tell you exactly what you wanted to hear and not mean a word of it," said one former business partner. "From the day I met him, it seemed he was buying people's love and respect. His charisma was constantly throwing money at people."

Warning signs?

New York hedge fund manager Richard Bookbinder of Bookbinder Capital Management passed on an investment after he learned that Petters had lied on a Dun & Bradstreet questionnaire about earning a degree from St. Cloud State University.

"Things popped up and we didn't feel comfortable. When people gave money [to Petters] they didn't ask, 'Who's this guy? What's his background?'" he said. "The question is: This information was out there in 2002. We looked at it and we're a small firm; why didn't other people look at it?"

Randy Shain, vice president of First Advantage Investigative Services, which did the due diligence for Bookbinder, said he investigated Petters and his Petters Company, Inc. (PCI) for four different clients. Each client looked at his findings and walked away.

"The amount of litigation involving Petters was pretty startling," Shain said. "We don't tell clients what to do. We let the clients decide. But a background report tells you what has happened in the past, and human beings tend to do the same thing again, especially under stress."

Colleagues, friends and others say they saw few outward signs that Petters' empire -- built on borrowed money -- was beginning to crumble.

The payments to charitable foundations, which had been earning as much as 18 percent on loans to Petters, began coming later and later this year.

Interlachen Harriet Investments, a Minneapolis hedge fund that had lent $60 million to Petters in April, spent much of the summer pestering Petters for repayment and proof that the money had been used as promised, to buy and re-sell high-end televisions to Wal-Mart and other retailers.

After making $10 million in payments in June and July to Acorn Capital Group, an investment fund that had lent him about $273 million, Petters missed the Aug. 1 payment. Acorn filed suit Aug. 14, five days after the foundation's fundraising gala.

Dean Vlahos and his wife invested nearly $30 million with Petters. He would not discuss their relationship in depth. But Vlahos did say he had traveled to Las Vegas a few times with Petters, yet never saw any signs of the kind of high-roller gambling habits outlined in an FBI affidavit. "I had no idea," Vlahos said.

Wozniak, who owns some Sun Country shares, found dealing with Petters nearly impossible this year.

"I bet in the last eight months he canceled 10 meetings," Wozniak said. "It seemed he had people pulling at him from all directions."

One business partner said in recent months that Petters was often absent and conducted meetings by phone from Las Vegas. Ted Mondale said he saw Petters at a dinner at Manny's in downtown Minneapolis about two weeks before agents raided his home and business. Though outwardly upbeat, "he seemed distressed," Mondale said.

Four days before the "Night in Barcelona" party for his son's foundation, Petters was the keynote speaker at the Carlson School of Management. He told his own remarkable story and advised the assembled students and faculty members to build connections and relationships if they wanted to be successful.

"You can't survive without them," he said. "Without trust, you really can't do anything."

A betrayal from within

The beginning of the end came Sept. 8, when Petters Co. Incorporated's vice president of operations, Deanna Coleman, approached authorities.

Coleman, a 42-year-old native of northwestern Minnesota, had joined Petters around March 1993. She told investigators that the investment fraud had been going on throughout her employment with Petters. She admitted she profited handsomely from her role in helping to create false purchase orders and sales receipts to fool investors.

For her work, Coleman was paid $300,000 a year and had received at least $8 million in bonuses dating back to 2004.

As a confidential witness for the government, Coleman began recording conversations at work. In one, Petters talks about the "stressed financial condition" of his company and that he had no choice but to continue preparing phony purchase orders and sales receipts to lure investors.

On Sept. 24, federal agents shut Petters down.

Staff writer Jennifer Bjorhus contributed to this story. David Phelps • 612-673-7269 dphelps@startribune.com Jon Tevlin • 612-673-1702 jtevlin@startribune.com