b.. APRIL 22, 2009
Roots of $3 Billion Fraud Case Lie in DVD Players, Not CDOs
By SUSAN CAREY
MINNEAPOLIS -- Bernard Madoff bilked the public with fictitious securities
transactions. Tom Petters, prosecutors allege, gulled his victims with
nonexistent DVD players and flat-screen TVs.
Among the spate of alleged scams that have come to light in recent months,
the $3.5 billion one that Mr. Petters is charged with is among the most
unusual. The Minnesota businessman promised fat returns to investors who
lent him money to buy surplus merchandise and resell it to famous retailers
like Wal-Mart Stores Inc.
"In fact, there were no such purchases or resales," says a federal
indictment. It says both were faked. Mr. Petters denies the charges.
Two months before Mr. Madoff burst onto the public stage last year charged
with a Ponzi scheme, authorities here accused Mr. Petters, a gregarious
51-year-old appliance wholesaler, of running a multibillion-dollar fraud of
But Mr. Petters's case broke in early October as the world was riveted by an
unfolding financial crisis. So his story has gone largely unnoticed
nationally, while Mr. Petters sits in a rural county jail -- where, until
recently, he couldn't leave his cell without shackles.
Mr. Petters used the proceeds of his alleged scheme to fund an "extravagant
lifestyle," a Dec. 1 federal indictment says, as well as to acquire a host
of other businesses -- ranging from Polaroid Corp., Sun Country Airlines and
part of Fingerhut Cos. -- to stakes in private companies. He gave millions
of dollars to colleges.
Now, cases against Mr. Petters and five others are playing out in five
federal district or bankruptcy courtrooms in Minneapolis and St. Paul.
Alleged victims range from hedge funds to universities to creditors of
myriad related businesses that have been forced into receivership or
bankruptcy. One religious foundation invested almost its entire $28 million
nest egg with Mr. Petters.
The five other defendants -- among them an employee who went to prosecutors
with tales of wrongdoing last summer -- have pleaded guilty to felonies,
agreed to have their assets placed in a receivership and are awaiting
sentencing. One of them, according to a Federal Bureau of Investigation
affidavit filed in court, described the fraud as a Ponzi scheme, a deal in
which returns to existing investors are paid with money from new investors.
Their lawyers didn't make them available for comment.
Mr. Petters "is going to fight" the charges, says his attorney, Jon Hopeman.
He faces trial on 20 federal counts of fraud, money laundering and
conspiracy in September. Through his lawyer, Mr. Petters declined to be
An old friend, Jim McAlister, says Mr. Petters was optimistic and joking
around when visited recently at the Sherburne County Jail in Elk River,
Minn. "Look at me," Mr. McAlister recalls Mr. Petters saying. "I lost 10
pounds. I'm in better shape than I've ever been in. My blood pressure's
Mr. Petters grew up the fifth of seven children in a devout Catholic family
in St. Cloud, Minn., says one of his brothers, Jon. Their great-grandfather
from Germany had opened a tailor shop in St. Cloud. It's gone now, but a
Petters Building still stands downtown.
While still in high school Mr. Petters started a business selling stereo
equipment to students at St. Cloud State University, even leasing office
space and hiring salespeople. His parents shut him down after learning he
was skipping school. Mr. Petters later attended the college himself, but
soon dropped out and went to work for an electronics retailer in Iowa and
Colorado. He returned to Minnesota in 1988, so broke that he moved in with
Jon, the brother says.
Tom Petters went through a divorce. His lawyer says he also had
rehabilitation for cocaine addiction. Court records show Mr. Petters was
involved in multiple breach-of-contract lawsuits with business partners --
them suing him or vice versa.
Staked by a loan from Jon and a friend, Mr. Petters started a wholesale
brokerage business that bought and resold surplus goods, later called
Petters Co. By the mid-1990s, he had a small Minnesota retail chain that
sold closeout and overstock apparel, furniture, toys and groceries. But he
tired of retail and sold most of the stores. He preferred wholesaling and
its constant middleman juggle of buying and reselling odd-lot shipments of
televisions or frying pans or Coca-Cola.
Acquaintances say Mr. Petters was motivated less by money than the challenge
of selling. "Wealth isn't one of our objectives in life," Jon Petters says
of his family. "Tom said, 'If you have it, you have to give it away.' Tommy
was always loaning money or giving money to people or co-signing for a
Federal prosecutors say the alleged fraud began in Petters Co. about 14
years ago, and worked like this: Mr. Petters and an unindicted business
broker solicited investors for loans to buy merchandise; the loans would pay
double-digit interest rates and be secured by the merchandise or accounts
Some of the money raised went directly to two purported suppliers of goods:
Nationwide International Resources Inc., of Los Angeles, and Enchanted
Family Buying Co., of Excelsior, Minn. According to prosecutors, neither of
them bought or sold any goods; they usually just paid themselves a
commission and routed the rest of the money back to Petters Co.
Mr. Petters and associates allegedly created fake purchase orders, bills of
sale, wire-transfer confirmations, shipping documents and statements
purporting to show goods being bought and resold at a profit, to retailers
such as Costco Wholesale Corp. and Wal-Mart's Sam's Club.
An order dated April 17, 2008, showed Enchanted selling 2,800 Hitachi
projectors to Petters Co. for $5.26 million, according to an FBI affidavit
filed in federal district court in Minneapolis. A purchase order dated 11
days later portrayed Sam's Club as buying the projectors for $5.84 million
and thus producing a profit of nearly $600,000.
A Wal-Mart official told the FBI the retailer doesn't do business with
vendors via paper records but on a special Internet site. He called the
Sam's Club purchase order fictitious.
In all, the purported suppliers of merchandise funneled "tens of billions of
dollars" through their bank accounts to accounts controlled by Mr. Petters
and his companies, says the indictment. The suppliers' owners have pleaded
guilty to conspiracy to launder money and await sentencing.
Fidelis Foundation, a Minnesota religious charity, had $27.6 million
invested in eight promissory notes from Petters Co. backed by fictitious
purchase orders, prosecutors say. "Our ability to donate to charities has
all but dried up," says Joseph Smith, the foundation's president.
Hedge funds Palm Beach Finance Partners LP and Palm Beach Finance II LP
started investing with Mr. Petters in 2002, says a lawyer for the funds,
Steven Thomas, and received 15% annual interest and timely payments. The
funds say they're owed more than $1 billion, the second-biggest bankruptcy
claim against the Petters operation. The biggest, $1.5 billion, is from
Lancelot Investors Fund Ltd., which filed for bankruptcy last fall.
A few would-be investors stayed away. Randy Shain, who does background
checks, says he researched Mr. Petters for clients around 2002 and was
struck by the volume of litigation against him. "For 15 solid years, there
were one to two lawsuits a year for not paying for something or not paying
for products purchased," says Mr. Shain, of First Advantage Investigative
Services in New York. His clients steered clear.
Investors who asked to see inventory often were rebuffed or shown empty
warehouses or warehouses full of other companies' goods, according to
Douglas Kelley, who is overseeing a receivership and selling assets of Mr.
Petters and other defendants to raise money for creditors.
The defense will respond to such allegations in court, said Mr. Petters's
lawyer, Mr. Hopeman. But, he added, "What were these people thinking? Hedge
funds were so desperate to show positive terms for their investors that they
are partly at fault for their losses. Aren't they required to do due
While Mr. Petters was thriving, he acquired five lavish homes in several
states, along with several Mercedes cars, a Bentley and expensive boats.
He also acquired businesses. In 2002, his Petters Group Worldwide joined
with a former official of Fingerhut to buy the catalog retailer, ending up
as a passive minority shareholder. Two years later he financed a management
buyout of Internet auction site Ubid.com and became its largest shareholder.
Petters Group Worldwide also acquired Polaroid and, in conjunction with a
local hedge fund, leisure carrier Sun Country Airlines. His interests
included patents, real-estate development projects and stakes in startup
technology companies and an upscale restaurant chain.
Not all worked out. The price he paid for Polaroid in 2005 was $426 million
in cash and debt. Last week, Polaroid was auctioned off by a bankruptcy
court for $88 million.