By Edward Wyatt
The New York Times
October 9, 2010
Sitting in a Minneapolis mansion and listening to a charismatic investment manager describe a currency trading system that kept earning handsome returns year after year, Arthur F. Schlobohm IV was certain he had stumbled onto a Ponzi scheme.
A longtime trader who started running tickets on the floor of the New York Stock Exchange as a teenager, Mr. Schlobohm, known as Ty, knew that Minneapolis, his home for nine years, was too small a town for a $4.4 billion investment fund to have escaped his notice.
It had taken him just a few Google searches to discover that the fund’s manager, Trevor G. Cook, had been suspended twice by the National Futures Association and been fined $25,000 for using false information to open a trading account for a customer. Calls to contacts in Switzerland and Kuwait also raised doubts about Mr. Cook’s boasts about deal-making abroad.
Yet Mr. Schlobohm later found himself back in Mr. Cook’s mansion, surrounded by a room full of his neighbors, many of whom were about to hand their life savings to a charlatan.
“If I could have just leaned over and whispered in someone’s ear, ‘Don’t invest in this! Just trust me!,’ there would be a family out there now with kids that could go to college,” Mr. Schlobohm recalls of the meeting, which took place 18 months ago.
But he couldn’t do that. At the time, Mr. Schlobohm, now 37, was working as an informant for the Federal Bureau of Investigation. Wired to record Mr. Cook’s sales pitches and carrying a hidden camera, Mr. Schlobohm gathered evidence for at least four months as the Justice Department zeroed in on the scheme.
Mr. Cook pleaded guilty to mail and tax fraud last summer and was sentenced to 25 years in prison for orchestrating what ultimately became a $160 million swindle. William J. Mauzy, a lawyer who has represented Mr. Cook, did not respond to repeated requests for comment and for an interview with Mr. Cook.
That the authorities brought Mr. Cook to justice is undoubtedly a positive outcome. But Mr. Schlobohm’s journey as a whistle-blower, and some of the financial losses that still occurred even though authorities were closely monitoring Mr. Cook, also underscore the limitations of the system.
During the period when Mr. Schlobohm helped the F.B.I. to gather evidence, from April through July 2009, at least $16 million flowed into Mr. Cook’s fund — and disappeared. From the time securities regulators first had credible information that he was engaged in a fraud and when the authorities shut down his fund, December 2008 to July 2009, some $35 million flowed into his coffers — funds that afforded Mr. Cook a lifestyle that included an expensive gambling habit, a collection of Fabergé eggs, fancy cars and the construction of a casino in Panama.
“There was a tremendous amount of guilt being there,” watching Mr. Cook lure investors, said Mr. Schlobohm in an interview, the first in which he has spoken publicly about how he helped put Mr. Cook behind bars. “Knowing this was a fraud with the highest degree of certitude, and having to watch people in the process of losing their life savings, was extremely difficult.”
The United States attorney for Minnesota prosecuted the case against Mr. Cook, and the Commodity Futures Trading Commission and the Securities and Exchange Commission are both pursuing civil suits against Mr. Cook and helped with the federal investigation. Those agencies point to the Trevor Cook case as an example of the positive lessons authorities learned from the Bernard L. Madoff scandal and other regulatory debacles. (In the Madoff case, tipsters warned regulators for years of problems, but they did not take action until Mr. Madoff’s fund collapsed.)
For all of the Justice Department’s efforts, though, only about 5 percent of the $160 million invested in Mr. Cook’s scheme has been recovered.
And for his part, Mr. Schlobohm says that his time as a whistle-blower was often an ordeal, leaving him worried about his safety and that of his family. After he began acting as an informant, he was spending considerable time on the case. He and his employer, an investment company, agreed that it was better for him to quit than to risk dragging the firm into the probe.
“There were definitely times when I was fearful,” he says. “I had to ask questions and dance on a tightrope, pretending I was going to help them bring money in without being obvious I was working with the federal regulators. They certainly knew what they were doing was a fraud, so I was surprised that they weren’t thinking that maybe someone else had discovered it.”
ONE day in early 2009, Ty Schlobohm was visiting the 117-year-old Romanesque mansion that Mr. Cook had bought for $2.8 million and outfitted as a modern trading floor, where walls of flat screens flashed currency prices from around the globe.
“I was walking down the stairs, and on the first floor they had a big conference room,” Mr. Schlobohm recalls. “There sat no less than 25 women, all north of 65 to 70 years old, at an investment seminar where one of the salesmen was waxing poetic about the strategy. I was fairly certain at that point that I was looking at some degree of fraud.”
That epiphany, backed up by his research into Mr. Cook’s trading strategy, which included claims of no-interest loans from a Jordanian bank, led Mr. Schlobohm to take a raft of documents to the authorities.
“I realized,” Mr. Schlobohm says, “that in what was somewhat of an unremarkable financial career, this was that fork in the road where I could do something good.”
There had already been others who had raised questions about Trevor Cook. The Commodity Futures Trading Commission, a federal agency that regulates commodity markets and monitors foreign currency trading, got a full report on Mr. Cook’s suspension in 2006.
Then, in April 2008, Duke Thietje, a Florida investor, filed a lawsuit in a Minnesota state court against Mr. Cook and his firm, Universal Brokerage Services, contending that Mr. Cook lost $450,000 he had turned over to him in 2005 to invest in foreign currencies.
Mr. Thietje abandoned his lawsuit in the fall of 2008. But around that time, his lawyer turned over copies of his filings to the C.F.T.C., providing that agency with its second warning about Mr. Cook.
The C.F.T.C. would not comment on the documents, in part because its civil fraud charges against Mr. Cook and his companies are still pending.
After examining Mr. Thietje’s allegations, the C.F.T.C. decided that it lacked the jurisdiction to do anything about Mr. Cook, according to people close to the investigation who spoke on the condition of anonymity because some charges are still pending. It wasn’t until March 2009, when Mr. Schlobohm contacted both the C.F.T.C. and the United States attorney in Minneapolis with his information about Mr. Cook, that the C.F.T.C. began to connect the dots.
That was made more difficult because Mr. Cook’s ventures went by an ever-changing lineup of names: Universal Brokerage Services, UBS Diversified, Oxford Global, Market Shot, the Basel Group, Crown Forex.
None of them, however, were registered with either the Commodity Futures Trading Commission or the S.E.C. So even after Mr. Schlobohm provided his own research pointing to a Ponzi scheme, regulators said they had limited options as to how they could act.
According to two senior regulatory officials speaking on the condition of anonymity because the civil cases are still in court, the agencies could not simply walk in and demand to see the firms’ books and records without running the risk that the group would fold up shop and disappear with investors’ money.
And the agencies thought that convincing a judge that the Cook firms’ assets should be frozen required more evidence than they had from Mr. Schlobohm, the officials said. Mr. Cook was indeed sending some of his victims’ funds to foreign currency trading accounts, where his unauthorized trading was losing millions of dollars. In the end, regulators discovered 21 domestic bank accounts and 27 brokerage accounts involved in the scheme, as well as 19 foreign accounts at 17 institutions in 12 countries, many of which zealously guard the identity of depositors.
Mr. Schlobohm had few doubts, however. Mr. Cook was telling potential investors that he was producing monthly returns of one-half to 1 percent, month after month, without a loss, over a period that included one of the worst investment markets in modern times.
Mr. Cook claimed to be generating those profits by performing a so-called carry trade that allowed him to game the differences on currency yields in various countries. He used investors’ money, he said, to buy high-yield securities denominated in a currency like the Australian dollar. He then sold low-yielding securities denominated in United States dollars, and pocketed the difference in returns. Next, he said, he used interest-free loans to set up a mirror-image trading position, creating a perfectly hedged transaction that, he said, produced guaranteed profits.
The free money, he said, came from a bank in Jordan, which, because of Shariah Islamic law, was not allowed to charge interest. Mr. Cook said the difference between the two trading positions generated annual returns of 10 percent to 12 percent — year after year after year.
In reality, what Mr. Cook was running was a plain-vanilla Ponzi scheme, in which he simply used money from new investors to pay off earlier investors and maintain the mirage that his funds were earning handsome returns.
EARLY in his discussions with the F.B.I., Mr. Schlobohm recalls, an agent informed him “that Trevor Cook had been on their radar screen before,” but the bureau had been unable to pin anything on him.
The F.B.I. took the lead in the Cook investigation, focusing on gathering evidence for a criminal prosecution rather than on immediately shutting down the fraud and securing investors’ funds. An F.B.I. spokesman declined to comment on the investigation.
Unlike civil cases, criminal cases often require that investigators amass evidence of both the crime and the perpetrator’s intent before producing an indictment — usually translating into longer, more challenging investigations.
Given those hurdles, the F.B.I. came to rely heavily on Mr. Schlobohm to gather information for its case.
Wearing two microphones and carrying a hidden camera, he attended at least 10 meetings in which Mr. Cook or his associates tried to raise money from investors.
Some parts of the undercover operation didn’t go smoothly. With tape recorders strapped to him, Mr. Schlobohm was reluctant to go to the bathroom at the mansion for fear of discovery. “I was crossing my legs and chewing on my knuckle,” he recalls, and says that he once was forced to drive to a nearby F.B.I. building to relieve himself.
Other aspects of his duties were also tedious. The special agent assigned to Mr. Schlobohm had no expertise in financial crimes, and Mr. Schlobohm said he had to spend hours explaining carry trades and hedges and foreign currency markets to the agent.
“I had a wheelbarrow of information on this fund in March 2009,” Mr. Schlobohm says. “On a daily basis, I was saying all you have to do is ask an hour’s worth of questions to understand that Ledger A will not match up with Ledger B in terms of assets. That could be completed in a day. And I just kept being given ambiguous answers, that there was a process, there was a protocol, and that they could not just shut it down.”
Officially, the C.F.T.C. and the S.E.C. said the case was an example of a successful multi-agency investigation. But in truth, with the F.B.I. and Justice Department running the undercover operation, the regulatory agencies were sidelined. In April 2009, after the undercover operation began, the United States attorney’s office specifically asked the civil regulators to halt any overt investigations to prevent tipping off the targets, according to two regulatory officials.
It wasn’t until late June 2009 that securities regulators got the go-ahead from prosecutors to finally subpoena the records of Mr. Cook’s companies. The next month, investors first became aware that something might be amiss in Mr. Cook’s mansion when a group of Ohio investors filed a lawsuit against Mr. Cook and his companies, contending that they had refused to let the investors withdraw their money.
That private lawsuit — not the federal investigation — essentially shut down Mr. Cook’s operation because it caused investors to scramble for answers about their investments and to get a court order to freeze assets. The S.E.C. and the C.F.T.C. filed civil suits against Mr. Cook and others in November 2009, and the United States attorney filed a criminal case against Mr. Cook this year.
Peter Silverman, a lawyer who represented the Ohio investors, said that many financially savvy people could have seen signs of a fraud in Mr. Cook’s investment materials. “I think it was inexcusable that the authorities did not move in more quickly to stop people from investing more money,” he says.
Joseph T. Dixon III, the chief of the fraud and public corruption unit of the United States attorney’s office for the District of Minnesota, said in an interview that the case progressed as rapidly as possible, given the circumstances.
“Criminal cases take some time to put together,” says Mr. Dixon. “We have to be able to prove our charges beyond a reasonable doubt.”
Mr. Dixon rejects comparisons of the Cook and Madoff cases. “We didn’t just sit on this information,” he says. “We moved very rapidly. There is a tension between trying to prevent a fraud from happening and having to build a case we believe we can take into court.”
He contends, however, that securities regulators were free to take action sooner if they wanted. “Categorically at no time did we ever interfere with a regulatory agency’s ability to move,” he said.
Mr. Cook, after pleading guilty to one count of mail fraud and one count of tax evasion, was sentenced to 25 years in prison. He was ordered to pay $158 million in restitution. But at last count, only about $9 million had been recovered.
Many people close to the case say they believe that Mr. Cook stashed money away — suspicions that were confirmed in August when investigators first found thousands of $100 bills and gold and silver coins hidden in the walls of his brother’s basement, then uncovered a duffel bag full of Iraqi dinars, Turkish lira and other currencies in a locker at the Mall of America.
MR. SCHLOBOHM says his experience shows that for many whistle-blowers, the risks can outweigh the rewards. But while he has mixed feelings about how the investigation proceeded, he has no qualms about his decision to cooperate with the authorities to shut down Mr. Cook’s operation — and he says he hopes that others in the investment arena will see it as their duty to do the same.
“I was doing this, and continued to do it, for moral reasons,” he says. “I was finally in the position to maybe not make a bunch of people money but maybe to save some people their life savings.”
Mr. Schlobohm says that a few weeks into the operation, his contact in the F.B.I. offered to try to arrange some compensation, an offer he says he rejected. The F.B.I. declined to comment.
There were significant costs, however. In April 2009, shortly after he had started working undercover, Mr. Schlobohm found his work as an informant had begun to overtake his regular job. Because he was spending significant time away from the office, he had to tell his employer what he was doing.
Although his employer was supportive, Mr. Schlobohm and his bosses agreed that he should leave the firm to avoid drawing it into a financial morass. (For the same reason, both Mr. Schlobohm and the company asked that it not be named, although a senior official there confirmed his account.)
“I had to make a decision — either I could continue on with this, which was taking a considerable amount of resources,” or keep his job, he says. “And I chose to resign, to finish this out. So it was a financial risk to myself.” Now, he trades for his own account and on behalf of a New York investment firm.
He was worried that his undercover work might ruin his career in financial services and, as his mind wandered amid all of the secret taping and debriefing he was doing, he worried about the safety of his family.
Mr. Schlobohm says that because regulators and law enforcement authorities are more reactive than proactive when it comes to financial crimes, it’s up to members of the industry to alert people about frauds before investors are hurt.
“The private sector — people like myself, people that are allocators of capital, people that are professional analysts in the asset-management world — have the highest degree of knowledge to be able to sniff this out in a minuscule amount of time, like I did,” he said.
Mr. Dixon, the prosecutor, agrees: “We need citizens in the business community to come forward with information so we can move forward.” For him, the lesson of the Trevor Cook case is, in part, “the importance of business professionals stepping up and bringing us information — even if there is no financial incentive and sometimes may be financial risk to them.”
There is not, Mr. Schlobohm said, a culture of silence among investment firms and managers. But there are subtle pressures.
“If I’m a large university or a huge hospital, and I want you to consult or manage hundreds of millions of my dollars, I want you out there making money,” he says. “I’m not giving you money to go off and be a vigilante, a financial vigilante of sorts.”
The upside of being a whistle-blower might be improving. The Dodd-Frank Act, the regulatory overhaul signed into law by President Obama this summer, included provisions to strengthen whistle-blower protections and to encourage people to come forward with information about investment frauds. Now the S.E.C. and the C.F.T.C. can reward whistle-blowers with up to 30 percent of any amount over $1 million recovered from an enforcement action.
But because Mr. Schlobohm’s revelations about the Trevor Cook case took place in 2009, these new provisions don’t apply to him. An earlier S.E.C. whistle-blower program applies only to insider trading cases, but an Internal Revenue Service program might apply, given the tax charges in Mr. Cook’s case.
Under the I.R.S. program, Mr. Schlobohm might be eligible for up to 30 percent of the taxes and penalties in excess of $2 million collected by the I.R.S.
Mr. Schlobohm has hired Phillips & Cohen, a Washington firm that specializes in whistle-blower cases filed under the False Claims Act, to represent him. But he says that he doesn’t know if he would accept a reward if one were offered, and that if he did he would probably use it to help victims of the fraud.
“If I were to receive some reward, I think that would be great,” says Mr. Schlobohm. “But that’s not why I did it.”
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