Film Alleges Official ‘Fraud’ Against Victims of $3.65 Billion Ponzi Scam

Victims of a massive financial fraud unveiled a documentary Aug. 25 in Minneapolis that portrays federal authorities as helping bankruptcy lawyers and the government feast on dwindling victim assets without adequate protections for fairness.

The Second Fraud, spiked last December from planned showings on four Minnesota TV stations with purchased time, tackles an especially sensitive story in that state: What happened after local financier Thomas Petters caused the estimated $3.65 billion in losses that authorities revealed in September 2008?

But the film's theme -- and larger importance -- is not about the fate of the Gatsby-like Petters, now 53. He's a college drop-out who took charge of Polaroid and several other well-known companies before receiving a 50-year federal prison term in April.

Instead, the film's main focus is the respected Minneapolis attorney Douglas A. Kelley, right, a former federal prosecutor and U.S. senate staffer. The film portrays him as an opportunist empowered by the courts to arrange big legal fees for himself and his cronies without full due process, thereby causing a "second fraud" upon lenders and investors. Without accepting either that view or the Kelley's position that he's carrying out his duties in the most public-spirited way possible, it's reasonable to wonder how well our watchdog institutions are protecting our financial future from either scamsters or saviors.

This Petters tale isn't boring: On his way up, Petters, shown at left pretrial in 2008 at a county jail, hid his criminal record and gave every appearance of success until he was fingered by a former mistress to whom he'd given millions.  Before that, however, he kept a front of business success with lavish spending on a celebrity lifestyle, charities, contributions to top political figures -- and to his inner-circle of corrupt colleagues.

For those interested in the political implications: Many on both the right and left, whether in Tea Party-style protests or in more formal writings, are speaking out these days about how federal power grabs are eroding historic due process protections for the public.

We at the Justice Integrity Project that I lead see that evidence abounds around the country of excessive legal fees and huge forfeitures to the federal government without trial. Critics include Tyranny of Good Intentions author and former Reagan Assistant Treasury Secretary Paul Craig Roberts (a recent guest on my radio show), the free-market Reason Magazine and left-leaning Harper's. They each recently protested relatively new legal rights by authorities to seize a person's or a company's assets without trial even in civil cases.

Regarding excessive legal fees in bankruptcy cases, the problem is so serious that the American Bankruptcy Institute published a report last month entitled: "When a Pig Becomes a Hog it is Slaughtered: Retention and Payment of Professionals in Bankruptcy Cases."

What's the relevance, if any, to the Petters case in Minnesota? Some creditors who financed the movie claim that both of these abuses are a big problem.

That's disputed by authorities, who maintain that they are providing the largest possible return to victims within the law.  Bankruptcy gives secured creditors high priority for claims, aside from spending for bankruptcy professionals, similar current expenses and various claims of the federal government.

In the madhouse jockeying for advantage commonplace in a bankruptcy, creditor interests can be easy to overlook, especially when victims are mostly from out-of-state and questioning prominent local figures.

On Aug. 19, for example, the Minneapolis Star-Tribune published an important article entitled, "Legal Deal Could Speed Victim Repayments in Petters Case" about a plan by Kelley to give the federal government as forfeiture $20 million in assets he's obtained from the Petters empire.  The relevant documents are here, here and here.

But Kelley's self-serving comments about his deal-making had no response or other context from any creditors -- who surely must number among the "victims" the paper referenced in its headline.

* * * *

The account below is largely based on the federal government's civil and criminal cases against Petters and his confederates, and news coverage in the traditional media. Information comes also from two creditors' websites here and here protesting the Petters scams, plus an ad campaign by creditors last winter alleging irregularities. The photos above are drawn from the later site. They include four figures from the case described below, plus mutlimillion-dollar vimctim/investor Mrs. Dean Vlahos, left from left, and money launderer Larry Reynolds, fifth from the left.

Author and former Chicago Sun-Times city editor James Merriner wrote the ads last winter, and is developig the material into a book on the Petters case already excerpted on his site. The ads began in the Star-Tribune, Minnesota's largest paper and itself long under bankruptcy court supervision in the same court system that the ads attacked.

The Star-Tribune cancelled the series after the ninth installment, and refunded the $62,000 payment. The smaller St. Paul Pioneer Press later ran the entire 17-part series.

The controversies prompted four local TV stations to drop plans last December to air a 60-minute version of the movie, according to Ryan Frost, The Second Fraud's producer, director and writer. The trailer is here, with the film planned for distribution at film festivals and by DVD after its premier Aug. 25 at the Uptown Theater in Minneapolis. Details are in a column adjoniing this at right.

I invited Kelley, Polaroid CEO Mary Jeffries and several other leading figures to comment for this story but they failed to respond.  Their views are instead summarized from filings, hearings and other news stories.

* * * *

Tom Petters built on youthful salesmanship skills developed at an electronics store to achieve mogul-status in the supply chain industry.  By now, that tale has frequently been recounted, including by the Star-Tribune and the Justice Department in its news release after his sentencing.

Along the way, Petters had once bragged in his office about a romp in a gondola with Petters Vice President for Operations Deanna Coleman during a trip to Italy. But Coleman, who'd worked her way up from being a receptionist at the Petters Companies, feared much more embarrassment:  That her boss and his other confederates would blame her for the Ponzi, especially since she'd received $8 million in bonuses as part of a Petters practice of rewarding key staff.

So, she told the FBI she was willing to wear a wire.  Her tapes of her boss resulted in a massive raid on the Petters home and headquarters on Sept. 24, 2008.

Petters hired Doug Kelley as lawyer representing his companies.  Kelley is a dynamic, well-spoken former Green Beret in Indochina who leads a regionally prominent boutique law firm. Kelley earned his law degree from the University of Minnesota in 1974, and went on to become a Department of Justice attorney and a Washington staffer for a Minnesota Republican senator.

Kelley briefly represented the Petters companies.  But as the crisis worsened, Kelley won temporary appointment from U.S. District Judge Ann Montgomery after the raid to become the receiver representing those with claims against his former clients.

Montgomery is the federal judge overseeing the government's civil case against Petters, six other defendants and their companies. Nominated by President Clinton, she's also a law school classmate and former Justice Department colleague of Kelley's.

Her order on Oct. 22, 2008 confirmed for Kelley his power to sell assets of any Petters civil defendant without trial or even a court hearing. The order also provided Kelley with an unusual grant of judicial immunity that limits potential review and redress for creditors.

Kelley rejected any role in the case for William Procida, a New Jersey-based liquidations expert who had been elected by creditors.  Kelley also became trustee, a post usually held in bankruptcy cases by a separate attorney. Earning $475 an hour according to recent filings, Kelley has staffed his team with some 40 professionals, including his law partner Kevin Wolter.

Among the creditors' biggest gripes is that Kelley took steps that, in essence, use valuable companies such as Polaroid to generate legal fees arising from the scam Petters Companies.

They protest Kelley's decision within days of his appointment as receiver to absolve Mary Jeffries, who was Polaroid CEO after previously serving as COO of the scam Petters Companies, of suspicion of wrongdoing.  Kelley maintained her as Polaroid CEO even though she was among the Petters executives receiving seven-figure annual bonuses.

"Clearly, some of those bonuses are suspect, but others are totally on the up and up," Kelley told reporters.  "Mary Jeffries works for Polaroid, and her bonus was well deserved."

In the view of creditors critics, Jeffries helped Kelley by testifying that some creditors who claim they are secured lenders with priority for Polaroid assets were actually investors in the Petters scam, a distinction that dramatically lessened their rights.

Critics further complained that Kelley forced a prompt sale of Polaroid in a tainted bidding process.  That sale, the creditors allege, leaves scant funds to reimburse them after insiders run up fees that reportedly total more than $30 million, as of early this year.

Kelley and Polaroid failed to respond to my requests for comment.  But Kelley has previously said that he and his team are dedicated to their fiduciary duty to preserve for creditors what's left of the Petters empire, which aside from Polaroid included such well-known companies as Sun Country Airlines and the retail goods distributor Fingerhut.

Among those disputing Kelley is Thane Ritchie, founder of the hedge fund Ritchie Capital. He's estimated that he has between $150 million and $170 million at extreme risk because of fraud and cronyism.

Ritchie, a former college football star whose hedge fund once controlled $3 billion in assets, is the son of former Washington Post investigative reporter Scott Armstrong.  Partly from Ritchie's frustration in obtaining what he regarded as adequate news coverage of the Petters scandals, he became newsmaker himself over the past year, but without much to show for it so far:

First, he helped file a racketeering lawsuit against Kelley, the Star-Tribune and others alleging a criminal conspiracy to loot the estate. Defendants denied the allegations, and soon won dismissal.  Even the web-based MinnPost new-site, in effect a competitor to the Star-Tribune, hammered Ritchie for it.

Next, Ritchie announced a plan to explore creation of a national Third Party similar to the 1990s efforts of Ross Perot and Jesse Ventura. Ventura, now an author and TV host, was elected to be Minnesota's governor in 1998 with the help of an innovative campaign by the same ad agency that's helped promote The Second Fraud.

Finally, Ritchie took preliminary steps to buy Newsweek from the Washington Post.  But the Post's owners decided to sell the magazine for $1 (plus assumption of debts) to electronics magnate and foreign policy crusader Sidney Harman, the husband of House Homeland Security Intelligence Subcommittee Chair Jane Harman (D-CA).

Now, however, Ritchie and other investor critics are focused on their Minnesota court cases. In particular, they protest Kelley's multiple, court-conferred roles that enable him to run up legal expenses, allegedly with too much secrecy and with too many conflicts, whatever his bi-partisan connections and repute.

So, the movie premiere was that start of what could be something big, combining raw-edged fears about financial security, the law and the media.

To be sure, "creditor in bankruptcy" doesn't necessarily evoke a sympathetic image. But another way of considering this is: If major lenders couldn't find what they consider a fair platform for their grievances in court, politics or the media, who could?

Contact the author Andrew Kreig or comment via Facebook