Monday, July 1, 2013

The Ponzi & National Financial Lending LLC

The Association of Certified Fraud Examiners describes a Ponzi scheme as follows:

"A Ponzi scheme is an illegal business practice in which new investor’s money is used to make payments to earlier investors. In accounting terms, money paid to Ponzi investors, described as income, is actually a distribution of capital. Instead of returning profits, the Ponzi schemer is spending cash reserves, all for the purposes of raising more funds. Where a basic investment scam raises money and disappears the Ponzi scheme stays in business by circulating investor funds. There are usually little or no legitimate investments taking place. Most of the funds are used by promoters for expensive lifestyles and transferred into property or offshore accounts. Schemes typically run for at least a year, although some Ponzis have flourished for a decade or more."

According to Mike Moffat, an economist who makes contributions to, the five key elements of a Ponzi scheme are:

1. The Benefit: A promise that the investment will achieve an above normal rate of return. The rate of return is often specified. The promised rate of return has to be high enough to be worthwhile to the investor but not so high as to be unbelievable.

2. The Setup: A relatively plausible explanation of how the investment can achieve these above normal rates of return. One often-used explanation is that the investor is skilled ("sophisticated"") and/or has some inside information. Another possible explanation is that the investor has access to an investment opportunity not otherwise available to the general public.

3. Initial Credibility: The person running the scheme needs to be believable enough to convince the initial investors to leave their money with him.

4. Initial Investors Paid Off: For at least a few periods the investors need to make at least the promised rate of return - if not better.

5. Communicated Successes: Other investors need to hear about the payoffs, such that their numbers grow exponentially. At the very least more money needs to be coming in than is being paid back to investors.

The steps in a Ponzi scheme are:

1. Convince a few investors to place money into the investment.

2. After the specified time return the investment money to the investors plus the specified interest rate or return.

3. Pointing to the historical success of the investment, convince more investors to place their money into the system. Typically the vast majority of the earlier investors will return. Why would they not? The system has been providing them with great benefits.

4. Repeat steps 1 through 3 a number of times. During step 2 at one of the cycles, break the pattern. Instead of returning the investment money and paying the promised return, escape with the money and start a new life.

Jaime Holmes, an Attorney, CPA, Certified Fraud Examiner, and expert witness gave testimony and demonstrated the elements of Ponzi in Point Center Financial's (PCF's) National Financial Lending (NFL) blind mortgage pool in the recent Investors v Point Center Financial civil litigation. According to the federal tax returns filed by PCF for the NFL LLC, cash "distributions" to investors were reported in excess of earnings, meaning that cash either came from capital, new investor money, or both.

2002               $363,644         $390,440                    ($26,796)
2003            $2,900,000        $3,400,000                ($521,576)
2004            $7,700,000        $3,300,000             ($1,200,000)
2005          $14,400,000      $23,200,000             ($8,800,000)
2006          $19,600,000      $40,000,000           ($20,300,000)
2007            $8,500,000      $26,000,000           ($17,400,000)
2008               $876,697      $15,900,000           ($15,000,000)

TOTAL      $54,500,000    $118,000,000          ($63,400,000)

Over a seven year period, PCF distributed over $63 million to investors more than the NFL blind pool ever earned. Where did the money come from?

In early 2007, Point Center froze NFL redemptions. Yet it continued to make semi regular distributions.

Point Center disputed the numbers at trial. Their CFO Gwen Melanson offered testimony and corresponding exhibits designed to downplay the information they themselves provided the IRS under penalty of perjury.

The exhibits attempted to obfuscate the data by introducing "accrued income" into the math to give the 'appearance' of reducing the shortfalls on paper. The flaw is that the accruals did not represent actual cash earned or received by NFL. Melanson's 'sleight of hand' math failed because she cannot distribute cash she hadn't earned or received. But that did not stop Point Center from attempting to distract and confuse the jury with the irrelevant data.

In contrast, the IRS Schedules 1065 are all about cash. Even bookkeeping neophytes know that you cannot mix cash and accrual based accounting. It's one or the other. In presenting hybrid exhibits, Ms. Melanson not only misrepresented the evidence, but demonstrated the lengths that she, Harkey, and Point Center will go to create fallacious illusions for whomever they intend to manipulate.

Monday, March 18, 2013

The Harkey Scheme

Danny Joe Harkey is a so-called "hard money" lender who operates Point Center Financial, an LLC he successfully mismanaged into the ground along with $750 million dollars in funds belonging to 3,000 investors. Over the course of the past few years Harkey pocketed over $100 million to $150 million in "fees" all of which were derived from investor funds.

Earning fees in the lending business is customary and isn't a bad thing as long as your investors see a return on their investments and recapture 100% of their principal. But when you're Dan Harkey and getting paid 100% while your investors lose nearly all to 100% of their investment, well, something's grossly wrong with this picture.

Take, for example, Harkey collecting and paying himself fees on unfunded portions of the loans that he writes. Let's say Harkey finds a lender who needs $20,000,000 to take out other loans and finish a construction project. The deal is crafted, paper is collected, investors are lined up, and the day comes to close the deal. Only Harkey only brings $16,000,000 to the table. The parties agree to close the deal with an addendum that states that Harkey will try to raise the balance of the money.

Two material events occur: 1. Harkey pays himself fees based on $20mm instead of the $16mm that he funded; and 2. the fees are paid entirely from investor funds. The borrower never shells out a dime. In short, Dan Harkey pays himself his fees from investor funds - up front - at closing - as if the loans are fully funded on money he never lent.

It's called "self dealing" and is defined as: "the conduct of a trustee, an attorney, a corporate officer, or other fiduciary that consists of taking advantage of his position in a transaction and acting for his own interests rather than for the interests of the beneficiaries of the trust, corporate shareholders, or his clients. Self-dealing may involve misappropriation or usurpation of corporate assets and opportunities. Self-dealing is a form of conflict of interest."

At its core, the Harkey Scheme is about aggregating fees regardless of whether or not a loan is successful or not. And there is a persistent pattern that emerges that applies across most of Point Center Financial's loan portfolio. Harkey underfunds a loan triggering a default when the borrower is unable to raise the remaining funding. One of two events will then occur: Harkey will renegotiate a new loan, to take out the old loan, but at higher fee rates, or Harkey will pursue non-judicial foreclosure and take possession of the collateral real estate. Almost every loan that Harkey has made since 2004 has defaulted and/or placed into foreclosure.

Harkey uses predatory commercial lending and loan servicing tactics to take advantage of sub-prime borrowers desperate to complete their projects, underfund them, then sits back and wait for them to default. He knows the borrowers will default because he only writes loans to unqualified borrowers.

While borrowers are in default he collects higher fees. Then he renegotiates a new loan at even higher fees. He doesn't restrict the new loan to the amount needed to complete the project. Instead he writes a whole new loan with even higher origination fees. Then Harkey underfunds the new loan but takes all his fees upfront at closing again. When the borrowers default a second time he forecloses, sits on the property, and accrues even more "management fees" until a tax sale forces him to dispose of the asset at just enough pennies on the dollar to pay his "accrued" fees and commissions.

Investors barely receive a fraction of the proceeds if anything when an REO property sells. The interest that investors received on the front end of the loan was pure fiction funded from their own principal contributions. How is that treated for tax purposes? Investors, believing that their interest was paid by borrower contribution declare the interest income on their tax returns and pay taxes on money they already paid taxes on.

Dan Harkey has mastered the fine art of "Invest a dollar, I'll pay you a nickel".

But wait! There's more! When Harkey sells the property, he takes more fees for brokering the sale from proceeds that should go to investors. Instead of distributing those proceeds Harkey sits on them because "he may need them to fund his legal defense when angry investors sue him". Let's do the math: Paid himself at least $100 to $150 million dollars in fees but is paying his legal bills from investor proceeds. Really?!

Skin In The Game

Putting skin in the game is seen as a sign of good faith and show of confidence in the future of a loan and the project that it funds. It represents the borrowers' commitment to a successful outcome. For example, if a pig and a chicken decide to open a ham-and-eggs restaurant, the chicken is merely involved while the pig is committed; it has skin-in-the-game. In 'Harkey speak', "skin in the game" means borrowers never have to bring a dime to closing.

In other words, underfunded or not, Harkey's loans were 100% investor financed.  So, after adamantly pitching to investors that all of his borrowers had to have "skin in the game" how is it that no borrower ever put up a dime of their own money? Did Harkey game his investors?

At closing, all the fees and expenses were paid with investor money. Harkey placed investors' money into loan holdback accounts to make monthly interest payments back to the same investors. You cannot do that without diminishing the value of investor principal. The Mortgage Loan Disclosure Statements clearly indicate that the "borrower will be required to pay the principal and interest...". Unless explicitly stated, wouldn't a reasonable investor believe this to mean that the borrowers would make their interest payments from funds or cash flow that the borrowers' already had in place long before the the loan was ever made? You know, from their own pockets? But according to Harkey, it's really not investor funds after he gives it to the borrower.


Harkey uses the "bad real estate market" excuse to justify incomprehensible behavior in his lending practices and practically writes the definitions of "predatory lending" and "predatory loan processing. Bad market my ass. Lending money to unqualified borrowers, under funding loans, paying interest to investors with their own money, and duping investors with material misrepresentations has nothing to do with a bad real estate market.

Furthermore, one shouldn't confuse what happened in the FDIC backed consumer residential real estate market with commercial raw land development and vertical construction projects. Paint me stupid but aren't they really two separate market segments, and shouldn't loans over, say, $1 million bear just a wee more scrutiny than say a loan for $100,000? How about a $40 million dollar loan?

Harkey is a guy who just doesn't write bad loans, he looks for them. But hey, he's selective! He only takes on bad loans that meet his high standards for having "hair". Hair on a loan defines its level of difficulty. Loans with hair are "sub-prime" meaning they don't meet the standards by which institutional lenders are comfortable with extending credit.

Six Inches of Spin

There's nothing wrong with hard money lending nor sub-prime loans provided that the actual risks for each loan are individually and thoroughly researched, analyzed, and fully disclosed prior to enlisting investor subscriptions and payments. I do, however, find egregious fault in hard money lenders who define "due diligence" and "underwriting" as the process of slapping as much paper together as possible to overwhelm and snow "sophisticated" investors with their loan underwriting prowess.  Especially when the 'final' due diligence package is missing core components needed to adequately qualify a loan and contains material misrepresentations, unverified data, withheld data, and gross omissions. When you combine Point Center's "disclaimers" with their due diligence you, as an investor, end up with thick binders I affectionately like to call "six inches of spin".

But We're Sophisticated Investors!

I love the way Harkey strokes potential investors by calling them "sophisticated". "I wanna tell you that this is a highly sophisticated group" he croons during one of his many seminars. Wouldn't you want people to think you're sophisticated? But "sophisticated" in 'Harkey speak' means "give me all your money".  No wonder he's known as 'the man who steals from widows and orphans.'  Harkey, the self-proclaimed 'godfather of trust deed lending', is nothing other than a slick con-man who's had two previous failures from which to hone his skills. He obviously has some skills. He managed to pull the wool over the eyes of very intelligent people whom one would assume to be sophisticated such as doctors, lawyers, banking professionals, and the like. He's even ruined investments made by his own trusting employees.

Which reminds me, would it surprise you to know that Harkey has never employed a CPA and that his CFO, Gwen Melanson, has a two year degree from Orange Coast College as a dental hygienist? Sorry Gwen, I wouldn't let you clean my teeth much less manage my investments. Seriously, let's see a show of hands: How many investment houses out there would hire a dental hygienist to manage a half of a billion dollars in investor funds? Any takers?

I mentioned pending litigation against Dan Harkey and Point Center Financial. It's being heard in the Orange County Superior Court of the State of California - Case No. 30-2008 00114401. It's scheduled for trial shortly after the first of the year. Over Eighty the 2,000 to 3,000 Point Center investors banded together in 2008 to file this action. I suspect the majority of Harkey's investors would have formed a certified class were they not in denial about their investments when the original suit was filed. It's a lot easier to delude yourself into believing that your investments failed due to "a bad market" than believe someone you trusted knifed you in the back and stole your money.

I understand from some investors that they didn't want to join the suit because they were afraid that if they rocked the boat they would lose their remaining investment principal with Harkey. Guess what? It's gone anyways. You invested money in collateral whose value was overinflated by multiples. Even if the market goes back to the heights of 2005 you will never recover your full principal. I believe it was part of their plan.

More Information

There is a lot of specific detail about the mis-deeds of Dan Harkey and Point Center Financial at the Point Center Investigation web site at I actually researched their claims. Then I researched Harkey's counter claims which amounted to nothing more than fiction, diversion, and misrepresentation; something about Harkey that I've grown familiar with. Frankly, I had no dog in this hunt when this fiasco came to my attention. I have nothing to do with Point Center Investigation. But I can tell you now that after performing my own analysis, it is clear that Dan Harkey had an agenda, and come hell or high water he was going to do it on the backs of his 'sophisticated' investor group.

If you are an investor and wish to file a complaint with the Securities and Exchange Commission (SEC) their complaint form can be found here:

Harkey's most recent mis-venture is called Cal Comm Capital and operates out of the exact same facility as Point Center in Aliso Viejo, California and with slight variations is doing the same thing under a different name. It's not my place to to tell anyone where or how to invest their hard earned dollars. If you're a 'sophisticated' investor you might want to give them a call. But if you want to protect your capital and see a return on your investment there are better places out there to put your money.

Look for updates in the coming weeks, especially the relevant details from the pending litigation. I'd like to see Dan Harkey criminally prosecuted for defrauding his investor base. If anyone has anything meaningful to contribute, and can factually back their claims, please don't hesitate to send a private message.

© 2012 - 2013 All rights reserved.