Accused Fraudster Spent His Money on Other Frauds

I just stumbled on this hilarious Matt Levine story from 2015. It reviews the case of James Louks and his company FiberPoP Solutions, which defrauded investors of $4.3 million. But what did Louks do with the money? He invested it in other frauds, most of them much more transparent than his own. From the SEC complaint:

22. In 2004, Defendants pursued funding through a transaction in which, in exchange for an advance fee of $200,000, FiberPoP was to receive at least $20 million. Defendants never received this funding.

23. In 2012, Defendants provided an advanced fee of $10,000 to “Vital Funds, Inc.,” ostensibly toward a two-year lease of a $33 million stand by letter of credit. The individuals involved with Vital Funds, Inc. were found guilty of prime bank scheme-related criminal charges in April 2015 in U.S. v. Holland et al., 3:14-cr-73 (M.D. Fla 2014).

24. In June 2013, Defendants deposited $500,000 into an escrow account as a deposit for a $35 Million stand by letter of credit. The individual with whom they deposited the funds emptied the escrow and was indicted for conducting a prime bank scheme.

25. In 2013, Defendants entered into an agreement with Worldwide Funding III wherein they deposited an advanced fee of $90,000 into an escrow account, purportedly in exchange for a €10 million financial instrument. This instrument was then supposed to be placed into a trading account for FiberPoP’s benefit. The escrow account was emptied in September 2013, and Defendants never received the €10 million financial instrument.

Levine considered that maybe Louks was also somehow part of the schemes he was passing the money to, but apparently not; it really seems that he was just getting repeatedly scammed. Did he even know what he was doing?

The SEC said that Louks "knew or had reason to know that the financing schemes were fraudulent," but that's a big "or." There's lots of reason to know that FiberPoP kept investing in frauds. You or I, if we were the chief financial officer of FiberPoP, would have spotted the frauds. They just sound like nonsense, for one thing; what could "a two-year lease of a $33 million stand by letter of credit" even mean? Louks never "conducted any meaningful due diligence." And he was occasionally warned against getting involved in these transactions, but kept doing it anyway.

But all of that is just logic. I prefer to think that there's a more romantic explanation for how Louks kept getting fooled, which is: Maybe he believed it? Did Louks know that he was being scammed, over and over again? Or each time, did he think he was getting a little closer to the truth, to finally understanding how the complex world of multi-million-dollar finance worked and how he could use it to his advantage?

A few weeks ago I said that the financial industry is "built on the dream of making money for nothing, of arbitrage, of perpetual motion machines, of converting intellect into cash without the annoying interventions of hard work and risk." That is not because financiers are lazy jerks. It's because that really is what finance looks like from the outside (and, once in a while, if you're lucky, from the inside). It is an abstraction, moving around digits that represent real economic activity without actually doing any of that activity. Bankers and hedge fund managers sit at computers and push buttons and money comes out. James Louks has a computer. Why shouldn't he be able to make money come out of it?

The people selling Louks "advanced fee" and "prime bank" schemes weren't just selling him ways to get rich. They were selling him perceived mastery of an alienating system, a way to make the complexities of modern finance tractable and turn them to his own benefit.

If modern finance is astrophysics, these scams are like astrology: They look superficially like the real thing, but instead of a cold indifferent universe, they proclaim a faith in a universe centered around the individual listener. It seems to me that Louks didn't want to hear about Fama-French factors and the tradeoffs between risk and return. He wanted to hear about a financial system that lets a fortunate few initiates create money easily and risklessly, and he wanted to be one of them.