EDITOR’S NOTE: Here is the declaration of James E. Byrne, an expert with whom the government consulted in the Nicholas Smirnow/Pathway To Prosperity Ponzi scheme case. It is a remarkable read — one that provides a free education from an expert who has consulted with the FBI and Scotland Yard, among other prominent law-enforcement organizations.
DECLARATION OF PROFESSOR JAMES E. BYRNE
I, Professor James E. Byrne, declare under penalty of perjury pursuant to 28 U.S.C. Section 1746:
I. INTRODUCTORY STATEMENT
1. I have been requested by counsel for the United States (hereafter “US”) to render my expert opinion in the above-styled litigation against Pathway to Prosperity Network or the P2P Network (hereafter “P2P”) in connection with the request for seizure of assets and other related relief. Specifically, I have been asked to opine regarding the character, nature, viability, and legitimacy of the transactions that are the subject of this action and any resemblance that they may have to fraudulent financial investments.
2. I understand that it is my duty to express my expert opinion independently of any influence or advocacy.
3. In rendering my opinion, I have examined the documents indicated in Exhibit A. My
opinion is subject to revision or amplification should further documentation or information be provided to me.
4. I have rendered my opinions in light of my experience, knowledge, research, and studies
in the field of commercial transactions, banking operations, financial and payment systems and instruments, and commercial fraud.
5. My Declaration is organized in the following manner:
I. Introduction (~ 1 to ~ 5)
II. Qualifications (~ 6 to ~ 13)
III. Summary of Opinions (~ 14)
IV. Explanation of Opinions (~ 15 to ~ 47)
A. The Transactions Reflected in the Materials (~15 to ~ 19)
B. The P2P Investment Compared to Legitimate Investment Opportunities
and Transactions (~ 20 to ~ 22)
C. High Yield or Multi Level Marketing Schemes (~ 23 to ~ 29)
D. Resemblance of the Transactions in the P2P Materials to High Yield
Features (~ 30 to ~ 47)
V. Conclusions (~48 to ~ 49)
II. QUALIFICATIONS
6. For more than 25 years, I have served or do serve in various positions of leadership and
responsibility in the field of international banking operations including:
- Chair and Reporter of the International Standby Practices Working Group (1994-1998) which drafted ISP98 (ICC Publication No. 590) and Secretary to the Council on International Standby Practices (lSP) (since 1998) which issues Official Comments on the ISP.
- Member of the Advisory Group to the International Chamber of Commerce (hereafter “ICC”) Task Force that drafted UCP600 (2003 – 2007).
- Member of the U.S. Delegation to the Commission on Banking Technique and Practice of the ICC (since 1995).
- Chair of the Group of Experts summoned to advise the Secretariat of the United Nations Commission on International Trade Law (hereinafter “UNCITRAL”) on the adoption and implementation of the United Nations Convention on Independent Guarantees and Standby Letters of Credit (since 2001).
- Head of the U.S. Delegation to the UNCITRAL Working Group on International Contract Practices which drafted the United Nations Convention on Standby Letters of Credit and Independent Bank Guarantees (1988 – 1995).
- Past Chair of the American Bar Association’s Subcommittee on Letters of Credit (1996 – 2000); Vice Chair (1994 – 1996).
- Member o fthe following ICC Task Forces on the eUCP and the International Standard Banking Practice.
- Member of the US Delegation to the meetings of the Commission on Banking Technique and Practice of the ICC .
- Advisor to the US National Conference of Commissioners on Uniform State Laws Drafting Committee on the Revision of UCC Article 5 (1990 – 1995).
- Director of the Institute of International Banking Law & Practice (since 1987).
- Editor of Letter of Credit Update (1985 – 1997) and of Documentary Credit World (since 1997), monthly journals of letter of credit and bank guarantee law and practice including related commercial frauds.
7. For more than 20 years, I have been involved in the following activities in connection
with studying and combating commercial fraud:
- Chair of the Group of Experts on Commercial Fraud of the Secretariat of the United Nations Commission on International Trade Law (hereafter “UNCITRAL”) (2002 to 2005).
- Co-Chair of the UNCITRAL Symposium on International Commercial Fraud (14 to 16 April 2004).
- Co-Chair of the North American and European Steering Committees on Combating Commercial Fraud (1999 – 2005).
- Advisor to the Secretariat of UNCITRAL on Commercial Fraud (2005 – 2008).
- At the request of the US Department of State, I have addressed the Plenary Session of UNCITRAL on its project on combating commercial fraud in 2002, 2003, and 2004.
8. Since I first became aware of the problem of commercial fraud in 1987, I have been consulted by the US Office of the Comptroller of the Currency, the US Securities and Exchange Commission, the Federal Bureau of Investigation, Scotland Yard, Standard & Poor’s, the Commercial Crime Bureau of the ICC, various banks and corporations, and numerous individuals regarding commercial and financial fraud. In connection with this work, I have examined more than 1,500 sets of documents.
9. For more than 25 years, I have lectured and taught courses in the areas of letters of credit, international trade finance, and commercial fraud, to bankers, business people, lawyers, banks, corporations, and trade associations in more than 35 countries throughout the world.
10. In addition to the materials that I have reviewed, my opinions are based on my knowledge of standard international letter of credit and general commercial practice, and my research and studies regarding letters of credit and commercial fraud. My research and conclusions are regularly published and circulated in the letter of credit, financial, and commercial community and are subject to ongoing critical assessment. My qualifications and my publications are set forth in my resume which is attached as Exhibit B.
11. I have received the following degrees: L.L.M., University of Pennsylvania (1978); J.D., magna cum laude, Stetson University College of Law (May 1977); B.A., cum laude, University of Notre Dame (June 1968).
12. I have been a full-time faculty member at George Mason University School of Law since August 1982 where I teach subjects related to commercial law and practices including Commercial Paper, Letter of Credit Law, Contracts, Sales, Electronic Commerce, International Commercial Transactions, and Commercial Fraud.
13. I have given sworn written expert statements to courts in China, France, England, Singapore, South Korea, Switzerland, and the United Kingdom. I have been admitted as an expert on commercial fraud, banking operations,and standby letter of credit practice and given expert testimony in Canada, Hong Kong, Norway, and Thailand as well as in approximately 20 federal and 4 state courts in the United States.
III. SUMMARY OF OPINIONS
14. In my considered professional opinion, the investment scheme described in the materials that I have reviewed are not legitimate but resemble and are classic instances of so-called high yield frauds and fraudulent pyramid schemes. The proposed returns are excessive for even the most risky legitimate investments and are simply preposterous for investments whose principal is supposedly guaranteed. In addition, the materials contain other features common to commercial frauds including an element of a pyramid scheme and, if there were payouts, it is my opinion that it is highly likely that they were derived from the investment of the same or other victims, making the scheme also a ponzi scheme. It is apparent to me that the materials and the scheme which they describe were deliberately and artfully constructed, drawing on similar scams to deceive, confuse, entice and trap would-be investors.
IV. EXPLANATION OF OPINIONS
A. The Transactions Reflected in the Materials
15. Cast in the form of an “investment club”, the scheme described in the materials offer
sustainable higher returns than those available from conventional forms of investment
(“the highest returns in the safest environment”) in addition to so-called “handsome
referral commissions”. The investment aims for investors with USI00 to US$25,000 to
invest, making it a working class type of fraud.
16. The funds are turned over to the investment and “earn” returns that range from 1.5% daily for a 7 day plan Plus the return of the initial investment to 2.67% daily for a 60 day plan or 160.2% plus the return of the initial investment. The weekly returns on the 7 day
investment would amount to approximately 540% per year without taking into account
the principal and the 60 day plan would return approximately 950% annualized.
17. Despite the excessive nature of these returns, the principal invested is said to be
“guaranteed” by a “personal guarantee”.
18. There is no explanation in the materials that I have examined as to the source of these excessive returns or how they can be guaranteed. The materials do state, however, that it is not invested in “public securities” or the stock market, “Forex” (which I understand to mean foreign exchange transactions), and is chiefly “offshore” and managed by ”’EXPERTS in their own fields”.
19. In the course of the investment, the materials that I have reviewed describe another venture that was begun, sometimes described as “Energy Ltd.”. “P2P Energy Bank”, and other times described as a “global ‘bank”‘. Coupled with this plan was the issuance of debit cards by which investors could withdraw their supposed funds.
B. The P2P Investment Compared to Legitimate Investment Opportunities and
Transactions
20. While it is possible that a legitimate investment can occasionally yield a return in the ranges indicated in the materials, such returns in the times indicated are extremely rare and are not sustainable. Such investments are highly speculative and most such investments result not only in no returns but in the loss of principle.
21. In the legitimate world of financial investments, the return on an investment correlates with the perceived risk undertaken. The riskier the investment, the higher the return and the lower the perceived risk, the lower the return. In legitimate financial transactions risk is measured in a variety of ways which, while not perfect, provide a relate notion of the perceived riskiness of the investment. The return on obligations of the US government for a similar period sets the bench mark for relatively safe investments and investments deemed by rating agencies to be investment grade track the yield on Treasury obligations.
22. The returns indicated in the materials that I have examined for this scheme are so high that it would not be excessive to term them “extraordinary”. Yet because the principal is guaranteed, they would be regarded as extremely safe. Moreover, the returns are described in the materials as being obtained from “low or medium risk ventures”. Such combinations do not exist in the world of legitimate finance. These proposed returns turn the general rule regarding risk on its head, proposing to pay phenomenal returns for “safe” investments.
C. High Yield or Multi Level Pyramid Schemes
23. While it is my opinion that the investments described in the materials that I have reviewed do not resemble legitimate transaction, it is also my opinion that they do resemble and are, in fact, an instance of so-called high yield investment scams and of so called Pyramid scams.
24. High Yield investment scams began to appear in a concentrated manner in the 1980s. They offered excessively high returns. Originally, they used different names since the term “high yield” was attached to a type of highly speculative legitimate investment at the time, one that involved investment in so-called ‘Junk bonds” or bonds which were not rated by rating agencies because of the low creditworthiness of their issuers. At that time, they were known by a variety of names, the most infamous of which was “prime bank” investments, a name taken from the fact that the preposterous returns were often attributed to the involvement of a major (or “prime”) bank. After the original meaning of “high yield” was forgotten and the term “prime bank” attracted unfavorable publicity, these schemes began to describe themselves as “high yield” investments.
25. Regardless of the name, they have common characteristics which do not necessarily have anything to do with the involvement of banks. Indeed, the investments are of two types, some are very specific regarding the nature of the investment, attributing the returns to some esoteric aspect of international finance such as forfeit or first demand guarantees.
Others are vague about the nature of the investment. Invariably, the esoteric sources of the returns turned out either to be fictions or not to yield such returns in the real world. On the other hand, the vague schemes were equally unreal. No real investment could simply avoid explaining its nature or character.
26. Multi Level Marketing schemes (sometimes referred to as “MLM”) were quite common in the 1980s and early 1990s and when connected with high yield scams are invariably pyramid schemes. Recently, such combinations have been less common as their fraudulent character became exposed. The schemes play on notions of cooperative investment, with the pooling of funds to achieve a disproportionate return end. They involve incentives to attract other investors in the form of various financial incentives. frauds. It is also interesting to me that the materials themselves deny that P2P is a “failed” M.L.M. scheme.
27. There are a variety of characteristics common to commercial frauds. Some are always present and others are less omnipresent. These features include:
a. returns that are disproportionate to the risk involved;
b. the source of the return is obscured;
c. entail unnecessary secrecy;
d. contain references to attractive moral principles;
e. do not involve investments that can return the promised yields;
f. involve intricate explanations as to why the promised returns have failed to materialize.
28. While not all of these elements may appear in a single scheme, it is common for several of them to appear. The defining character of the scam is the promise of disproportionate returns.
29. Regulatory authorities and other responsible institutions of the leading developed countries have publicly warned about High Yield Investment Scams and have disassociated themselves from them, including the US Office of the Comptroller of the Currency (since 1986), the Federal Reserve (1993), all US banking regulators (1993), the Head of the Banking Supervision Division of the Bank of England (1994), the British Bankers Association (1993), the US Securities and Exchange Commission (1993), the International Chamber of Commerce (1993), the US Bureau of the Public Debt (1999), and UNCITRAL and the UN Commission on Drugs and Crime (2007). Since the initial warnings, numerous other warnings have been given and can be readily obtained by any person professionally experienced in finance or investment.
D. Resemblance of the Transactions in the P2P Materials to High Yield Features
30. As indicated, the feature most characteristic of a high yield scam is the disproportion between the supposed returns and the perceived risk. That feature alone would identify the scheme described in the materials that I have reviewed as fraudulent. There are, however, other features of the scheme that reinforce this conclusion.
31. As also indicated, a similar characteristic of a species of high yield scam is the failure of the scheme to offer any explanation whatsoever of the source of the extraordinary returns and guaranteed. The failure of the materials that I have reviewed to account for its promised guaranteed returns other than suggesting that it chiefly from “offshore” sources marks it as belonging to this branch of the scheme. It is somewhat unusual in that it excludes several investment modes such as traded stock, publicly traded securities, and foreign exchange (although such investments are not risk free and do not provide guarantees of the initial investment).
32. A typical characteristic of high yield scams is that they contain an international dimension. Such an attribution adds an element of glamour, makes it much more difficult for an investor to determine the authenticity of the claimed returns. An investor could convince him or herself: “Even though such returns cannot be obtained locally, perhaps it is possible in other countries.” In fact, the same fundamental law about the correlation between risk and return applies everywhere. As indicated, the materials that I have reviewed peg the source of the promised extraordinary returns as being offshore and refer to the “international market” that they have attracted, falling into this pattern while providing some explanation for the source of the returns, however vague.
33. Another feature of high yield scams is a sense of exclusivity. This sense is honed to a high degree in multi level marketing programs. The notion is that investors are being introduced into a special network of investors with insights not accessible to ordinary mortals and obtained in part by pooling their resources. The materials that I have reviewed contain such features as illustrated by the use of the word “Club” to describe the venture, regular reminders that the program is by invitation only and that membership is by the grace of the team of fraudsters that control the program, regular allusions to the positive affect produced by pooling (enabling investors to earn dividends “totally out of reach for the average individual” and referring to accessing “the high interest that millionaires enjoy”), and its ability to garner the type of returns only available to the very wealthy, and regular appeals to the common interest and proper behavior.
34. Coupled with this sense of exclusivity, is the notion of confidentiality, another feature of high yield scams. The message is that the investment is by invitation only, not to be publicized, and that the investor is obligated to respect its confidentiality by not discussing it with outsiders. The materials that I have reviewed contain such references. The investor agrees that the material generated “must be kept private, confidential and protected from any public disclosure” [bold typeface in original]. The transactions are described as “private”. The materials also state that “[w]e will not tolerate nor accept any bad publicity of any nature, from anyone whatsoever” [bold typeface in original] with the threat of expulsion in the event that this prescription is violated. When complaints were made externally to service providers or supposed payment agents,
scathing rebukes were made to the “members”.
35. In part, this notion of secrecy in commercial frauds is meant to discourage reporting the scheme to investment councilors or public authorities who would recognize it for what it is. In addition to the features mentioned above, the materials that I have examined contain implicit warnings that complaints to public authorities contribute to the delays in paying out funds. In a similar vein, the materials incorrectly state that the transactions are exempt from the DC Securities Act of 1933 and the Securities Exchange Act of 1934 and that the materials themselves are not solicitations for an investment, a tactic not uncommon in high yield scams.
36. In multi level marketing, there is an inconsistency with such a notion in that there are
incentives to inducing others to invest. However, fraudulent commercial schemes are not
noted for their internal consistency and such an inconsistency appears in the materials that I have examined. The materials that I have reviewed attempt to juggle this inconsistency by prohibiting advertising (unless it is approved) while offering incentives for finding new members and permitting them to inform relatives and friends and networking on a small scale without permitting general advertising.
37. As noted, the materials that I reviewed contain elements of a pyramid scheme. A pyramid scheme is one in which early investors earn returns from inducing investments by subsequent investors. The more investors that a person introduces, the greater the yield to the person who introduced them.
38. It is not uncommon for commercial frauds to contain or repeat warnings against similar
frauds. This feature disarms suspicion with the notion that someone would not be warning about a fraud if it were itself such a fraud. The materials that I have reviewed contain several warnings about “H.Y.I.P.” (which I understand to refer to “High Yield Investment Plans”) and M.L.M.s (which I understand to refer to “Multi Level Marketing” programs). They also contain warnings to the effect that the fraudsters who have prepared the materials do not “believe” in them. Indeed, the materials that I have reviewed contain a perceptive critique of high yield programs (the interest that is offered is “ridiculous”) and state that “[t]his ‘Club’ does not rely on new people joining to succeed or sustain….”
39. There is also a warning about the ponzi character of such schemes. The reference to “ponzi” schemes is derived from the scheme perpetrated by Charles Ponzi early in the 20th Century by which he paid earlier investors from the investments from subsequent investors or merely booked returns so that investors had large paper profits. Such schemes can only succeed provided that they balance the amounts withdrawn both by investors and the fraudsters themselves with the amounts invested. Recognizing its vulnerability to criticism, the materials cynically assure the investor that th funds pay “real returns/dividends”. They also describe a high yield program as one that “uses the funds from one investor to pay the next investors’ commission.”
40. The cynicism of the drafters of these materials shows in their tongue in cheek statement that their “programers” recommend the use of “H.Y.I.P.” “Software”. Even if there was such software, the underlying ‘joke” was that the same software would have worked because the P2P program was just another high yield scam.
41. Incidentally, I note that these references reveal the familiarity of those who developed this scheme with high yield and multi level marketing frauds. This familiarity is not surprising to me since the scheme that they have created is an instance of them but it is unusual for the scams to reveal their awareness of the nature of these schemes so expressly.
42. As indicated, high yield scams often contain references to the altruistic nature of the program or those involved in it, seeking to appeal to this aspect of human nature in part in the hope that such an appeal will result in the suspension of prudent judgment about those who have (or claim to have) such traits. While not a major feature of the materials that I have examined, there is a reference in them to the “strong moral foundations” that underlie the scheme.
43. It is not uncommon for high yield investments to refer to themselves as “legal” and to use the term “clean”, sometimes in reference to the funds that they receive or pay. Sometimes they require such a statement from investors. While the materials that I have reviewed do not use the common formula, they do contain a statement that the program is legal. While odd, this term alone is not decisive. However, the statement is that they program is “legal and clean”. The term “clean” has no meaning in this context in legitimate investments and in my opinion is drawn from the family of high yield frauds that commonly use it.
44. In rendering my opinion, I am not unmindful of the disclaimers made in the materials that I have reviewed. It is not uncommon for high yield scams to contain such disclaimers in an attempt to provide the fraudsters with excuses or defenses in the event of inevitable complaints. Such attempts to avoid liability must be read in the context of the entire scheme. A few lines in pages of materials that suggest that the investor assumes all risk, particularly when they contradict the inducements and guarantees, would be readily overlooked by any investor and does not, in my opinion, alter the fraudulent character of a program promising impossible guaranteed returns. In this vein, the materials state that the investor agrees to indemnify and hold the principals harmless from “any liability”. They also state that the investment is at the investors own risk, despite the guarantee that is prominently given, and that past performance “is not an explicit guarantee for the same future performance”, conveniently ignoring the promised returns which are not said to be dependent on any such contingencies and do not refer to past performance but are promises of future performance.
45. I note that the materials that I have reviewed state that the investments are undertaken by experts in their fields. Such claims are common in high yield investment scams. In my opinion and experience, any expert or and most experienced investment counselor would immediately recognize the fraudulent character of the scheme described in the materials.
46. It is difficult from the materials to determine the full scope of the Energy Ltd. program and the plan to obtain debit cards. Attempts to imitate a bank or to provide debit cards are advantageous for a high yield scam in that they provide the appearance of legitimacy. However, claiming to be a bank or, as the materials sometimes qualify it, a “bank” does not make something a bank. Moreover, one need not be a bank to distribute debit cards. It is not clear from the materials whether the debit card program was ever launched but, even it it was, it merely would constitute a private label arrangement by which the program would fund withdrawals through a third party service provider. In the past, I have encountered high yield scams with such features.
47. As indicated, it is common for high yield programs to generate numerous excuses when, as is inevitable, investors are unable to obtain their funds. Such excuses are intended to pacify investors, generate sympathy, or await the investment of further funds. The materials that I have reviewed contain numerous examples of such excuses. Delays are blamed on computer “glitches”, program failures, errors, trips, failure of investors to comply with rigid and counter-intuitive rules, failure to fill out forms properly, excessive demands on staff, marriages, third party providers, and the Great Recession of 2008/9. They are coupled with threats and warnings as well. A classic example is the expression of perplexity as to why anyone of good will would not “appreciate the opportunity” to earn “the returns we are being paid” and as to why they would “complain and moan” “if there is a 30,60,90, or even 120 day delay”.
v. CONCLUSIONS
48. It is my considered professional opinion that the programs described in the P2P materials that I have reviewed constitute an instance of high yield and multi level marketing fraud and are not legitimate.
49. It is also my opinion that the materials that I have reviewed were deliberately constructed to give the impression of legitimacy and to entice unsophisticated investors.
EDITOR’S NOTE: The “story” below is not real. The PP Blog occasionally presents fantasy posts, parody and satire as a means of advancing the discussion about issues in the world of online crime and marketing schemes.
