While I was trudging around in the mud of the Peruvian Amazon, getting nibbled by flesh-eating bugs and inhaling heaven knows what kind of toxic fumes at an illegal gold mine, investigators at the U.S. Securities and Exchange Commission and the U.S. Attorney’s office in Connecticut were mucking around in a considerably less pleasant swamp — the sprawling Francisco Illarramendi fraud case.
The English-language press has finally started to understand this story, so if you need a quick recap, go see the Financial Times here, and the Associated Press here. (Thanks, FT, for the link!) The story up to now is that the US Securities and Exchange Commission sued Illarramendi, a Connecticut financial advisor, for supposedly taking investments out of a hedge fund and using the money to make private equity investments in the names of other funds — rather than in the names of the original fund and its clients. Most of the allegedly misappropriated money came from the pension fund of Venezuela’s state oil company, PDVSA. Upon closer examination, it turned out that the hedge fund’s “legitimate” activity was very sketchy — it existed to conduct black market currency trades between the Venezuelan bolivar and other currencies, a practice that is illegal in Venezuela. Then, out pops an amended SEC lawsuit and a press release from the US federal prosecutor in Connecticut, saying that Illarramendi had been not just mis-investing 10% of one fund, and not just running a currency scheme, but in fact had been running a Ponzi scheme. He pleaded guilty to several charges, including admitting to having agreed to pay a couple finance-industry types $3 million to write a letter vouching for the existence of non-existent money.
Legally speaking, that’s where we stand now. The US is accusing ex-banker Juan Carlos Horna Napolitano and accountant Juan Carlos Guillen Zerpa with conspiracy to obstruct justice. Illarramendi is awaiting sentencing and could face “a maximum term of imprisonment of 70 years, fines, restitution for the full amount of the losses suffered by investors and creditors, and forfeiture of assets,” according to the prosecutor’s statement. Ouch.
But guess what: We still haven’t plumbed the full depth of the fraud. There may be more people involved. Some of the money that got invested into the Illarramendi funds may have been fake to start with. And PDVSA may be playing both sides of the fence, as both victim and friend-of-the-perpetrator.
A lot of names are involved in this case, but most of them have yet to show up as defendants in either criminal or civil cases. I am putting together a list and will post it soon, after I have done the due diligence of trying to contact everyone on my list. It is only fair to give them a chance to reply.
It’s easy to blame Illarramendi for all the losses at the PDVSA pension fund. But a person familiar with the case tells me that Illarramendi and other fund managers are chosen in part based on their willingness to accept inflated values for the deposits they receive. That is, PDVSA’s pension fund had already lost money, and was carrying assets on its books at fake, inflated values.
To explain: Something that has happened from time to time in Caracas’s financial markets is that someone issues a bond or other form of IOU that becomes worthless, but nobody wants to take the loss. The ultimate debt is never going to get paid, as the money is gone. But the paper is on someone’s books. Banks, of course, would rather have an illiquid $50 million IOU on their books than nothing at all. In fact, this was the ultimate cause of the fraud by FTC Capital Markets against PDVSA in 2008, according to a Venezuelan familiar with the case.
FTC misappropriated money from Citgo as part of a favor for buddies back in Caracas who needed to get $50 million in cash into Banco Industrial de Venezuela (BIV), this Venezuelan said at the time. It all happened during the global financial crisis, and regulators were asking about an illiquid note that was on the bank’s books. BIV needed to cash in the note, so they went to FTC, which had issued the note, and FTC took the money from Citgo — without Citgo’s permission or knowledge. Citgo denounced the theft and Guillermo Clamens and FTC took the fall. Please note that I can’t confirm this version of events, and am open to being told otherwise, but it lines up nicely with the SEC’s version in its complaint. (Clamens and FTC settled this civil case without admitting wrongdoing. A case brought by Citgo went to arbitration.)
So now imagine the unaccountable, unaudited PDVSA pension fund. How many similarly worthless notes does it have on its books? How much cash does it hold that have lost value to inflation and devaluation? Did the fund ever invest in any of Venezuela’s numberless pyramid schemes, and take some unrealized losses? I don’t know. But the person familiar with the US case says that there were items on the pension fund’s books at inflated values. It may be that Illarramendi wasn’t the first Ponzi scheme, but rather a Ponzi of Ponzis. A of dustpan of garbage investments.
Who’s the real “victim”?
Legally speaking, PDVSA’s pension fund is the victim here. But for several years, the fund has been run entirely from inside PDVSA. The company’s CFO, Eudomario Carruyo, has signed recent letters to the company’s union and pensioners regarding pension fund management. Rafael Ramirez, the company’s president, said recently that the company is now participating in the US case to recover money for its pensioners.
This could get rather uncomfortable for PDVSA and Ramirez. The early investors who received ill-gotten gains thanks to the PDVSA investment include people close to the Venezuelan government, according to the person familiar with the case. PDVSA, in case you don’t know, is a very political organization, not only owned by the Venezuelan government but very involved in government policy. So PDVSA has a conflict of interest.
In general, when there is a conflict between government policy and workers’ pay or rights, PDVSA sides with the government on the political issue and then buys off the workers with cash. That seems to be happening. Nobody has confirmed it yet, but it seems that PDVSA’s withdrawal of Venezuela’s whole monetary stabilization fund at the beginning of February was an attempt to shore up the pension. This is speculation, mind you, but the timing is right, and the central bank says that the $829 million withdrawal was a “withdrawal from the Monetary Stabilization Fund following a request by the Finance Ministry and instructions of PDVSA.”
I don’t understand why the pensioners and unions haven’t hired their own US lawyer and sought to kick PDVSA off the case. My guess is that living in Venezuela, it doesn’t even occur to them that they could do such a thing.