Bayou transfers set off alarms

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It looked like a high-stakes game of three-card monte.

In the months before Bayou Management LLC's hedge funds collapsed, its founder sent most if not all of what was left of his investors' money ricocheting around the world -- from New York to London, Germany, Hong Kong and Flemington, N.J. Sam Israel III also signed an investment contract that was supposed to alchemize the bulk of the money -- $100 million -- into $7.1 billion.

The game ended, authorities say, only after Mr. Israel turned the $100 million over to a New Jersey man who tried to continue shuffling the money around, aided by a Kentuckian, a pair of Europeans and a small-time Hollywood moviemaker. Sensing something suspicious, employees of several financial institutions helped Arizona authorities seize the $100 million so it can be returned to Bayou's investors.

A detailed look at these machinations, culled from court records and interviews, offers an inside glimpse of what authorities say is a little-known netherworld of investment charlatans. It also shows how antifraud tripwires now arrayed throughout the U.S. finance system have increased banks' vigilance.

Prompted initially by criminals hiding ill-gotten gains and more recently by terrorist financiers, state and federal authorities have pressured financial institutions to be ever more wary of accepting large unexplained deposits. Bank executives long have complained that money-laundering rules are onerous and costly.

In the Bayou case, it was branch-level employees who blew the whistle. "Everyone in the banking industry has gotten religion," says Ian Comisky, a money-laundering expert. Banks report lots of innocuous activity to authorities "defensively," he adds, "but it seems like they picked up something correctly in this case."

Authorities say Bayou investors' money was being used in a convoluted and timeworn scam usually attempted on a much smaller scale. The scheme involves promising investors eye-popping returns to get a hold of their money. Then the con artists persuade a series of banks to accept the cash by overwhelming low-level employees with financial gobbledygook -- just plausible enough to pass muster but ultimately so nonsensical that the banks look negligent later. The grifters then make off with the money, leaving victims with only an impenetrable money trail to follow and flatfooted bankers to sue.

Investigators say Mr. Israel was either the conmen's co-conspirator or a swindler who got swindled -- a hapless mark making a last-ditch $100 million bet to recoup losses after wildly exaggerating results for years. He didn't respond to numerous messages.

Bayou's woes burst into public view last month, after Mr. Israel, 46 years old, announced he was closing shop but failed to return investors' money. Authorities say investors had entrusted his Stamford, Conn., firm with more than $300 million, and Bayou claimed that those assets had grown to well over $400 million. But federal prosecutors say in a Sept. 1 civil suit that the firm had "overstated gains, understated losses and reported gains where there were losses" since 1998, the year after it started investing. The suit calls Bayou's assets, including the $100 million seized by Arizona, "the proceeds of criminal activity" and demands that all remaining funds to be turned over to the federal government for return to the investors.

Prosecutors say Bayou began trying to cover its tracks in April 2004 with a dizzying series of transactions. First, it transferred $150 million from Citibank in New York to a securities account at Barclay's Bank in London before returning the money to Citibank. Then, in July 2004, Bayou emptied its five Citibank accounts of $161 million. About $60 million of that remains unaccounted for, including $32 million wired somewhere in the U.S. On July 8, 2004, $120 million was wired from the Citibank accounts to a German bank, Bayou lawyers say in court papers, and then $115 million of that was transferred to another German bank on Oct. 25, 2004.

On Dec. 5, 2004, Mr. Israel and Bayou Chief Financial Officer Daniel Marino, meeting as Bayou's board, authorized Mr. Israel to sign a $100 million investment contract for money to be held at a London securities firm under his and Bayou's name. The next day, about $121 million from the second German bank -- the gain came from euro's value increasing -- was wired to the London Securities firm, but in mr. Israel's name only, bayou says in court papers.

Then things went from odd to truly bizarre, according to arizona court filings.

On March 29, 2005, Bayou hired Southern California businessman Lewis P. Malouf as "director of investments." Little is known about Mr. Malouf, but local federal court records show a person with the same name and a similar signature filed for bankruptcy protection in 2002 to avoid eviction.

That same day, Messrs. Israel and Malouf, 61, signed a 12-page contract, all in capital letters, under which Mr. Malouf would oversee two "private, managed, buy/sell leveraged transactions" totaling $100 million. Without explaining how, the document projected returns of $7.1 billion over 10 years.

To execute the investment, Mr. Malouf turned to Karl Johnson, who runs a company called Majestic Capital Management from his home in Flemington, N.J., says Paul Robbins, a lawyer for Mr. Johnson. The lawyer says Mr. Johnson, 64, never met Mr. Israel. Mr. Robbins says his client "is not involved -- nor did he have the intention of being involved-with anything illegal."

Mr. Malouf declines to discuss the matter in detail. "All of this information is inaccurate," he says via email. He specifically denies any business dealings with Mr. Johnson or Majestic.

Back in April 2004, just as Bayou started moving funds around the world, Mr. Johnson went to Wachovia Bank's Flemington branch and opened the first of several accounts for Majestic, Arizona authorities say in court papers. Bank employees told investigators that Mr. Johnson regularly called about big pending deposits from overseas that never materialized.

This time was different: In mid-April 2005, $99 million was transferred from London to a Wachovia branch in Hong Kong, before being sent to one of Majestic's Wachovia accounts, records show. Another $809,000 or so was wired there a week or two later. (Bayou lawyers say in court papers that the money came directly from accounts controlled by Mr. Israel, including the London one that previously had held $121 million, but filings by Arizona officials say the funds came through other accounts.)

Mr. Johnson told a Wachovia banker that the money belonged to a wealthy New Yorker he declined to identify, lest Wachovia poach his business, and would be invested in "bond deals" by Dietmar Hormann, a German money manager for an outfit named Advanced Asset Management, authorities say. (Mr. Hormann says Mr. Johnson hired his firm, based on a reference from a mutual friend in California, to help invest $100 million.)

Messrs. Johnson and Hormann wanted to move the money from the bank account to a Wachovia Securities brokerage account. Mr. Hormann contacted Douglas Falconer, a Hollywood producer with some small movies to his credit for whom Mr. Hormann was trying to raise capital. On April 25, Mr. Falconer made a "cold call" to a Wachovia Securities branch in Los Angeles, where he was connected to broker John Carswell. (Mr. Falconer confirms calling Mr. Carswell as a favor to Mr. Hormann, but denies knowingly taking part in any scam.)

Mr. Falconer told Mr. Carswell that Mr. Hormann and a colleague, Nebile Brougham, would contact him. When they did, Mr. Carswell was told that they wanted Majestic's $100 million moved to a brokerage account via a "MT103 transfer," Arizona officials say in court papers.

Mr. Carswell was baffled: Why would a Hollywood filmmaker call him on behalf of a German trader? Why move the money from New Jersey? And what was an MT103 transfer? Mr. Carswell had no idea, nor did his coworkers. His assistant, Nilsa Santiago Sabir, asked Mr. Johnson, but his explanation was "confusing and not making any sense," Arizona authorities say in court papers.

Ms. Santiago referred the matter to Wachovia Securities' antifraud unit, where compliance analyst Austin Jones did an Internet search that turned up a mention of Mr. Hormann and Ms. Brougham in connection with "an alleged $300 million fraud" in Hong Kong weeks earlier, court papers say. Mr. Jones emailed the find to Ms. Santiago. "It shows beyond a shadow of a doubt that this is a scam," he wrote.

Mr. Hormann and Ms. Brougham, who is based in Geneva, deny involvement in fraud. He says his firm bowed out of the Hong Kong deal when questions arose about it. They also say they stopped dealing with Mr. Johnson. They say they knew nothing of Bayou or its deal with Mr. Malouf and thought Mr. Johnson owned the $100 million. "Why should anyone give him funds? Maybe an idiot from Timbuktu," says Ms. Brougham.

Back in Flemington, Mr. Johnson was now a regular at the Wachovia branch. On April 29, he asked to transfer the $100 million to his brokerage account. Banker Clarinda Estevez told him her authority was limited to $500,000 transfers and, in any case, the brokerage account hadn't been opened. He became upset, saying he was in danger of losing $15 million and his "position." Ms. Estevez asked what he did for a living.

"Young lady, you shouldn't be asking those questions," he replied, Arizona authorities say in court papers.

Now the Flemington bankers were suspicious, too: Except for Majestic's initial Wachovia account, all the others -- including the $100 million one -- had been opened over the phone, and there was "no normal business activity" on any of them, authorities say. The circumstances reminded Ms. Estevez of a fraud she'd observed at another bank.

Mr. Johnson returned later that Friday and persuaded another employee to open a brokerage account and transfer the $100 million. The transaction was rejected because that employee also had insufficient authority. Unaware of that, Mr. Johnson sent flowers the following Monday. The card said something like, "Thank you ladies for all your work," court records say.

Ms. Estevez reported the matter to Wachovia Bank's antifraud unit the next day, May 3, three weeks after the money arrived. Within days, Wachovia told Mr. Johnson to withdraw the $100 million by June 16.

Mr. Johnson then turned up at a Smith Barney brokerage and asked to set up a $100 million account. There, Arizona authorities say his story changed: He said Majestic Capital Management was a unit of the Majestic Foundation, an offshore charity, and profits from the account would finance AIDS clinics around the world. He said the money was "good, clean and cleared funds." The brokerage rejected Mr. Johnson's business and referred the matter to Smith Barney's antifraud unit.

Next, Mr. Johnson went to a Commerce Bank branch, which accepted the $100 million deposit on about May 10. But after an employee drove by Majestic's business address and found it to be Mr. Johnson's "modest residence," the matter was turned over to a bank compliance officer, Don Temple.

Mr. Temple called Mr. Johnson and received yet another story: The money had been held in London for three years and belonged to the Maloof family -- no relation to Mr. Malouf -- owners of the Sacramento Kings basketball team. He mentioned the two Europeans and said they would be buying "Fed-rated" bonds at discounts and selling them for certain profit on the "Euro clear screen." He refused to explain further, saying he feared the bank would steal the idea from him.

Mr. Johnson then had a Kentucky associate, Tedd Collins, call Mr. Temple, Arizona authorities say. Mr. Collins related yet another story, authorities say: The money was from a loan secured by an Arizona gold mine worth $152 billion, authorities say. (Mr. Collins didn't return calls.)

A day or so later, the Arizona's attorney general opened its investigation. Authorities there won't say who tipped them off or why the tipster called authorities in a Southwestern state. But the matter ended up with one of the nation's most prominent money-laundering cops -- Cameron "Kip" Holmes, an assistant attorney general who helped draft a 1985 money laundering statute for Arizona that became a model for other states. Wachovia, Commerce and Smith Barney were subpoenaed on May 13.

Within days, Commerce Bank returned the money to Wachovia. Mr. Holmes's investigators quickly concluded that much of what Mr. Johnson and his associates had said was false. When the Maloofs' money manager was asked if the family had $100 million in a bank account, "he laughed out loud," court papers say. The story about the $152 billion Arizona gold mine story also was implausible: Less than $8 billion in gold had been mined in the state since it joined the union. As for Mr. Collins, Wachovia determined that an account he maintained at another bank in Kentucky had been used in an attempted $22 million counterfeit-check fraud, court papers say.

The authorities decided they had stumbled upon a massive attempt at what experts call "prime bank instrument fraud." Perpetrators, Mr. Holmes explains, "use specific language, like MT103, that implies some kind of special knowledge, but it's just an emperor's-new-clothes situation." The funds are funneled through various institutions to "remain ahead of the trailing train of original victim investors," an Arizona investigator adds in court papers.

When victims come looking for their money, each fraudster along the trail claims to be a victim of the previous one. To deflect blame, the Arizona investigator says, they trick "generally inexperienced front-line employees of large financial institutions" into accepting their money, while purposefully leaving behind evidence of fraud -- exposing the bank to civil suits, sometimes filed by the fraudsters themselves.

That's what Arizona officials say was attempted at Wachovia, Smith Barney and Commerce Bank. "These three financial institutions are really good examples of compliance people working smoothly with customer service people," says Mr. Holmes. "It's also an excellent example of people resisting the lure of a big deposit." (Wachovia and Smith Barney declined to comment; representatives of Commerce Bank didn't return calls.)

On May 19, an Arizona state court seized the money, finding evidence that it was "being used in a fraud on various financial institutions," the state says. Arizona wants to hand the matter over to federal authorities. The federal probe continues.

In early June, Bayou sent its clients an update on their investments. "The final two weeks of the trading month of May were full of hope and promise," it said. The firm's bets had "paid off well."


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