General Electric Capital Corp., one of the world’s top lenders, learned about one of the world’s largest Ponzi schemes long before it was exposed but kept silent to get back more than $48 million in outstanding debt, according to a lawsuit filed in one of South Florida’s biggest bankruptcy cases.
The amended complaint filed Dec. 21 in the Palm Beach Finance Partners L.P. bankruptcy case contains a damaging letter and quotes from testimony tying GE Capital to Tom Petters, currently serving a 50-year prison sentence for perpetrating a $3.65 billion Ponzi scheme.
Palm Beach Finance claims it lost $1.1 billion in cash and interest in the investment fraud.
GE Capital is the financial services unit of General Electric based in Norwalk, Connecticut. It has more than 60,000 employees worldwide. In 2011, it had more than $580 billion in assets and $6.5 billion in profits.
GE Capital in 1998 and 1999 approved a $50 million revolving line of credit for Petters and another $55 million credit line to his online discounter, RedTag Inc.
Petters ended up paying the $48 million balance to end his relationship with GE Capital once the financial giant started questioning a series of fake invoices and checks for merchandise supposedly sold to Costco Wholesale Co., attorneys for Palm Beach Finance said.
GE Capital settled with the court-appointed trustee for Petters’ defunct company for $19 million in Minnesota, but the estate of Palm Beach Finance is suing the lender for $1.1 billion.
Without GE Capital, the 290 institutional and individual investors with two Palm Beach Finance hedge funds never would have been caught up in Petters’ scheme, said Palm Beach Finance bankruptcy trustee Barry Mukamal, a Miami partner with the accounting firm Marcum. The funds were formed specifically to invest in Petters’ company and basically financed it after GE Capital got out in 2002. Palm Beach Finance filed for voluntary Chapter 11 bankruptcy protection in 2009.
Petters’ scam was predicated on a merchandise scheme in which he would buy items in bulk and sell them to stores for a profit. Investors would make money on the 90-day turnaround. The problem was there were no real goods changing hands.
Mukamal’s lawsuit alleges GE Capital learned in 2000 that Petters produced false invoices for deliveries to Costco but did nothing.
“Rather than report it, they decided to keep silent for a return of their money,” Mukamal said. “All it had to do was pick up the phone and call a regulator.”
Petters’ fraud at Petters Group Worldwide LLC came to a halt in 2008 after one of his co-conspirators and former girlfriend approached prosecutors.
Mukamal is represented by attorneys Michael S. Budwick and Solomon B. Genet, partners at Meland Russin & Budwick in Miami. The lawsuit claims GE Capital aided and abetted the fraud and seeks the $1.1 billion lost by Palm Beach Finance.
Mukamal said the GE Capital lawsuit is only one of several significant complaints filed, including one against BMO Financial Group Inc., which owns the Bank of Montreal and the bank that held Petters’ accounts, and Fulbright & Jaworski, an international law firm that initially advised the Palm Beach Finance funds after Petters’ Ponzi scheme was revealed.
Attorney David Foster, a partner with Latham & Watkins in Chicago who is representing GE Capital on the current lawsuit, could not be reached for comment by deadline. GE Capital’s response to Palm Beach Finance’s amended complaint is due today, Mukamal said.
GE Capital learned Petters Group Worldwide was a fraud about two years after granting the line of credit, Genet said. GE Capital even vouched for his character in correspondence that the scam artist used to lure others into the Ponzi, according to the complaint.
“On a personal level, I have known Mr. Petters for a little over two years and have found him to be of high character and possessing strong moral values,” Richard L. Menczynski, assistant vice president of GE Capital, wrote in a Jan. 4, 2000, letter addressed “To whom it may concern.”
The lawsuit before Chief U.S. Bankruptcy Judge Paul Hyman alleges Petters “ghost wrote” the letter and had Menczynski sign it. Menczynski left GE Capital once the credit line was approved to join another financial institution but returned when Petters asked GE Capital to rehire him, according to the complaint. Menczynski became Petters’ primary account manager.
GE Capital got all of its money back and then some, including the $55 million credit line given to RedTag. Menczynski left GE Capital in September 2000 to become RedTag’s vice president of finance.
“Petters provided Menczynski a substantial salary increase and a down payment on a home,” according to the lawsuit. “Petters showered Menczynski with enormous bonuses and benefits.”
The complaint also alleges Petters gave exorbitant gifts to at least one GE Capital employee.
But it was Petters’ own line of credit that gave GE Capital motive to participate in the Ponzi, Genet said. It had a profit-incentive clause that garnered GE Capital more than $400,000.
“The profit-sharing success fee arrangement [among other things] rendered GE Capital not merely a lender but a de factoPetters Capital ‘business partner,” the amended complaint read.
The lawsuit also discusses out how Kroll Inc., a New York-based investigative firm, produced a report recommending GE Capital steer clear of Petters, citing a “history of criminal and civil problems including: arrest warrants for forgery and bad checks, and lying to court and being found to have acted in ‘bad faith.’ `”
Catharine Midkiff, GE Capital’s senior vice president of risk and underwriting, confronted Petters with the Kroll report before the line of credit was issued and recommended to her superiors it be denied, saying, “I do not approve of being in business with a person who has previously demonstrated a lack of integrity.”
But Midkiff was ignored. The lawsuit states the profit-sharing arrangement “influenced GE Capital to overrule Midkiff.”
Mukamal said GE Capital had such an extraordinary relationship with Petters that it wrote the “To whom it may concern” letter that contradicted the Kroll report and the recommendation of its own officer.
GE Capital did nothing when it learned in October 2000 that Petters was running a Ponzi scheme and not making money flipping groceries. This discovery was made when GE Capital learned the Costco purchase orders produced by Petters were fake, according to the lawsuit.
Petters, who called Midkiff’s replacement Paul Feehan, “was infuriated and shouted obscenities at Feehan, demanding that GE Capital never again contact Costco about Petters,” the complaint stated.
When Petters tried to draw on the RedTag line, Feehan inquired whether checks from Costco for purported goods provided by Petters were real. It was then that Petters paid GE Capital and sought other investors.
Mukamal said GE Capital violated numerous regulatory and internal policies when it failed to report that Petters was running a scam.
“I believe GECC had an obligation to report the fraud,” Mukamul said. “This obligation was mandatory, arising from both the regulatory structure GECC operates in, and GECC’s internal policies. GECC’s failure was also inconsistent with being a good corporate citizen.”