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Ponzi Traps Can Snare Anyone

NASCAR stock car driver, Brennan Poole, in a car sponsored by DC Solar.
DC Solar-sponsored driver Brennan Poole in the NASCAR Xfinity Series Road America 180, August 2016.
Photo by Wikimedia Commons user Royalbroil.

Anytime you’re in danger of believing you are too smart to be taken in by a Ponzi scheme, you can now recall the fact that Warren Buffett’s Berkshire Hathaway Inc. lost more than $300 million to a pair of fraudsters.

In January, the married couple who owned DC Solar Solutions Inc. pleaded guilty in federal court to involvement in a scheme that exceeded $900 million. They will be sentenced in May. Prosecutors said the scheme was the largest in the history of the Eastern District of California, an area that includes Sacramento.

According to reports, DC Solar drew investors with promises of federal tax credits. The business was supposed to sell mobile solar generators designed to provide emergency power to cellphone towers, among other applications. Investors put down $45,000 per generator and could then claim a renewable energy tax credit for an equal amount. The rest of the generator’s $150,000 cost would come from leasing the generator out to end users through DC Solar. Any lease money over $105,000 would come back to the investor as profit. This deal sounded great to many investors, including the insurance company Progressive Corp. and building materials maker Sherwin-Williams. Berkshire Hathaway reportedly invested a total of $340 million.

The problem was that fewer than half of the 17,000 generators DC Solar claimed to sell between 2011 and 2018 ever existed. The generators that did exist reportedly provided less lease income than expected. Instead, the company sold the same 6,000 units to buyers, over and over, and used money from new investors to pay back existing investors.

DC Solar’s owners, Jeff and Paulette Carpoff, have been accused of fraudulently creating financial statements and lease contracts to conceal these discrepancies. While DC Solar did lease some generators to telecom companies, federal officials claim that more than 90% of the funds the company recorded as lease revenue were actually investor assets. Some of that money went to pay back early investors, but not all. The Carpoffs reportedly also used the money to buy at least 140 cars, dozens of properties and a stake in a private jet service, among other forms of conspicuous spending. Besides the money laundering charges in California, the couple faces civil charges from the U.S. Securities and Exchange Commission.

Berkshire Hathaway’s part in the drama came to light last May, when the conglomerate announced it had taken a $377 million charge the previous quarter. It explained this decision by saying it had determined tax benefits it had accepted between 2015 and 2018 related to DC Solar were likely not valid. By that time, DC Solar had already filed for bankruptcy.

A defining feature of the DC Solar fraud, like any Ponzi scheme, was that it used money from new investors to pay off the original investors. This is the reason such fraud often proliferates in strong economic conditions. When things are good, it is relatively easy to find new money to feed into the scheme’s machinery. But when the inflow dries up, the entire system collapses. This is why a side effect of an economic downturn is that many schemes of this type come to light.

We have had a solid decade of economically good times. But as I have written before, a recession is inevitable sooner or later. Investors, even savvy ones, seem to be in danger of forgetting that taking big risks can have big consequences, whether in the form of an enterprise that fails for honest reasons or in the revelation of underlying fraud.

An attorney for Jeff Carpoff said that his client intended DC Solar to be a legitimate business, but that it overwhelmed Carpoff as it grew. Yet the image of a man resorting to crime to save a struggling business is hard to square with evidence that Carpoff and his wife hired the rapper Pitbull to perform at a holiday party or that they bought a semiprofessional baseball team.

I do not want to sound as if I am blaming the victims for the perpetrators’ criminal behavior. Still, the story of DC Solar is one more cautionary tale for investors. When you invest in publicly traded assets, disclosure requirements provide some level of protection against misconduct on this scale. But the growing enthusiasm for private equity and venture capital could leave eligible investors exposed, even when they are generally savvy about their approach. Thoughtful and experienced investors are still only human. We all run the risk of occasionally forgetting that if something sounds too good to be true, it probably is – even the Sage of Omaha.

Vice President and Chief Investment Officer Paul Jacobs, of our Atlanta office, contributed several chapters to our firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55, including Chapter 12, “Retirement Plans;” Chapter 15, “Investment Approaches and Philosophy;” and Chapter 19, “A Second Act: Starting a New Venture.”

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