How The Banks Got Duped

July 15, 2005
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GRAND RAPIDS — Eight months ago today, federal agents stormed the

25 S. Division Ave.
headquarters of Cyberco Holdings Inc., commonly known as the CyberNET Group, kicking off the sensational outing of West Michigan's most notorious fraud case ever.

Led by the late Barton Watson, CyberNET defrauded dozens of banks of over $114 million through a complex Ponzi scheme using shell corporations, fake collateral and incredible lies.

The scheme spread across both coasts and the globe. Only three days before the raid, CyberNET purchased a legitimate company in the Philippines and secured a $30 million loan with a national bank based in California. The latter deal was nixed when the company dropped into bankruptcy a week later.

Essentially no different in structure from a crop of local Ponzi schemes revealed in the past year, such as Dan Broucek's Pupler Distributing and Doris Shaw's land contract scam, CyberNET is unique not only for its surprising victims but its long list of seemingly obvious red flags.

Bankruptcy attorney Todd Almassian of Keller, Vincent & Almassian PLC represented debtors in both the CyberNET and Shaw cases.

"It really is unique," he said of CyberNET. "We typically see Ponzi schemes in which individuals aren't necessarily familiar with financing and aren't sophisticated in these arenas."

Daniel J. Yeomanss, vice president of Management Services Realty, was the original receiver for CyberNET and Pupler Distributing.

"I wouldn't say individuals get taken any more than banks," he said. "I've seen savvy investors taken for lots and lots of money. In Pupler, there were a lot of attorneys in there, a lot of accountants who gave money to Broucek. Whoever you are, you've got to do your due diligence."

Almassian explained that there are two components in such schemes: the dishonesty of the debtor and a lender not doing the proper homework.

In the CyberNET case, the banks did little to verify that the collateral represented actually existed and if another creditor had already perfected its security on it.

The majority of commercial business loans in West Michigan are secured with some type of company asset, such as real estate or equipment. Usually, the bank first performs a UCC search on the asset to determine if another lender has a lien on the property. CyberNET altered or concocted many of its serial numbers, so the UCC search often failed to alert the lender.

In the final year, however, the company began recycling serial numbers, according to Yeomanss, and this led to the initial discovery of the fraud by Charter One Vendor Finance of Illinois.

As Yeomanss explained, a UCC filing at the Secretary of State for a company the size of Steelcase Inc. would be about 40 pages. CyberNET's was 600.

"Any banker that went to pull a UCC and found it was a $7,000 fee to pull the file on CyberNET might think twice about what was going on," he said. "That was how the whole thing unraveled."

When Charter One inspected the CyberNET headquarters, it discovered only 34 of the 66 computer servers that it had loaned the company $3 million to acquire.

Other times, lenders inspected the assets but were fooled by theatrics. CPR Director of Technology Jeff Tatreau toured the facility prior to the bankruptcy auction in March.

"I felt like I was on a movie set," he said. "It didn't look anything like what I knew a data center should look like."

In fact, many of the servers were nothing more than boxes with blinking lights, according to the FBI affidavit. One loan had been secured with a server that had been purchased on eBay after having been struck by lightning.

"They took a $65,000 loan out on a 500-pound paper weight," Tatreau said.

"There may have been some people outside of their expertise," Yeomanss said of the lenders. He explained that technology is an area where fraud is a little easier to commit, because, particularly in West Michigan, bankers are more familiar with a piece of machinery like a die press than a server.

"The banker goes in and looks, sees the lights are blinking and checks it off," he said. "He may not have any idea how to verify that it is a real server."

CPR is developing a new service around asset evaluation, verifying the value of technology collateral for financial institutions.

Although not marketing a service as such, ISG President Dan Horne said that it resembled a common service his and similar firms have long provided: network assessment.

Horne said this often occurs during bankruptcies or when a company is closing down a location, situations where assets are likely to "walk out the door."

Yeomanss said that all investors, whether an individual or financial institution, should seek help if they don't understand a deal.

"But what happens is that increases the transaction cost," Yeomans said. "And people don't want to spend money to walk away from a deal."

Yeomans points out that several out-of-state lenders did send in third-party verification companies to examine the assets. Those companies are currently being sued for negligence.

Jonathan Smith, executive vice president of Fifth Third Bank's West Michigan commercial lending operation, believes the losses could have been avoided much earlier.

"Collateral problems end up being the result, but the issue is that (lenders) did not know whom they were dealing with," he said. "If you have a superior understanding of the people, in the end you'll have a superior understanding of the collateral."

Smith said that Fifth Third avoids business with clients that don't pass a detailed character examination.

"It's a lot of homework, making sure that you know who you're doing business with," he said. "We limit our exposure to companies that we have no prior experience with. That may cause us to miss some opportunities, but we believe it also causes us to miss some things that would be disappointing to our shareholders."

Yeomans said that for roughly $100, a background check would have revealed Watson's stint in federal prison in the 1980s.

"And more common sense: Call around and ask other people how their experience has been with that particular investment group," he said.

This is the most surprising part of the CyberNET story. Usually, in a region where the banking industry is consolidated in one-square mile, word gets around quickly, Yeomans said.

In 1992, long before Huntington Bank extended a $13-million credit line to Watson, Old Kent Bank had sued him after he attempted to finance an $80,000 boat with a doctored tax return.

In 2000, Hastings Public Schools sued CyberNET for passing off remanufactured computers as new. A year later, the firm's accountant, Guy Hiestand, quit for ethical reasons, then alerted Macatawa Bank (then Grand Bank) of potential fraud. That same year, Herman Miller Inc. was one of several local vendors to deny a relationship to the company to creditors seeking a reference.

Lenders could have noticed that Cyberco was comprised of 22 different entities and that all but one were not in the CEO's name.

"I don't think people connected the dots," said Steve Rayman of Rayman & Stone PC, CyberNET's bankruptcy trustee. "Sometimes, the bigger the lie, the easier it is for people to swallow it. It was a grandiose approach. How do you challenge someone that gives you 20 different numbers for 20 different countries?"     

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