James Scott Brown, 66, Leawood, Kansas, an attorney, and Derek J. Smith, 67, Oxfordshire, United Kingdom, a real estate speculator, pleaded guilty in federal court to their roles in a fraud conspiracy that stole more than $52 million from their victims.
The defendants pleaded guilty in separate appearances in the U.S. District Court in St. Louis, Missouri, and before U.S. Chief District Judge Linda R. Reade, Northern District of Iowa, to the charges contained in an April 28, 2011, federal indictment.
Brown and Smith each pleaded guilty to participating in a conspiracy to commit wire and mail fraud. During a 10-year period from 2000 to 2010, investors in the United States loaned a total of $52.5 million to Smith and co-conspirators through a Ponzi scheme that was known as the British Lending Program (BLP). Victims believed they were loaning money for legitimate real estate development projects, but in reality, most of their money was kept by co-conspirators (or used to pay interest and principal to other lenders).
Brown, an attorney, practiced law in England for several years prior to 2000. Brown also participated in the UMKC program at Oxford University. Between 2000 and 2010, Brown did not actively practice law; instead, Brown‘s primary occupation was the BLP, from which he took substantial fees. Brown did business as British American Group and as J. Scott Brown and Associates.
Smith was a structural engineer and a business and real estate speculator/developer who resided near London, England. Smith did business as Princess Hotels Management and as Distinctive Properties. Smith was previously successful, but during the 1990s he acquired distressed hotel properties which were not profitable due to a recession in the English real estate market. By the end of the 1990s, Smith was in need of capital to maintain his ownership of several small hotels which were not trading profitably and to support his retention of several options to purchase land.
The British Lending Program
According to the plea agreements, the British Lending Program (BLP) operated as a Ponzi scheme and served as a fee-generating machine for the benefit of co-conspirators.
In the original, legitimate form of the BLP, funds were loaned by U.S. investors/lenders for short terms at high interest rates. Early loan funds were sent to the United Kingdom and lenders received written loan agreements through a British law firm. Borrowers paid interest to lenders directly or through intermediaries and loan principal was repaid at the termination of a loan (unless a loan was “rolled over,” or renewed, for an additional year). Brown and his family were lenders in the BLP, then Brown began soliciting other lenders and took finder’s fees for himself.
Brown and co-conspirators developed a packet of marketing materials and began marketing the BLP to other U.S. lenders in 2000. Later, they also utilized third-party recruiters to locate new investors and bring their funds into the BLP. Soon afterward, Smith became the sole and exclusive “borrower” in the BLP and became the focal point of marketing efforts.
According to the plea agreements, conspirators claimed that lenders’ loan funds were sent to Smith in England for use in his real estate activities, and that payments of interest and principal came from England out of Smith‘s business revenues and profits. In reality, Brown admitted, the vast majority of BLP loan funds were never sent to or received by Smith for use in productive business activities. Instead, the vast majority of funds remained in the United States under the control of Brown and co-conspirators.
Between 2000 and 2010, Smith received the benefit of a total of approximately $6.1 million, while approximately $52.5 million in loan funds were received in the BLP. In contrast, Brown took “fees” totaling approximately $1.4 million. Approximately $27 million was used to pay interest and principal to lenders. All BLP funds were dissipated and as of June 2010, the BLP had no funds.
Brown admitted that conspirators marketed the BLP to lenders based upon a number of false, fraudulent and deceptive material representations.
Conspirators told investors that Smith and the BLP had a track record of success and a unique ability to identify undervalued properties and properties whose value could be greatly increased through the re-zoning process. Smith‘s goal was to sell or “flip” the properties for a profit. Conspirators also allegedly claimed that Smith was a highly successful real estate owner and developer who generated cash flow and profits from “flipping” properties and options. In reality, Smith‘s trading properties were unprofitable and required funding to avoid foreclosure; Smith‘s re-zoning efforts did not produce successful property flips. Smith could never repay the large sums which had been borrowed in his name from BLP lenders.
Conspirators claimed that Smith was willing to borrow at, and could afford to pay, high rates of interest, and that British banking practices made it cumbersome for Smith to borrow funds in a timely fashion to take advantage of time-sensitive opportunities. In reality, no real estate developer could afford to make enough money from BLP loans with the small amount of funds left over after payment of interest and fees to make a profit and to meet BLP interest and redemption obligations. Smith could not borrow from a traditional lending institution because he lacked sufficient equity in his properties to serve as collateral, because his hotels were not profitable and because his options could not serve as loan collateral.
Conspirators claimed that there was little or no risk of not being repaid in full, because the present market value of Smith‘s assets exceeded his liabilities by a ratio of at least 2-to-1 and often as high as 6-to-1. In reality, Smith‘s financial statements were false and misleading.
Many victims loaned funds which had been saved for retirement and were held in Individual Retirement Accounts. Many IRA lenders let their “interest” accrue and also rolled their loans over annually for years, each time receiving a signed loan agreement for a new, larger amount. Thus, many IRA lenders were led to believe that their IRA accounts were growing and that they could be relied upon in retirement.
By pleading guilty, both Brown and Smith agreed to forfeit to the government any property obtained through the conspiracy, including a money judgment of $52.5 million. Brown also agreed to forfeit to the government a 207-acre farm in Siloam Springs, Ark. Smith also agreed to forfeit to the government several real estate properties in England, including a hotel.
Under federal statutes, Brown and Smith are each subject to a sentence of up to five years in federal prison without parole, plus a fine up to $250,000. A sentencing hearing will be scheduled after the completion of a presentence investigation by the United States Probation Office.
Beth Phillips, United States Attorney for the Western District of Missouri, announced the guilty pleas.
This case is being prosecuted by Jess Michaelsen, Steven Holtshouser, and Richard Finneran, Special Attorneys to the U.S. Attorney General. It was investigated by the FBI and IRS-Criminal Investigation.