Friday, January 27, 2012

The DOJ Response to 2nd Motion of James Fry for Dismissal of Charges

In the pretrial hearings leading up to the Vennes trial (May 18th), we will learn a little more about the Government's case. Yesterday, prosecutors responded to a motion to dismiss some of the charges (PDF).

A bunch of interesting stuff in there including this information about the Arrowhead "pitch books":

Count 25

In Count 25, defendant Fry is charged with making false statements during his first day of testimony under oath before the SEC, October 25, 2010, during which defendant Fry was questioned about several documents that had been disseminated to investors by Arrowhead Capital Finance, Limited. The documents were riddled with inaccuracies and misrepresentations. When confronted with them by the SEC, the defendant sought to blame his employee, Lxxx Rxxxxxx. He claimed that the employee had, in effect, gone off and marketed the Arrowhead funds on her own, without the defendant’s approval, and in some cases without his knowledge. This version of events was not just false, it was knowingly false, and at trial the government will prove it knowingly false beyond a reasonable doubt. It was the defendant who approved the misstatements and omissionsthat were served up to investors and potential investors, not the defendant’s staff.

The defendant began by claiming, as set forth in the Bill of Particulars, that his employee was engaged, without his knowledge, in “cold calling” of potential investors. Having, he apparently believed, established that this employee was in communication with investors without the defendant’s knowledge or consent, the defendant then continued, as specified in the Bill of Particulars, by claiming that the so-called “pitch books” this employee sent out were not approved for distribution, and further claimed that he had had numerous conversations with this employee in which he told her that the pitch books were inaccurate. In order to buttress his claim that the pitch books were unapproved because of their inaccuracy, the defendant claimed, also as specified in the Bill of Particulars, that the pitch books were not distributed “wholesale” by Arrowhead, and that as to the few pitch books that were distributed by this rogue employee, he, the defendant, quickly stopped the employee’s distribution of them.

All of these statements have in common the defendant’s claim that his employee, operating on her own, made false statements and omissions to investors without his knowledge. The government’s proof of falsity as to each alleged false statement will be the same - that the employee in question was closely supervised; that, more particularly, communications with investors were undertaken with defendant Fry’s knowledge, and that communications with investors were personally vetted by the defendant; and finally, and most specifically, that the content of pitch books was reviewed closely by the defendant, and that pitch books were not sent to investors before the contents of the books were reviewed and approved by the defendant.

One of the most important of the misrepresentations in the “pitch books” was the claim that when a PCI promissory note was paid off, the payments came directly from a retailer to Arrowhead, without passing through PCI, referred to in the Superseding Indictment as the “Flow of Funds” misrepresentation. Superseding Indictment (“SI”) at ¶ 31 (“FRY, and others acting at his direction, falsely represented to investors that when a ‘Big Box’ retailer purchased consumer electronics or other goods from PCI, in a transaction that was financed by the Arrowhead Funds, the retailer made payment for those goods directly to a bank account controlled by Arrowhead Management.”) In fact, the money actually came from PCI. Id. (“In truth and in fact, the Arrowhead Funds received all their ‘payments’ for the purported consumer goods from PCI and not from the retailers who were purportedly buying the goods being financed.”) As explained in the Superseding Indictment, this misrepresentation was important to investors and potential investors “because it prevented investors from accurately assessing investment risk in two ways. First, the misrepresentation that funds were being received from retailers falsely assured investors that genuine transactions were taking place. Second, it falsely assured investors that Arrowhead Management could prevent PCI from simply converting the investors' money for its own use.” SI ¶ 32. The defendant’s attempts to falsely distance himself from his employee’s marketing efforts are also an effort to distance himself from the falsehoods in the “pitch books” about flow of funds. This issue will be taken up in more detail in the discussion of Count 26, below.

In sum, the same proof will be used as to all of the statements alleged to be false in Count 25, and Count 25 is therefore not duplicitous.


Fry also made false statements during his second day of testimony, October 26, 2010, which are charged in Count 26. Count 26 of the Superseding Indictment alleges false statements related to the “flow of funds” of the Arrowhead investments. The importance of the flow of funds to investors is alleged with specificity in the Superseding Indictment and will be proven at trial. The primary significance of the flow of funds, as represented to Arrowhead investors by defendant or those acting at his direction, was that it gave the investors the false assurance that the deals underlying the PCI Notes were genuine. Arrowhead investors were led to believe that Arrowhead was seeing hundreds of millions of dollars in payments from retailers such as Sam’s Club and Costco go into Arrowhead’s bank account, indicating, falsely, that there were hundreds of millions of dollars of real consumer electronics deals. Had investors learned that the payments came from Tom Petters and that Arrowhead never saw payments from these retailers, the investors would have realized that Petters could perpetrate a fraud scheme by using new investor money to pay off earlier investors - as, indeed, happened. In other words, the purported receipt by Arrowhead of money directly from retailers was anti-fraud insurance for investors.

Accordingly, the first two false statements set out in the Bill of Particulars under Count 26 - “FRY testified that he believed that retailers paid the custodian bank directly until September 24, 2008" and “FRY later testified that he believed that retailers paid the custodian bank directly until he learned about the clearing account, but he was told by FRANK VENNES that the clearing account was controlled by M&I Bank not Petters” will both be proven false by the introduction of evidence, amounting to proof beyond a reasonable doubt, that defendant Fry knew from the earliest days of his involvement with Frank Vennes and Tom Petters that money to pay off promissory notes ALWAYS came from PCI and NEVER came from the retailers. The same is true of the fourth statement set out in the Bill of Particulars under Count 26, “FRY testified that he was not aware that retailers made payment to a Petters bank account instead of the funds’ collateral accounts.” Like the first two statements, proof of this statement’s falsity will be shown by evidence of defendant Fry’s knowledge of the true flow of funds; from Petters to Arrowhead, rather than from the retailers to Arrowhead.

As to the third statement whose falsity is alleged in the Bill of Particulars - the assertion that “FRY testified that Frank Vennes was no longer involved with ACM CORP’s Petters notes by 2001 - he had nothing to do with the transactions, was no longer the go- between and had no authority” - this too bears on flow of funds. Co-defendant Vennes continued to be the intermediary between Arrowhead and PCI. Defendant Fry was well aware of the sensitivity, especially from institutional investors, about any involvement by co-defendant Vennes in the Arrowhead investment. As noted above, however, by falsely describing the flow of funds, and omitting any description of co-defendant Vennes’s involvement, defendant Fry was again able to assuage the concerns of his investors.

Finally, the fifth false statement in Count 26, - “FRY testified that he was not aware that LXXX RXXXXXX distributed pitch books to potential investors” - is again, an attempt by the defendant to absolve himself of responsibility for the falsehoods in the “pitch books,” including the falsehoods about the flow of funds


Finally, on November 5, 2010, defendant Fry, in his continuing under-oath testimony before the SEC, repeated the false statements he had made on October 26 about the flow of funds. On November 5, 2010, as stated in the Bill of Particulars, “FRY testified that he was never aware that Petters Company, Inc., not the retailers, wired money into ACP II’s [Arrowhead Capital Partners II] collateral account”; also on November 5, 2010 “FRY testified that neither Lxxxxxx Sxxxxxx nor Mxxxxxxx Pxxx ever informed him that Petters Company Inc. was wiring money into the funds’ collateral accounts.” Finally, on November 5, 2010 “FRY testified that he was never aware that Petters Company Inc. wired money in payment of EF [Elistone Fund] Petters notes.”
All of these statements will be shown to be false by the introduction of evidence showing that defendant Fry was well aware of the origin of the money used to pay off his funds’ promissory notes. The second false statement in Count 27 alleges the falsity of the defendant’s claim that two specific, named employees never informed him that money was being wired from Petters Company, Inc. into the Arrowhead collateral accounts. These two employees are not mentioned in any other false statement count; however, proof that these two employees told defendant Fry that money was coming from Petters and not from the retailers will be introduced to prove not only the falsity of this particular statement, but also to prove the falsity of all the defendant’s false claims that he was unaware of the true flow of funds. Therefore, the same facts will be used to prove the falsity of all these statements, and the inclusion of three false statements in Count 27 is not duplicitousness, because they are all part of the same scheme to conceal defendant’s knowledge of misrepresentations to investors regarding Arrowhead’s investment in PCI Notes.

There's a hearing scheduled for February 2nd.

UPDATE: The hearing took place today.