A recent case decided by the U.S. Sixth Circuit Court of Appeals holds a cautionary tale for Texas investors or any one who may want to invest in oil and gas. The case is United States v. Smith decided on April 15, 2014.
This case involved the Smith brothers, Michael and Christopher, who operated a company called Target Oil. Target conducted speculative oil drilling in several states, including Texas, but also in Kentucky, West Virginia, and Tennessee. The Smiths told potential investors that certain wells were sure-fire investments, but these wells often produced no oil at all. In fact, some of the wells had not even been drilled. Investigators discovered that from 2003 to 2008, Target Oil received approximately $15.8 million from investors, but only distributed royalties amounting to $460,000. Their operation was a classic Ponzi scheme. That means that the Smith brothers paid new investors from the investment funds of previous investors, rather than from the production proceeds from the wells they were supposed to be drilling. As in all Ponzis, for the first few months the investor thinks they’ve made a good investment. At some point, as in all Ponzis, the fraudsters run out of new investors to scam and the returns to investors stop. The newer investors get nothing at all. These kinds of schemes seem to come out of the woodwork when the price of oil approaches $100 per barrel.
Michael and Christopher Smith were arrested and charged with conspiring with others to defraud investors of millions of dollars. In the trial court, Michael Smith was convicted of conspiracy to commit mail fraud and of 11 substantive counts of mail fraud. He was sentenced to 120 months in prison and ordered to pay $5,506,917 in restitution. Christopher Smith was convicted by the same jury on seven counts of mail fraud. He was sentenced to 60 months in prison and ordered to pay $1,652,075 in restitution. The Sixth Circuit Court of Appeals affirmed the convictions in an opinion written by Justice Ronald Lee Gilman. The Court rejected the Smith brothers’ complaints of insufficient evidence, that the government introduced evidence that effectively amended the indictment, that a defense witness was erroneously excluded, that their sentences were procedurally and substantively unreasonable and that their forfeiture judgment was excessive.
I don’t think the sentences were harsh enough! This case involving the unscrupulous Smith brothers is just one example of many oil and gas investment scams, including many that affect Texas residents. It is a vivid reminder of the need to get advice before you invest. A background check by an oil and gas attorney is absolutely critical before making these kinds of investments. A background check is not a guarantee that the investment is not a scam, but it can usually uncover a number of facts that are strong indicators of fraudulent activity. For example, a background check can determine if a company really owns the leases and wells that they say they own.
I get two to three calls each month from people who invested huge sums in Ponzi schemes just like the one run by the Smith brothers and who are trying to get their money back. In a few cases, I am able to do so. In many cases, the criminals have spent the funds and a civil lawsuit would be an empty exercise. Save yourself some heartache and have an attorney do some investigating before you invest! The fee is quite modest and it is just good business to get some independent verification for a substantial investment.
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