"If Donald did something wrong, that's on him. I got no control. I'm getting hit by friendly fire. I have done absolutely nothing wrong but invest and trust a friend...I said, 'You know what, donald, I like you, i trust you.' So that's how it pretty much came to fruition." - Charles Barkley
NBA Hall of Famer, Charles Barkley, recently made headlines after losing at least $4 million to his longtime friend and business associate, Donald Watkins, via an investment fraud as alleged in a complaint filed by the Securities Exchange Commission (“SEC”). Watkins’ companies were really just fronts to collect money from investors to pay off personal expenses and debt.
Prior to these allegations of fraud, Watkins was enveloped in a lawsuit with two pension funds of Detroit (for their Public Works and Public Safety Departments) for a $30 million loan in a company he owned that went bankrupt and apparently never even paid one loan payment. Watkins ultimately settled this lawsuit for $4.25 million. This settlement was one of the many pressures in Watkins’ life that allegedly led him to commit this fraud.
In an interesting turn, this settled lawsuit against Watkins helped provide evidence that landed then-Detroit Mayor, Kwame Kilpatrick, and his Detroit Treasurer, Jeffrey Beasley, a fraternity brother of Kilpatrick’s, in prison for 28 years and 11 years, respectively, for bribes and kickbacks in a fraud that cost the city’s pension fund $97 million in losses! Didn't seem like Watkins was surrounding himself with the most savory of characters.
Private Investments, Private Lies
Watkins owned a "waste-to-energy” conversion company that he was seeking investment in. Barkley and several other NFL and NBA players invested a total of $6 million. Over the course of soliciting investments, Watkins made multiple false claims to his investors. He claimed that an acquisition of his company was closing within several months when there really was no acquisition in place. He later claimed the acquiring company was Waste Management, a $37 billion company. Watkins told at least one investor the acquisition would be for “$2 - $5 billion.”
In reality, Watkins had one 30-45 minute meeting with Waste Management which occurred a year after he told his investors that an acquisition was months away. It was all a scam.
Private Investments, Personal Use
As happens so often - and as I’ve detailed in numerous posts, particularly in The Fraud Triangle and Professional Athletes - pressures can take over one’s life and lead him or her to commit fraud. Watkins’ pressure was a ridiculous amount of personal expenses and debts. In addition to the $4.25 million settlement that Watkins owed, he defaulted on $2.75 million in debt he owed in connection with his partial ownership of a bank in Alabama, and Watkins owed Uncle Sam, his ex-wife, and a host of other creditors hundreds of thousands of dollars.
The SEC complaint went into painstaking detail to show exactly where his investors' money went. For example, following the receipt of $1 million by an NFL investor, Watkins used the money to: pay $165,000 toward his debt to his Alabama bank; $25,000 to his then-girlfriend; $500,000 to refund a client of his law practice (for unspecified reasons); $14,500 in alimony payments; $21,000 for payments on his personal airplane; $41,000 for payments to his personal credit card. Another investor's money was used to pay $226,000 of Watkins' personal taxes to the U.S. Treasury. One investor wanted a refund of his investment and was paid $750,000 directly from an NBA investor's money.
This is the life of a fraudster. Not only will he pay off debts that he owes, but he’ll use the money to fund his girlfriend’s lifestyle and his own luxuries, including his private plane.
Red Flags, Clear Eyes
Barkley was deposed by the SEC (as detailed in this article) and said his investments with Watkins were just based on his friendship, and not emails and other documents. Barkley said he told his financial advisor to make the investment and he did. Barkley’s trust in his friend clouded his judgment from doing what any seasoned investor will do: due diligence on the proposed investment, or as I like to say, trust but verify.
A simple Google search would have identified that Watkins was being sued for the $30 million loan at the time of investment. Could Watkins personally owe this entire amount if he lost the lawsuit? How would he repay a loss or a settlement? Is it possible that Watkins could use my investment to pay debts related to his fiasco (in fact, he also owed hundreds of thousands of dollars in attorney fees)? How can I be sure? Will Watkins provide me a personal credit report to show that he does not have any liens or outstanding judgments against him? Are there too many questions here that maybe I should reconsider whether it’s worth giving this man millions of dollars?
There were a number of other dubious claims that should have raised investor eyebrows. First, Watkins claimed that his company was several months away from an acquisition. What evidence did Watkins have that a blue chip company would acquire a company like his? Did he have tons of emails between himself and some of the highest executives of Waste Management to evidence their pursuit of his company? Did he have due diligence requests from Waste Management in relation to their proposed acquisition? What proof did he have?
Watkins was all talk, telling investors about supposed investment bankers who wanted to invest, but Watkins wanted to lure these pro athletes in on the deal by fabricating outside interest. Barkley told the SEC, "I think he said, 'hey listen, I'm keeping this thing close to the vest. I'm letting close friends of mine buy in for a little more because I don't want it spread out with a bunch of people and would you want to invest more.' I said, 'you know what, Donald, I like you, I trust you.' So that's how it pretty much came to fruition."
The promise of riches kept the investors at bay while the evidence of a deal was never provided outside of gross misrepresentations by Watkins.
Second, some of the money that Watkins received from professional athletes were loans that were paying 10% per year. This is all about risk and return: the more risk you take, the more return you should expect. A 10% yearly return is a pathetic return for a loan this risky. Watkins’ company has little to no financial reporting requirements and is basically unregulated. This is an incredibly risky loan which should have required a MUCH higher return.
Third, different investors investing the same amount of money somehow received different percentages of ownership despite the company’s value staying the same. The SEC does not detail Watkins reason for this, but investors could demand to see a what’s called a “cap table”, a document that lists who owns the company's shares. This may have identified additional red flags for the investor to think twice.
Fourth, the investment document signed by the investors did not provide the use of proceeds. Although the SEC stated Watkins represented that it would be used to fund his waste-to-energy company, why was this not in the investment document? Sure, Watkins could have lied on the investment document, but this lack of attention to detail should not happen on a legitimate investment document.
Their Right To Entice, Your Right to Documents
Here’s the thing with private investments: people are trying to get you to fund their business that statistically has incredibly low odds to make you a significant amount of money and an even lower odd to beat the market’s performance over the long-term. We’re induced by the idea of making a ton of money quickly while forgetting the power of compound returns over the long haul with "boring" index investments in the public markets. We also should be aware - as Barkley was - and read the disclaimers - as Barkley did - that we can lose all of our money.
Although the power of riches (and lies, in this case) is their weapon to entice you, your weapon is proof. You can ask for every document in this private company’s possession, and if they don’t want to provide you with what you request - you’re gone.
I went to an bi-annual review with a client to act as his advocate since he wanted a second opinion of his investments. As we talked with his financial advisor about his private investments, I drilled into each investment with numerous questions about the selection process for this investment, the initial due diligence and continuing due diligence on the investment, the managers of the private investment, the fees, the liquidity, the risk/return, the benchmark performance, the risks of the investment, the correlation of the investment to the public markets, and on and on.
The financial advisor answered every question with patience, willingness, and knowledge. He knew the answers and was clearly on top of the investments. Of course he believed there was risk in the investments, but he believed the return they had gotten and were expecting were commensurate to the risk. He then offered to show me his due diligence files and or emails with the investment managers for any of these investments.
THIS is the example of transparency and openness that you as an investor of private investments must demand. It’s your money, you have every right to ask for anything under the sun regarding your investments, so I advise you to do that, or you may end up feeling like Barkley:
"But the bottom line is I haven't gotten a dime back and we are proceeding -- this thing has been a shock to my system to be honest with you...This is a waste of my time. I feel angry, mad, disappointed that I'm even in this situation," Barkley stated.