So-called “prime bank” frauds are proliferating in British Columbia, even though they are among the most transparent of investment frauds. The reason is that the perpetrators are masters at identifying unsophisticated investors, cutting them out of the herd and gaining their trust.

Prime bank scams are based on the fiction that financial markets are controlled by a few big banks that routinely make huge rates of return. Ordinary people can participate in these rewards by pooling their money. But to keep the banks from spoiling the party, the investors must keep their participation secret.

It’s a ridiculous premise, but some people still seem to fall for it. It’s tempting to dismiss the victims with a “caveat emptor.” But these scams are not called “confidence schemes” for nothing. The perpetrators have many ways of instilling confidence and getting prospective investors to drop their guard.

A classic example isInter-national Fiduciary Corp. SA, run by Malcolm Stevenson and Daniel Byer of Abbotsford, B.C., and Preston Pinkett II of Virginia.

The three men induced dozens of people to invest a minimum of $100,000 each for reinvestment in “first-tier medium-term notes,” which could purportedly be purchased at a discount and sold at premium, generating a return of 6% a month on a “risk-free” basis.

The scheme, of course, was a sham. Typically, investors would receive a few months of interest, which would prompt them to invest more money. But any funds investors received were not being generated by the investment, but rather by new investors who were constantly being recruited in classic Ponzi fashion.

In all, 89 B.C. investors sunk a total of $23.3 million into this scheme; only $10.3 million was returned in the form of payments. Almost all the rest was scooped up by the perpetrators: Stevenson got $4.8 million, Byer netted $2.4 million and Pinkett collected $5.5 million.

The scheme was halted in November 2006, when the B.C. Securities Com-mission issued a cease-trade order against IFC and made formal allegations of fraud against the three men. During a hearing in October and November 2007, several victims told the BCSC panel how they were recruited through church connections in the Abbotsford area. (This type of “affinity fraud” is so commonplace that the BCSC is now funding two pastors — who call themselves “God’s Squad”— to educate church groups about the perils of taking investment pitches at face value.)

Some of the IFC victims told the BCSC panel that they tested the scheme by investing small amounts of money, then increased their investments after receiving several monthly payments.

The IFC con men had yet another way of building confidence.In many instances, they told inves-tors to send their money, in trust, to their lawyer, Sandy McCandless of Langley, B.C..

Among the investors who did so were Dennis and Catherine Hall of Delta, B.C. McCandless presented the couple with the necessary paperwork, including documents for opening accounts at three banks — two in Florida and one in Virginia. The couple then issued a $100,000 cheque to McCandless & Co. Law Corp., which McCandless accepted in trust and was to wire to the Virginia bank.

The Halls received two interest payments, one in September 2006 for $6,000 and another the following month for $5,800 (after McCandless took $200 as a legal fee). Then the payments dried up.

“The security we had was that we did it through a lawyer,” Catherine Hall testified. She described the experience as “absolutely horrible. It’s like a bad dream. I’ve struggled with my faith.”

In a decision released on Feb. 20, the BCSC panel banned all three men for life from the securities industry and ordered them to disgorge their ill-gotten gains and pay $4 million in administrative penalties. It is, however, unlikely they will pay a cent.

In total, investors in Canada and the U.S. lost about $40 million in this scam. IFC’s court-appointed U.S. receiver has recovered only about $8 million. After receiver’s fees and competing claims, the net amount available for investors will probably be minimal.

In an effort to boost the recovery, Dennis Hall has become the representative plaintiff in a proposed class-action suit against McCandless and another lawyer, Doug Welder, who appears to have played a lesser role in the scheme. The suit was filed by Reidar Moger-man, a lawyer at Camp Fiorante Matthews in Vancouver. It alleges the two lawyers committed fraud or, in the alternative, were negligent.

@page_break@Mogerman’s strategy is to tap into the Law Society of British Columbia’s trust protection coverage (formerly the special compensation fund), which reimburses clients for lawyer fraud. Alternatively, he wants to tap into the society’s errors and omissions insurance program, which compensates clients for lawyer negligence.

Each route is problematic. In the first instance, the law society has made it clear it will not compensate clients who forward money “in trust” to lawyers on account for investment schemes that go awry. Mogerman’s challenge is to persuade the court that client losses in the IFC scheme occurred as a result of funds being misdirected into the accounts of the perpetrators rather than being invested in a bogus scheme.

Claims against the trust protection insurance program are capped at $300,000 a transaction, which in the case of a class-action means each member of the suit. Most, if not all, IFC victims invested less than this amount, so the cap would mean little or nothing if a fraud claim is confirmed. Claims against E&O insurance are capped at $2 million per lawyer in any given year, which would materially limit the recovery if a negligence claim is proved.

As well, the lawsuit highlights a potential conflict of interest. Both insurance programs are administered by the law society, which is why the society has hired lawyers to represent McCandless and Welder. At the same time, the law society is responsible for investigating and disciplining errant members, which means it could dig up dirt against McCandless and Welder that Mogerman could use against the society in court.

At this juncture, the law society appears to be on the case. In December, the society’s disciplinary committee directed that a citation be issued against McCandless.

On Jan. 25, McCandless — who has had prior disciplinary problems, including a suspension — resigned and is no longer practising. Law society spokesman Brad Daisley says that, despite McCandless’ resignation, the society is preparing a citation against him.

Daisley also confirms that Welder, who has also been previously suspended for misconduct, is being investigated but remains a practising member. The RCMP’s commercial crime section in B.C. is also investigating the matter, but it will probably concentrate on the perpetrators rather than the facilitators.

It’s a messy affair that clearly demonstrates the perils of such cockamamie investment schemes. No sooner had the BCSC wrapped up the case, then it issued a public warning about another prime bank scheme operating in B.C. and Manitoba. This one is run by Gold-Quest International Ltd. , an offshore company that purportedly trades in foreign-exchange markets. It claims it will generate a 87.5% annual return, plus commissions, for bringing in new participants.

The BCSC noted the investments are not registered for sale in B.C. and urged investors to be cautious, a warning that, in all likelihood, is already too late for some investors. IE