Oil and gas investment fraud

What it is

Oil and gas investment fraud sells investors interests in a well or a drilling program on claims that are false: that wells have been acquired, that drilling is about to begin, that earlier wells hit oil or gas, or that the money will go into the ground. The four sentenced cases here involved a California boiler room, a Dallas promoter, a Kentucky company and a Texas family firm. They differ in size, but in each the company told investors one thing and did another with the money.

How it actually works

1. The pitch

   Investors are reached by cold call, brochure or presentation. Baiocchi’s telemarketers in Newport Beach and Montreal cold-called people around the country; Barber’s associates cold-called for two of his projects; Target mailed brochures and then followed up by phone. The SEC alert says common pitches refer to recent news such as high oil or gas prices.

2. The prospect

   The pitch describes a well that is producing or about to. Barber claimed one project produced more than 450 barrels a day when it produced under 15. Baiocchi’s callers said gas wells were already acquired and producing when none had been acquired. Target’s brochures contained geological reports saying a geologist had assessed proposed sites, and its salesmen said past wells had hit oil or gas. Aspen’s salesmen touted earlier wells without disclosing vendor liens and investor litigation.

3. The offering

   Investors are sold interests in a program, such as Barber’s Arrowhead, Sierra and Sidnee projects or Aspen’s Rancho Blanco programs. Barber’s sales literature said proceeds would be held in escrow until 80% of the offering was raised. Aspen’s salesmen told investors they could recoup their cash within three years, with production revenues lasting up to 20 years.

4. The money

   The money does not go where the pitch said. Barber withdrew investor money from escrow almost immediately. Baiocchi kept 60 percent of what investors initially sent, and over $2.9 million of $5.7 million went to accounts he controlled. Aspen’s funds were transferred almost immediately to its corporate accounts. Target returned about $1.19 million of $15.8 million.

   Where it could have stopped

   The SEC alert says the promoter often does not tell investors that he owns the drilling company, or plans to hire a driller at far less than what investors were told, pocketing the difference, and that he makes money even if the well comes up dry. It suggests asking what the funds will be used for, in writing, and who is being paid.

5. The silence

   Investors get little information. Aspen’s investors received no reports on the use and status of their funds and their attempts to audit were thwarted. Several states issued a cease and desist order against Target, and the Smith brothers concealed it from potential investors.

6. The prosecution

   The cases ended in sentences from 63 months to 18 years, with restitution orders from $3.8 million to $99,707,758 and forfeitures that included real estate, boats, luxury vehicles and an original Picasso.

Why it works

Investors cannot check. The SEC alert says that analysing an oil and gas investment may involve highly technical matters such as geological findings and new drilling technologies, and that the only information an investor has may come from the promoter.

The story is attractive. The SEC alert says that because the industry is often in the news, some people have used the appeal of “striking it rich” with a gushing well as the basis for fraudulent schemes.

The programs are private. The SEC alert says private securities offerings carry unique risks, are generally limited by law to certain institutional and high net worth investors, and typically have less liquidity.

Sales fees and the promoter’s pay may not be disclosed. The SEC alleged in the Petroleum Unlimited case that only $534,000 of the $2.9 million raised was used for drilling, with sales fees of 49% and 74% of the investments not mentioned. This is an allegation in the alert and the outcome was not read for this page.

Where it comes from

Entirely domestic in the documented cases, though Baiocchi’s telemarketers worked from Montreal as well as California and Aspen’s programs were sold to investors “throughout the U.S. and elsewhere”.

The earliest conduct here. Baiocchi’s scheme ran from 1995 to 1997 and was sentenced in 2005.

A rising caseload. The SEC alert says its cases went from few in 2005 and 2006 to more than 20 a year, and that state regulators saw a similar rise.

Older cases. The sentences here are from 2005, 2010 and 2011 and the alert from 2013. No later sentences were read for this page, so it does not describe more recent enforcement.

Real cases

Red flags

• Pitches that refer to recent news, such as high oil or gas prices.
• “Can’t miss” wells and guaranteed returns, including claims that major oil and gas companies are drilling nearby.
• Abnormally high rates of return, unsolicited materials, or pressure to decide because the offer is “limited” or “once-in-a-lifetime”.
• A salesperson who says they are an investor too, or asks you to sign that securities laws do not apply.
• Nothing in writing about how the money will be used.
• Claims that drilling is imminent when no driller has been hired.

If it’s happening to you

If you are asked to invest in a well or a drilling program:

1. Find out who is asking. The SEC alert suggests checking whether the seller is registered with FINRA’s BrokerCheck, the SEC’s adviser site or your state securities regulator.
2. Ask for the use of proceeds in writing, including sales fees and what the promoter and employees are paid.
3. Ask for the broker’s due diligence report if a registered broker recommends it.
4. Be wary of pressure and promises of low risk for high returns.
5. Report it. See where to report.

Where the money goes

Domestic in the cases here.

Investor money goes to the company’s accounts and is moved out. Barber withdrew escrowed funds almost immediately. Baiocchi kept 60 percent. Target’s company returned about $1.19 million of $15.8 million. Aspen’s funds were diverted for the defendants’ benefit and to costs of earlier wells, and the forfeited property included real estate, boats, luxury vehicles, an original Picasso, jade, jewelry and wine.

By the numbers

No published dataset breaks this scheme out as its own category yet, so there is no chart to show. The data page explains which agency categories exist and why some schemes are invisible in official statistics.