Originally published on Forbes.com May 15th, 2013
Billy Sol Estes died this week. He was quite a guy. To me it is one of those vaguely familiar names that were in the news when I was young, but you can always count on the New York Times obituary to fill in the details.
Billie Sol Estes, a fast-talking Texas swindler who made millions, went to prison and captivated America for years with mind-boggling agricultural scams, payoffs to politicians and bizarre tales of covered-up killings and White House conspiracies, was found dead on Tuesday at his home in Granbury, Tex. He was 88.
Somebody like that is unlikely to go through life without generating an interesting tax case and Billy Sol Estes is no exception. So once again, like Dr. Peabody and Sherman, we step into the wayback machine
We are heading to 1969 for Harry Moore, Trustee v United States of America. Harry Moore was the trustee for the estate in bankruptcy of Billy Sol Estes. He was appealing the Estes tax liabilities for 1959-1961. They were substantial – over twelve million dollars. That’s a lot of money even now. In 1960, you could buy a candy bar for a nickel and a comic book for a dime. That’s all I was buying back then. The bankruptcy trustee would want to contest the tax liabilities in order to allow more funds for other creditors. In cases like this, the bankruptcy court gets to decide what the correct tax is. This particular decision was an appeal to the Fifth Circuit.
There were two issues. One was about a fertilizer deduction, which is kind of amusing in the context of a tax case flowing out of massive fraud. The other is about gross income, which is the issue I find interesting. In order to get into the income issue the Court had to explain the nature of the scam that Mr. Estes was running. It was a doozy.
The Scam
First there were the farmers. Estes persuaded various farmers in West Texas to sign promissory notes for the purchase of anhydrous ammonia tanks, whatever they are, from Superior Manufacturing Company and Lubbock Machine and Supply Company. The farmers believed that they were essentially “loaning” Estes their creditworthiness. He would service their notes with the rental payments he received from “their” tanks and they would get a bonus of 10% of the tank cost.
The next step was for Superior and Lubbock to sell the notes and mortgages to various finance companies at a discount. Superior and Lubbock remitted 90% of the proceeds to Estes and kept 10% as a fee. Seems like 10% is a bit of a theme here. Makes the math easier, I guess. The finance companies thought there were some actual tanks being sold to actual farmers. Silly them. There were no tanks and the farmers did not think they owed anybody anything.
The numbers got pretty impressive. Remember this is around 1960.
The instruments of indebtedness were obtained from 70 different farmers. Billy Sol Estes received from Superior and Lubbock the sums of $215,137.56 in 1959, $4,197,919.88 in 1960, and $10,959,991.28 in 1961. He used these large sums of cash to expand his operations though part of the money necessarily had to be remitted to the farmers under his agreements with them. He made so-called rental payments of $50,591.62 in 1959, $544,584.66 in 1960, and $3,057,314.26 in 1961, which sums the Government has treated as necessary expenses of a swindle. Accordingly, after subtracting these necessary expenses, Estes received the net sums of $164,545.94 in 1959, $3,653,335.22 in 1960, and $7,902,677.02.
Those increasing numbers are what happens with a Ponzi scheme. You have to run pretty fast just to stay in the same place and really, really fast to get ahead.
Better To Owe It To You
At any rate, the Government argued that those net numbers were income to Estes. The trustee argued that they were loan proceeds. Either way he was engaging in fraud, but for income tax purposes, it makes a big difference. If I sell you the Brooklyn Bridge that creates immediate income. If I can convince you to loan me money using my interest in the Brooklyn Bridge as security and the transaction is recognized as a loan, that is not immediate income. Someday, I may have to pay the piper if I finally stiff you, but there are ways around discharge of indebtedness income, like bankruptcy, for example. That is why it is better to owe it to you, than cheat you out of it.
The bankruptcy referee had thought the transactions represented loans to Estes, but the district court overruled the referee and the Fifth Circuit agreed:
In holding that Estes “borrowed” the funds in question, the referee neglected to identify who he considered the lenders to be, which suggests to us that he sensed the difficulty of his position. We think Estes did have what amounted to loan agreements with the farmers: They loaned him their credit for a 10% fee and with the expectation that he would ultimately cover the notes and mortgages on which they were making themselves primarily liable. They were not buying the tanks for themselves and would not have signed the instruments of indebtedness unless they had understood that Estes was in turn indebted to them. On the other hand, the cash Estes obtained did not come from the farmers or the manufacturers but from the finance companies.
Estes dutifully made payments to the finance companies, but the fact that the finance companies were unaware that it was really Estes that had received the money was fatal to loan treatment.
Though he made regular payments and may have intended that one day the finance companies would be reimbursed in full, we cannot say that the good intention of a swindler whose identity is unknown to the party from whom the money is being obtained is the same in law and in fact as a consensual loan arrangement between two parties.
Oh What A Tangled Web We Weave
The trustee won on the fertilizer deduction issue. The Estes books indicated that he was paying $80 to $90 per ton for fertilizer. He had prepared financial statements that omitted the expense. At his criminal trial he testified that he was getting kickbacks from the company selling the fertilizer. The referee went with the first story and the Appeals Court went along.
How Does Estes Rate As A Fraudster
Ever since I was a teenager, I have had an interest in uncovering fraud. It is partially what drew me into accounting, where, thankfully, I only encountered it a couple of times in a long career. Dealing with fraud is not nearly as much fun as reading and writing about it. I have a fairly arbitrary standard that I use to rate frauds as works of art, which is what they are in a sense. The gold standard which probably will never be exceeded is the scheme conceived by Alves dos Reis.
He convinced a British bank note printing company that he worked for the Bank of Portugal. They printed millions of escudo notes for him which he used to buy stock in the Bank of Portugal, the only organization that could prosecute a counterfeiter in Portugal. You can read about it in The Man Who Stole Portugal by Murray T. Bloom.
Putting the Reis scam at 100, I would give the Billy Sol Estes fertilizer tank scheme an 80. Just for reference, Bernie Madoff gets a 20 – no elegance at all there. I would be inclined to raise Billy’s score some if it was established that the farmers were getting accelerated depreciation deductions and investment credits on the imaginary ammonia tanks – maybe an extra five points. I’d have to figure out how that worked in 1969 and the wayback machine only works once a day, so we’ll leave him at 80.
You can follow me on twitter @peterreillycpa.