Affinity group fraud

Among the more notorious scams that occurred in Arizona was a 1980s scheme centred on operations at a suspect gold mine near Rich Hill, northwest of Wickenburg. Phoenix-based Tracon International sold stock to investors from across the U.S., telling groups that Rich Hill was the largest gold mine ever discovered in the state.

Religious groups were prime targets, including entire church congregations. Hundreds of investors, mainly from the American Midwest, lost more than US$2 million before the scam was halted in 1984. Targeting of groups is known to some regulators as “affinity group fraud” and remains one of the 10 most prevalent investment fraud techniques in the U.S.

One stockbroker, who tried and failed to dissuade people from sinking money into the venture, described the mind-set of the investors involved: “It was almost a sweet gullibility that they had, as if they said to themselves, ‘Praise the Lord, I’m getting the opportunity to invest in this company'”

Tracon’s top four officers were indicted in 1987 after being investigated by federal authorities.

In 1988, on the other side of the state, the Pannos Mining Co. owned a bleak, 1,900-acre tract of brush-covered desert, about 45 miles northwest of Phoenix, which was being promoted as a vast deposit of rich gold and silver ore. The company, through three “boiler-room” companies operating 18 facilities across the country, recruited thousands of investors and raised millions of dollars by selling worthless certificates for gold and silver, which were to be delivered to purchasers at a fraction of the market price.

Pannos’s own documents described the property as containing US$826 million in gold and silver, and a mine life of 302 years. The documents also stated that investors could expect a return on investment of between 60% and 329% within one year, that the company was processing 50 tons of ore daily and that a 1,000-ton-per-day processing plant was under construction at the mine site. Not only was no gold or silver found in samples taken from the property by state officials, but no significant processing occurred and plant construction never got off the ground. The “fabulous” mine was merely a vacant tract of land.

The promotion continued for several years until the Federal Trade Commission filed suit and obtained a temporary restraining order halting Pannos and its boiler-room selling activities.

Two years later, a scheme involving the 107-year-old Mammoth mine, near Apache Junction, proved that investors will believe even the most far-fetched tale of mineral wealth. The securities division of the Arizona Corporation Commission (ACC) ordered Marshall Ott, the owner of a company named Western Labs & Engineering, to stop selling securities to Mammoth. Yet despite the order, the company convinced roughly 130 investors to contribute US$800,000 to the mining venture.

Western Labs offered gold ore for sale at US$10 a ton. The company’s staff of up to 35 employees sold the securities nationwide over the telephone, promising returns of 300-400% after the gold was mined and processed. No profits were paid, though the form of payment was supposed to be gold coins bearing the words “Jesus is Lord.”

The company based its claim of mineral value on unusual grounds: Ott told investigators that the idea to reopen the Mammoth mine came to him during a religious epiphany.

“Ott claims he died in 1980 and spent two and a half hours in heaven with God, who mapped out the Mammoth plan,” said an investigator.

Ott secured the investments in the Mammoth mine using an assay analysis from the 1920s, a time when large quantities of gold were extracted from the mine’s veins. Ott was indicted by an Arizona grand jury on charges of conspiracy, fraudulent schemes and artifices, and sale of unregistered securities.

It seems hard to believe to the average person, but mining fraud promoters can always find greedy investors who will believe their tales. Even obvious and outrageously false stories will find an audience with those who want to believe them badly enough. For example, New Times, a weekly newspaper in Phoenix, reported, in a deliberately and patently preposterous 1991 article, that gold was buried beneath the upscale Scottsdale Galleria shopping mall. The Times went as far as to provide cut-out shovel patches for its readers to pin to their clothing before mining the Galleria.

About 30 people camped out overnight at the shopping mall waiting for the “mine” to open. Police were called after an estimated 300 people showed up. By mid-morning, only a few dozen dazed fortune-hunters were still milling about the mall wearing the patches. Ken Phillips, chief engineer at the Arizona Department of Mines and Minerals Resources (ADMMR), remembers his office receiving a barrage of telephone inquiries regarding the Scottsdale Galleria mine.

Non-traditional mining venturers can be tenacious and adaptable scammers, too. The Nevada Secretary of State’s security division started focusing on the questionable claims and inside deals of two firms in the early 1990s. The firms, Mariah International and Guild Mark Industries, purported to be able to produce gold from the Sheep Hill cinder deposit in Flagstaff, Ariz. The investigation included allegations of misrepresentation of gold values, non-existent relationships with credible mining companies, and other abuses. It also included allegations of failure to disclose revocation of the companies’ stock in the state of Utah, affiliated transactions, and the sale of stock by a “possible control person.”

The U.S. Forest Service said it did not approve of any attempt to mine gold from cinders. Likewise, the Arizona State Land Department denied a prospecting permit for the Sheep Hill property, stating there was no indication of precious metals existing on the subject parcels.

However, the companies’ management was up to the challenge presented by the governments of Arizona, Nevada and Utah, and by the U.S. Forest Service. The management merged into a new company named MG Gold, which continued to trade on the over-the-counter bulletin board, a semi-formal network of brokerage houses that trade via on-line systems.

Shifting away from the infamous Sheep Hill, the new company targeted another cinder deposit in the Flagstaff area, known as the Sinagua cinder cone. By November 1997, MG Gold had issued 8.5 million shares and almost 4 million more free-trading shares.

In June 1999, MG announced the appointment of a new manager of the Sinagua pilot plant, who said he anticipated that, within two weeks, the plant would be ready for production at 10 tons per day. The cinders were described as containing in excess of 1.5 oz. gold per ton.

Somehow the gold did not materialize, and the company once again changed its name, this time to Xenolix Technologies. It also started to claim it had developed a process for extracting precious metals from fly ash, the byproduct of coal mining generally used in concrete and road building.

Along with these changes in early 2001 came an administrative action against the company and one of its officers by the securities division of the ACC. The charges pertained to fraud in the sale of unregistered securities. At the heart of the ACC action is the allegation that Xenolix committed fraud by withholding from investors the fact that the technology on which the company was relying had failed to produce any economically viable product from processing the cinders. Also targeted are press releases touting the Xenolix technology as being on the verge of producing highly successful results.

Xenolix has consistently claimed that conventional chemical analyses of samples do not detect its gold mineralization. It also claims to have proprietary “nano-technology” to detect and recover the gold, together with a precursor material for precious metals in the coal ash. The company’s attorney has fired back at the ACC in a letter, threatening litigation against the ACC, the Arizona attorney general’s office, the ADMMR, the Bureau of Land Managemnt and their employees. The letter appears to demand that the
ACC cease communicating with members of the public about Xenolix.

— The preceding is the second in a series of columns examining the history of mining scams in Arizona. The author is a lawyer based in Phoenix, Ariz.