By Robert Hunter

Most derivatives pros hope that by the time they turn 50, they’ve socked away enough dough to live out their golden years in comfort and serenity.

For Martin Armstrong, things won’t play out quite so nicely. In September, the founder and chairman of Princeton Economics International was arrested by federal authorities for allegedly bilking Japanese investors of up to $1 billion in fraudulent—and ultimately unsuccessful—futures trades in yen, precious metals and crude oil, among other instruments. The Securities and Exchange Commission and the Commodity Futures Trading Commission are pursuing civil complaints against Armstrong as well.

If convicted of the criminal charge of securities fraud, Armstrong could spend the next 10 years not in the ocean-side grandeur of his Maple Shade, N.J., estate, but rather in the bleak confines of federal prison. And he could be forced to ante up as much as $1 million in fines all told.

Authorities allege that Armstrong’s company and some of its overseas affiliates created a bogus investment fund that collected around $3 billion in principal from Japanese corporates. The fund issued “variable redemption” notes as well as fixed-term guaranteed notes paying 4 percent annually. While the proceeds were supposed to be deposited in separate accounts at Republic New York Securities Corp., they were allegedly funneled into a Princeton Global Management account managed by Armstrong and used to make bets on various derivatives, bonds and currencies. The result, say prosecutors: an elaborate Ponzi scheme, in which Armstrong operated undisclosed—and therefore illegal—commodity futures trading pools and other funds. Many of the bets have since turned sour, amounting to losses that could approach $1 billion.

The charges get even more sordid. The federal complaint asserts that Armstrong, with the help of an unnamed executive at Republic New York Corp., duped some investors into thinking they were investing in AAA-rated government securities. Prosecutors included as an exhibit in the complaint an August 16 letter written by William Rogers, president of Republic New York Securities’ futures division, that certifies to Armstrong that one account held $12.7 million in “AAA U.S. Government securities.” But Republic told the FBI that Rogers had no authority to write such confirmation letters, while Republic’s internal auditors said that “in nearly all instances, the confirmation letters falsely overstate the value of assets,” from “a few thousand dollars to as much as $46 million.” Rogers, meanwhile, admitted to Republic officials that he “did not generally confirm the accuracy” of the letters, according to the complaint.

Some of the Japanese companies left holding the bag include Kissei Pharmaceutical, which invested 3.5 billion yen, and Amada Wasino Co., a machine tool maker, which invested 3 billion yen. A group including Alps Electric Co., Gun Ei Chemical Industry Co., Amada Co., Amada Sonoike Co., Kaga Electronics, Maruzen Co. and Chudenko Electronics Co. announced a combined exposure of more than 62 billion yen.

On September 1, the FBI searched Armstrong’s Princeton, N.J., offices and seized more than 30 boxes of documents. Since then, many of Princeton Economics’ assets have been frozen.

For his part, Armstrong asserts that his only mistakes were following what he calls a common business practice in Japan that lets firms delay in reporting their losses, and betting that the yen would fall vs. the dollar. He denies all federal charges, and argues that prosecutors rushed to indict him on thin evidence to make sure he didn’t flee the United States.

The enigmatic Armstrong had long crafted a professorial, pedagogic image, and was known for an encyclopedic knowledge of economic history, sometimes making arcane references to the commodity markets of ancient Mesopotamia to colleagues on the New York Commodities Exchange’s trading floor. But despite his ivory-tower leanings, he never stuck around long enough to earn even a bachelor’s degree. His abortive academic career was limited to a few courses at the RCA Institute, a New York school now called Technical Career Institute. Armstrong’s do-it-yourself education included voracious reading and, tellingly, coin collecting, which led to early success as a metals trader at the Comex.

Armstrong quickly found that he had a knack for trading everything from gold and silver to stock-index futures, and he turned Princeton Economics into a powerhouse trading firm with 300 employees and offices in Philadelphia, Chicago, London, Hong Kong and Tokyo. His computer models and trading strategies were based largely on historical data, on the theory that history always repeats itself. In 1989, he became legendary in some circles in Japan when his models correctly predicted a 50-percent fall in the Nikkei 225 index from its peak of 39,000. Last year, he bragged in an interview that “In Japan, they call me Mr. Yen.”

But Mr. Yen’s predictions weren’t always correct. Last July, he predicted that the yen would fall from 147 to the dollar to below 200; instead, the yen has risen to around 106 to the dollar and he lost some $300 million. Because Armstrong had sizable positions in crude oil and precious metals as well, traders briefly worried that large-scale liquidations could rock those markets, prompting federal authorities to freeze Princeton’s assets.

If prosecutors have their way, Mr. Yen could soon become Mr. Five-to-Ten.

Charles Smithson, an erstwhile academic, prolific author and head of CIBC’s School of Financial Products, left CIBC in August to start Rutter Associates, a credit portfolio management consultancy based in New York.

Smithson is betting that managing credit portfolios will be the hottest risk management topic over the next five years. “We talk to firms about what credit portfolio management is, why a bank or investor would want to do it, what the tools are to carry it out, and some of the implementation issues. It turns out that credit portfolio management is one of those areas where there are a lot of potential slips between cup and lip. That’s why we called ourselves Rutter Associates—a rutter is what the early English navigators called the precursor to the chart. We don’t assert that we’ve got a complete chart to get you from here to there, but we do know some of the rocks other people have run into and we can help you stay off of those.”

Smithson says he left CIBC on good terms. Thus far, his boutique consultancy has three employees: Smithson and two other CIBC alums—Greg Hayt, a finance specialist, and Shang Song, a physicist-turned-finance-professional. Their first task may be their most difficult—finding office space in overcrowded Manhattan.

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