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When dry holes mean big bucks

Donald Speth of Utah just happened to be looking to make an investment when he received a phone call in 2005 from Target Oil & Gas Corp. in Central Kentucky.

Speth received a "fairly impressive brochure" in the mail about drilling projects in West Virginia. A geologist was quoted as saying that typical wells in the area have an average production of 13 barrels of oil a day.

With "a price of $60 a barrel, it is easy to see the upside of drilling in this area," the brochure said.

In January 2006, four months after Speth agreed to invest $9,700, he was told two of his wells had struck gas, he said.

A smooth-talking Southerner, Chris C. Smith, said he needed to pay a connection fee. But Smith promised to waive it if he invested in other wells in Kentucky, Speth said.

Smith was pleasant and not pushy, Speth said.

"I kind of took it because he sounded like a nice guy, and he sounded like he was honest," Speth said. "I told him I shouldn't even be doing it."

Today, Chris Smith, 48, of Prestonsburg and five other officials with Target Oil and an interlocking company, Kentucky Indiana Oil & Gas in Danville, are under indictment on accusations they swindled $3 million from investors across the country.

A landowner who leased his mineral rights in Bell County says the companies are not in the business of drilling for oil — they're in the business of drilling for dry holes and stealing from investors.

An attorney representing Michael D. Smith, president of Target Oil and controlling interest holder in Kentucky Indiana, said the companies did nothing wrong.

"Our folks thought they were doing stuff the right way," Lexington lawyer Derek Gordon said. "Who knows what you're going to find when you drill a hole?"

Gordon said he has not yet spoken with Michael Smith, 53, of Lancaster, in detail because the lawyer has been out of town. He declined further comment.

An attorney representing Chris Smith declined to comment.

The six men are charged with one count of conspiracy, 20 counts of mail fraud and two counts of wire fraud. Mike and Chris Smith, who are brothers, are charged with additional counts of selling securities without a license.

More bad guys than good

Oil and gas companies use drilling programs to raise capital from investors. The investors buy shares into the project and receive payments if the drilling strikes oil or gas.

Oil and gas companies are required to publish "offering circulars" for prospective investors that disclose all facts relevant to the investment decision, including risks, proposed distribution of any profits and how drilling costs are to be reimbursed.

Marketing the high-risk investments to the general public is illegal. Only accredited investors — which the federal government defines as millionaires or someone who has made $200,000 in one year the last five years — can be solicited.

Speth was not an accredited investor. Yet he and others across the country received cold calls from the companies, according to the indictment.

Three years after he was told his wells had struck gas, Speth has not received a dime on his $16,000 investment — despite repeated promises that the company should get permission to connect the well to a pipeline any day.

Frustrated, Speth contacted the Office of Oil and Gas in West Virginia in 2006. He says he was told that not only had Target never acquired the rights to connect the well to a pipeline, but it was so far away from one that the well would never be profitable.

"I don't believe he ever anticipated hooking it up," Speth said.

As the price of oil skyrocketed in recent years, peaking at nearly $150 a barrel last year, oil and gas fraud soared with it, securities regulators say.

A Dallas trial lawyer who specializes in suing oil and gas con artists — known as promoters in the industry — says scams are so prevalent that regulators can't keep up.

It's no secret who the promoters are, lawyer Mitch Little said. But there are so many of them, and the prosecutions of them are so expensive and labor-intensive, that fraud is rampant.

"The problem is there are more bad guys than there are good guys," Little said. "They are so overwhelmed with these energy scams, they literally don't have enough manpower or man hours to devote to them."

Securities regulators in Kentucky investigated Target Oil as early as 2003. The company, accused of selling unlicensed securities, agreed to change its sales practices.

But by 2004, the state was investigating it again.

In 2006, the case was referred to the United States Postal Inspection Service, which began its own investigation, said Kelly May, a spokeswoman for the Kentucky Office of Financial Institutions.

The federal government seized the company's books in 2007, according to court records in a civil action the office filed against Target.

Federal prosecutors declined to comment.

A comedy of errors

In 2005, Richard Hunter of Toledo, Ohio, leased mineral rights to Target for property he owned. Hunter described his account of the events as a comedy of errors.

Hunter said it took eight months for Target to so much as turn over a rock. Hunter's lease required Target to drill within one year, and he told the company he would not renew the lease if the company did not drill by then.

Eventually, Mike Smith told Hunter to pick out three sites to place the wells. Hunter, who had no experience in oil and gas, said he knew enough to ask why a geologist wasn't doing that.

Hunter says Mike Smith assured him that a geologist, Ray Garton, who is also charged, reported that anywhere they placed the well would be perfect.

According to a federal grand jury indictment, this was the company's modus operandi. The company allegedly turned the normal procedure on its head, with Mike Smith selecting drilling sites and Garton writing false geological surveys of them to dupe investors.

The surveys claimed to contain geological information specific to the proposed well. But they actually had information only about the general area, according to the indictment.

The drilling company that subcontracted with Target for Hunter's land said Target officials didn't know what they were doing.

"They weren't very experienced," said President Brad Liggett of Phoenix Drilling.

Liggett added that the drilling company didn't see anything suspicious.

While Hunter leased his rights to Target, the permit for the well actually came through Kentucky Indiana, the other company under indictment, state records show.

Of the three wells that were drilled for, one did hit gas. A well logger said it could produce up to 4 million cubic feet of gas a day, making it a large well, Hunter said.

Nonetheless, Target pumped it at only 500,000 cubic feet a day, one-eighth of its potential, Hunter said. The company promised to crank it up after a month but never did.

Eventually production declined further, and Target told Hunter the well was not producing at all.

Hunter does not know whether the production decline is legitimate. He plans to sue to get out of the lease and have another oil company examine it.

"I really do believe that Mike Smith and Target did everything they could possibly do to not be successful," Hunter said.

'I got duped'

That an alleged oil and gas promoter would not tap a well for all it's worth is not unusual, said Little, the Dallas lawyer.

For oil and gas promoters, running wells and cutting checks for investors is actually a distraction from the far more lucrative business of tapping investors, he said.

Hunter tells his story in a four-part video series that is on YouTube.com. He says it's therapy.

Three other Eastern Kentucky landowners said in interviews that they also were upset with Target Oil.

Dorsey Elmore of Lincoln County leased his mineral rights to Target in 2001. He said Target officials went door-to-door buying mineral rights in his neighborhood.

In a hand-written contract, Elmore agreed to let them drill for $250 a hole. They told him they would drill to 1,500 feet but drilled only to 500 feet.

They promised to clean up his property, but Elmore said they left it in a mess.

Little, the Dallas lawyer, said he's never heard of an oil and gas company paying property owners for each hole drilled. And going door-to-door is odd.

Vernon Hull of Clinton County says the same thing happened to him last year. Not only did Target not clean up his property, but it did not plug the holes with cement before abandoning them as required by law, Hull said.

Target Oil has been cited by the state repeatedly for improperly abandoning wells since 2003. Records at the Kentucky Division of Oil and Gas Conservation show it has been permitted to drill 149 wells in Kentucky and has accrued 69 violations, most of them for improper abandonment.

Nine violations are still outstanding. The state has never revoked the bonds the company is required to post with the state for projects.

In West Virginia, the company has seven outstanding violations.

Target has also received cease-and-desist orders from regulators in several states for allegedly selling unlicensed securities. The orders are easily found on the Internet.

Hunter readily admits he would have found several red flags if he had simply done some cursory research. But he was referred to the company by a relative of Mike Smith's who was not familiar with his business.

Hunter sees it as lost opportunity. But what bothers him is his belief he let his family down.

"What upsets me the most is not the fact we're not getting revenue checks," Hunter said. "I got duped and screwed my family over. It is embarrassing to me."

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