When James Potts walked out of Leavenworth five years ago, friends say he had only $5.30 and the hope of creating a publishing business dedicated to helping the prisoners he left behind.

With funds from the American Civil Liberties Union, Potts began to build, first writing a self-help legal manual for inmates that sold 25,000 copies in four months. Then he launched a nonprofit corporation run by ex-offenders and began publishing the only national law magazine for inmates. Its circulation quickly reached 4,000. His organization won almost $37,000 in foundation grants to revise his ACLU manual, and Potts began advertising a second book.

But what Jimmy Potts built is crumbling -- to the embarrassment of the ACLU and the disappointment of The Playboy Foundation, United Presbyterian Church and other groups that contributed money to his organization. Potts himself is back in jail after pleading guilty to a cocaine charge, and may be on his way back to prison.

His organization, Institution Educational Services, Inc. of Washington, is near bankruptcy because of financial mismanagement. Potts denies any wrongdoing on his part. The Postal Service is investigating him for possible mail fraud -- for taking money from prisoners for the book he advertised but never finished. The grants that were supposed to finance revision of Potts' ACLU manual have disappeared and the revision remains far from publication. Meanwhile, the Prison Law Monitor he had edited is $22,000 in debt, and Potts' successor says it will probably go out of business.

"It's a big loss to ex-cons and the people trying to help them," says Kenneth Schoen, director of the criminal justice program of the Edna McConnell Clark Foundation, which gave IES a $20,000 grant for the revision. "People tend to generalize about ex-cons and when they see something like this they say, 'Ah-ha. We were right.' "

IES, which used to have an office on T Street NW, acted as a clearing house for prison-related law cases and researched prisoners' civil rights suits. It received about 150 letters a week from convicts. But the organization's main work was its highly respected monthly magazine, which included articles by prison reform attorneys and legalistic summaries of court decisions related to prisoners' rights.

Potts, who spent 12 of his 34 years behind bars for various drug, burglary and theft charges, is in jail in Arlington, facing a sentence of up to 40 years for distribution of cocaine. He pleaded guilty to that charge and will be sentenced Oct. 7. Two of the original five IES staff members are back in prison. And the ACLU is hoping the whole matter will be quietly forgotten.

"The money is gone," said Edward Koren, a Washington ACLU attorney who worked closely with Potts. "It would be a wild goose chase to try to get it back now." The magazine board, made up mostly of prominent prison reform attorneys, plans to file no complaint against Potts or any of the ex-convicts who worked for him.

"They board members don't believe in the prison system," says Daniel Manville, the new Monitor editor, ex-offender and a third-year student at Antioch School of Law. "So why would they return people to a system they don't believe in anyway?"

From the Arlington jail, Potts says, "The money had to be misappropriated after I left. While I was there everybody in the office made sacrifices. People went without salaries. It was hard going."

Potts says he simply fell behind schedule on his book after his arrest on cocaine charges, and still plans to finish it. He also plans to return the money of those who answered his ads.

Potts says the Monitor "ran on a deficit of at least $3,000 all the time," operating on a "hand-to-mouth budget." The money paid the six employe salaries and the production costs of the magazine and the manual, Potts says. The Monitor's real financial troubles began last summer after he was charged with distributing cocaine, Potts says.

"I left so abruptly there wasn't time to make the proper transitions," he says. Potts jumped his $20,000 bail and went underground, although Manville says Potts continued to help edit the Monitor.

Koren says Potts appointed Thomas G. Chesonis, a staff member and ex-prisoner, as Monitor editor when he resigned. Chesonis, however, lost control of the magazine in a court battle with its board of directors, which appointed Manville to head the organization. But when Manville took over in January, he says, the Monitor's financial records were missing. Checks had been written, Manville says, but there was no record of who had received them.

Manville says there are two stories about where the records went: One is that Potts took them with him, a charge Potts denies; the other is that the records were in the trunk of Chesonis' car, which was stolen and later found in New Jersey -- without the records.

"I left the books in order," says Potts. "What they did after I left, I don't know." Chesonis could not be reached for comment.

Despite all these unexplained twists, those who backed Potts remain sympathetic to his cause.

"It's a damn shame," Koren says of Potts. "He came out of the joint with a burning desire to help others. Maybe he bit off more than he could chew."

Potts grew up on the wrong side of the law. Juvenile homes at age 15. Texas State Prison at 20. Leavenworth at 28. "It wasn't a matter of not going back to prison," Potts says, "it was a question of how long could you stay out."

Each time he went back he learned more about the law, trading legal advice for lawbooks and cigarettes, churning out articles for prison publications. When he was released from Leavenworth in 1976, Potts breezed through a one-year paralegal course at Antioch in three months, then got his job with the ACLU National Prison Project, a Washington-based prison reform group.

"The picture is fuzzy as to what actually happened," said Alvin Bronstein, director of the National Prison Project, the branch of the ACLU that worked most closely with Potts and his operation. "It is clear that funds were misappropriated. The funds and much of the equipment purchased for the publication of the revised manual and the magazine disappeared. Somebody there did it."

All of these troubles have dried up sources of money for IES.

"We can't get anybody to pick up the extra amount we need," says Manville. "No foundation wants to come along and pay off past debts caused by mismanagement."

The Clark Foundation has said it will be willing to forward the remaining $6,000 of its total $20,000 grant if IES writers actually finish the prisoners' self-help manual. But, says the foundation's Schoen: "We're not making any additional grants to them -- no dice."

Meanwhile, most of the original staff has scattered. Former IES executive assistant Joseph A. Lykins is in a California federal prison, and former treasurer Claxton C. Davis is in a Florida corrections center for check forgery unrelated to the financial problems of IES.