Investor Fraud – Anatomy of a Scam – Identifying a Ponzi Scheme and Scammers – Part II of III
Following the onset of the Great Recession of 2009, it didn’t take an expert to identify a right-hand man and his Ponzi scheme – the outbreak made the front pages of every major newspaper in the United States and abroad. The arrest and prosecution of pin striped with men has been epidemic.
The defined Ponzi scheme is the model of simplicity: the scammer uses money from new investors to pay return on investment to original investors, rather than paying ROI on income earned on legitimate investments or risky work. In short, the only source of income is the investment group. There is no real investment of that money or a legal business model that generates new revenue. The only “business model” involved is the Ponzi scheme itself.
To perpetuate the fraud and maintain the illusion of legitimacy, the architect behind the Ponzi scheme must constantly grow his pool of investors to pay the returns back to the original investors. Original investors may see dividends, but they will never see the return of the principal, as part of that goes into the scammer’s pocket and the rest is used to pay fake dividends to other investors. The investor pool is the only source of income from which dividends are paid. The more investors there are, the higher the annual dividend payments, the more new investors will be required to meet the promised returns and keep the ruse alive.
The tight margins involved in the scam often result in an end game in which the scammer exhausts their bluff and leaves town to start the Ponzi scheme again on new hunting grounds, or is arrested with few or no identifiable assets. to order restitution or award civil damages. This common scenario is one of the main reasons why this crime is such an insidious type of financial fraud: even after the perpetrator is prosecuted and convicted, the victim rarely recovers.
Scammers, like their Ponzi schemes, take many forms. A serial fraudster must avoid a criminal pattern that could identify him or her as the perpetrator of a new financial fraud. They must be low-key, low-key, and chameleon-like, with ever-changing personal and professional personalities. Since a Ponzi scheme in its pure form is simple in structure and easy to spot, the skill of the henchman behind the scam determines its success. If the scammer is an expert in his art, investors are unaware and not interested in the details of his “business”; the inner workings that would identify it as a Ponzi scheme.
One of the warning signs of financial fraud is the absence of a business plan: details and details. Keeping things cloudy allows the scammer to avoid liability. This is often accomplished by instilling an air of exclusivity, privilege, and mystique around the business model. By doing so, potential investors are less likely to ask the tough questions. Through social engineering and charisma, the scammer convinces his brand that he will be part of an investment opportunity that only extends to a select few. This psychological manipulation can be accomplished in a number of different ways, one of which is the affinity scam, where the scammer will target people of similar ethnicity, race, or religious beliefs. Many times there will be a staged investigation of the prospective investor, presumably to determine whether or not he qualifies under SEC guidelines; that is, whether the investor has the net worth and/or the sophistication, understanding and experience required as a precondition for participating in a given investment fund. In reality, this prequalification is an empty exercise: a posture to reinforce the company’s legitimacy traps. The reality is that the scammer’s only concern is that the brand is willing to part with their money; not if he is able to part with his money as a reasonably prudent investor.
Ponzi schemes are not limited to the stock market. They are as varied and numerous as services and products to sell. Because financial fraud can take an unlimited number of forms, it’s impossible to put together a comprehensive guide to avoiding it. The best form of vigilance is to stay alert to the scammer’s presence and not to the scammer himself. If you can identify a scammer, you can avoid the scam.
Behaviour: Watch the behavior of the suspected scammer and pay attention to any evasiveness when asked direct questions. Look for specific answers to specific questions. As noted above, the proof is in the details; the nuts and bolts of the paradigm. If the broker is hesitant to provide you with those details, the details of their investment model, walk away. Remember that vetting goes both ways: just as the money manager has the responsibility of qualifying investors, the investor has every right to check the broker’s references and audit his or her Wall Street or Main Street track record. . At the very least, have all contracts and documentation executed by a reputable securities attorney and accountant who is a certified financial planner.
Discretion and professionalism: While an asset manager is not required to disclose his client list to you, if he is a right-hand man with an A-list client base, he will often go out of his way to do just that. This lack of discretion sets you apart from legitimate brokers and is integral to creating a mystique around the investment firm. He’ll find that most trusted men choose brands who are neophyte investors or have only a rudimentary knowledge of stocks, bonds, and portfolio management. They may be A-list celebrities, but they are rarely A-list financiers and businessmen. Madoff was the master of this calculated discrimination, turning away more sophisticated investors who may have realized that “the emperor had no clothes.” and embracing less savvy celebrities whose star power would be a draw to other deep pockets.
Inflated Returns Promise: The old adage, “if it’s too good to be true, it probably is” applies here. Most likely an unrealistic ROI. Madoff guaranteed select investors in his fund annual returns of more than 46%. An absurd figure that should have prompted skepticism and more aggressive scrutiny from regulatory agencies.
There is nothing a good con man says or does that identifies him as such. Here’s the challenge: their entire approach is based on stealth as perception manipulation, flattery, charm, and deception. It’s a form of psychological warfare and one of the reasons scammers prey on vulnerable populations in society, such as retirees. They also often pander to the narcissistic tendencies of their investors, which is one reason actors are such easy targets. The art of the scam is just that: art, not science. It has much more to do with a mastery of psychology than finance.
common thread: There are few common denominators in this game, but there are some truisms. If you take anything from this op-ed, let it be this truism: A master scammer is one who identifies a need in his brand and convinces the brand that he can fill that need.
The reality is that the scammer rarely has the intent, ability, or desire to deliver on their promises, but they do have the intent and ability to stick with their brand in the belief that a big payday is a certainty in the near future.
Bernard Madoff and Allen Stanford set the bar high for institutionalized bribery with scams netting up to $65 billion. It wasn’t just the size of the shot, but the longevity and complexity of these cons that set them apart. They represent one end of the continuum both in the scale of the economy and in the enormity of crime. You would think that the klieg lights directed at these men and their public pillar would have had a chilling effect on like minded corrupt men of money. That was not the case. Shortly after Madoff and Allen were apprehended, con artists Paul Greenwood and Stephen Walsh were arrested for defrauding their investors of $554 million.
Climate and Zeitgeist: As with preventing any plague, the best way to protect yourself against the threat is to ensure a robust immune system that is unattractive to the virus. Over the past two decades, increasing deregulation and lax enforcement of existing rules created an ideal climate for defrauding seasoned and novice investors alike. It has been a breeding ground for scammers and Ponzi schemes.
We the People: Government agencies empowered to safeguard public trust suffered from political paralysis, inaction, and indifference. They cared more about public relations than policing Wall Street. The Securities and Exchange Commission and the Federal Trade Commission doubled as prep schools for future Wall Street financiers. The agencies became revolving doors for federal employees seeking higher-paying, more powerful, and prestigious jobs from the very companies they were charged with regulating. It is difficult to effectively investigate a company for securities fraud while approaching the audit like a job interview. I can tell you from first-hand experience in my efforts to bring a high-profile fraudster to justice that the SEC’s approach to investigating investor fraud is more like a “duck and cover” classroom drill. ” of the 50s than to a serious, probationary and aggressive mentality. investigation into the possibility of criminal conduct. Arguably these past two decades such agencies, whether by design or negligence, have only served to insulate the corrupt and criminals from scrutiny and exposure. Inaction is action. Over the last twenty years of deregulation, that inaction has often risen to the level of criminal co-conspiracy, but through the absence of intent. The FTC, the Treasury Department, and the SEC were powerless mother organs of a diseased, incestuous Wall Street culture that led to a crisis situation.
The very fact that the greatest con man in our nation’s history, Bernard Madoff, enjoyed a tenure as Nasdaq chairman and had a niece in bed, literally, with an SEC regulator is damning evidence of a fractured foundation. . When the SEC was at times shaken from its state of nepotism, torpor, and active avoidance of upsetting the status quo, its chronic delinquency left it at the crime scene as a coroner to record time of death, rather than in its intended role as sheriff to detect the homicide. Too often, the SEC’s role was that of an undertaker tagging and bagging bodies, falling considerably short of its intended role as defined in section 4 of the Securities Exchange Act of 1934.
Part III of III In this series of articles on Ponzi schemes, he will examine a scam in progress in the real world, the con artist behind it, and the investor victims of the criminal enterprise.
