Ponzi Schemes - A Sign of the Times

by Michael Diaz Jr. - Diaz Reus International Law Firm
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[authors: William Belke and Alejandro Garcia (DRRT Investigations)]

“If they ever tell my story, let them say... I walked with giants. Men rise and fall like the winter wheat... but these names will never die. Let them say I lived in the time of Hector. Let them say... I lived in the time of Achilles.” Troy (2004)

Like Achilles, many investors have journeyed far and wide seeking fame, glory and good fortune. For some, the journey is nothing more than a mirage of empty promises, leaving them stranded on the scorched shores of barren lands.

Unfortunately, this has been the decade of Ponzi schemes. Bernard Madoff and Allen Stanford, to name a few, were the unscrupulous giants who wreaked havoc on countless victims. Many victims were seasoned investors, while others were ordinary individuals seeking a profitable return on their investments. Ponzi schemes have no particular bias as to ethnicity, education, or social class. They lure investors with the promise of high returns and appeal to individual greed; the inordinate desire to acquire wealth. Too often, greed defiles logic and common sense.

Traits of a Typical Ponzi Scheme

The scheme is named after Charles Ponzi who actually did not invent the scheme but became notorious for using the technique in 1920s. The original scheme was based on the arbitrage of international reply coupons for postage stamps. The scheme received notoriety after Ponzi amassed large sums of money from his operation and subsequently diverted investors' money for personal use and sustained the scheme by making payments to the earlier investors.

Ponzi schemes are generally described as investment funds where withdrawals are financed by subsequent investors rather than from the profits derived from legitimate investment activities. The schemes usually attract investors by promising higher rates of return than other similar investments. The returns are often short term and aberrantly high. Often, the promoters of these schemes link the proposed investment activities to offshore investment ventures, hedge fund trading, or high yield investments programs. Shares are sold to unsuspecting investors who lack knowledge or competence and promoters often assert a privilege to secret or proprietary investment strategies. Promoters will often convince current investors to remain vested or invest additional monies. Promoters will also minimize withdrawals by offering new plans to investors with extended maturities and higher returns. All of these tactics offer nothing more than the illusion of solvency and conceals the unavoidable collapse. Other Ponzi schemes initially start as legitimate investments that encounter unexpected losses or fail to earn the promised rate of return. These promoters often fabricate false returns on financial reports to attract new investors and sustain the Ponzi scheme.

A Ponzi scheme must entice new investors and requires an ever-increasing flow of money from the new investors to keep the scheme going. Ponzi schemes are destined to collapse at some point simply because the systemic diversion of funds exceeds the proceeds from investors and earnings, if any.

Notorious Ponzi Schemes

The list of reported Ponzi schemes during this decade is long and continues to increase as victims come forward and report these crimes. The following represent some of the more significant cases in recent years.

Former NASDAQ chairman Bernard Madoff operated a Ponzi scheme and committed the largest instance of securities fraud in U.S. history. The Madoff Ponzi scheme reportedly started as far back as the 1990s and attracted over 1,000 investors. Madoff admittedly created false trading reports for each customer which caused an estimated $64.8 billion in losses prior to its collapse in 2008. Madoff pled guilty to multiple securities fraud charges and was sentenced to 150 years in federal prison.

Allen Stanford had an estimated net worth of over $2 billion and was once considered one of the richest men in the U.S. His financial empire stretched from the U.S. to Latin America and the Caribbean. Stanford operated a Ponzi scheme that issued bank certificates of deposit to defraud tens of thousands of people. Certificates of deposit are usually low-risk, insured instruments, but the certificates of deposit were fraudulent. Stanford was sentenced to 110 years in prison for swindling investors out of more than $7 billion over 20 years.

James Davis Risher, a twice convicted securities felon, operated a $21 million Ponzi scheme from 2007 to 2010 targeting elderly and unsophisticated investors. Operating through multiple U.S. banks and at least two Financial Industry Regulatory Authority (“FINRA”) registered investment firms, Risher was able to attract approximately $21 million from unsuspecting investors to be managed in his "private equity funds." Although millions did find their way to the FINRA-registered brokerages through which he advertised he would manage, many millions more were funneled through his bank accounts and used to purchase real estate, vehicles, artwork, and other effects. Risher was sentenced to 20 years in prison and ordered to repay the victims $17,756,186 in restitution.

Conclusions

A common sense approach and a healthy dose of skepticism provide a preliminary foundation from which to assess a potential investment. Before advancing any money, every effort should be made to acquire all available documentation on the proposed investment. Due diligence should be a prerequisite for the investor. Willful blindness is not a viable option. The level of due diligence may vary depending on a number of factors that may include, but are not limited to, the complexity of the investments, venues, and funding. Legal and financial due diligence may be appropriate for some investments that are highly technical and beyond the grasp of the investor. Investigative due diligence should also be conducted regarding the promoter/fund manager for the purpose of verifying and identifying derogatory information, contradictions, inconsistencies, or red flags associated with the integrity and reputation of the personnel managing the investment fund. Furthermore, the due diligence should incorporate appropriate inquiries with the Securities and Exchange Commission (SEC) and FINRA. Investors should generally be skeptical of unusual or ambiguous investments. They should seek competent legal and financial advice on investments that incorporate leverages and complex derivatives, and make sure they understand the risks and the processes associated with the proposed return on investment.

For the diligent who seek counsel and heed the warnings; let them say…“I endured in the time of Madoff and Stanford.”

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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