Don’t Fall For The Hype: Avoiding Ponzi and Investment Schemes

Crowe Soberman Insolvency Team
| 8/28/2015
Don’t fall for the hype

Bernie Madoff. Charles Ponzi. Enron. WorldCom. Most of us have heard of them. Some of us are glued to shows like CNBC’s American Greed, which focuses on the stories and details behind many white-collar crimes, many of which have affected everyday citizens. You would think we could learn.

Further compounding the problem is the current economic environment, including volatile stock markets and record low interest rates, which have resulted in bonds and other safer investments yielding historically low returns. As a result, many of us are unsure as to where to invest our savings. Unfortunately, and likely as a result of this, a growing number of us have been presented with investment opportunities that offer high investment returns (sometimes higher than 20 per cent) with “no risk.” Or that’s what they say.

The reality is that often these investment “opportunities” are pyramid or Ponzi schemes, which in general terms are fraudulent processes involving nothing more than returning/circulating a portion of investors’ monies (with the balance going to the fraudulent promoter of the opportunity), rather than the distribution of profits earned from running a legitimate business. Initially receiving their promised return with no delay or disruption, early investors believe their “investments” are legitimate and lucrative and because of this, in many cases, they end up investing even more. Unbeknownst to them, the returns that they receive are furnished by the swindling of eager investors wanting to jump in on the latest “big thing.” And the cycle goes on until the supply of new investors runs out, which eventually collapses the scheme and leaves many investors with nothing.

While in retrospect investors that suffered losses are shocked that they did not pick up on the fraud, the reality is that well designed Ponzi schemes are very difficult to detect. Below are a few traits of Ponzi schemes and recommendations on how to protect you (and your loved ones):

  • A very high rate of return. You should question how and, most importantly, why, a promoter is offering such a high rate of return. A seasoned businessperson, with a strong business plan and a stable history, should be able to borrow from traditional lenders (i.e. a bank) at much lower rates. Essentially, there would be no real need for your investment dollars. If there is, it is likely that the opportunity is high risk or worse, fraudulent.
  • “Complex business,” yet documents are not professional looking or are suspect. Many fraudulent promoters portray their businesses (and themselves) as very sophisticated. They often use multiple legal entities and emphasize all the different transactions they are entering into (many with related entities). Fraudulent promoters purposely try to complicate situations to their advantage, including making it harder for you to understand what is really going on, and thus ask questions. However, a telling sign is that frequently the documents they present to you – financial statements, projections, prospectuses and investment/loan documents – do not appear to have the same sophistication – this is a red flag. (Obviously, this point assumes you are receiving some documents from the promoter. If you are not, that is a bigger red flag!)
  • The promoter is inconsistent with the use of professionals. For example, promoters of Ponzi schemes often change banks frequently and entities within the same corporate group typically have different lawyers and/or accountants. The goal of this inconsistency is to reduce the risk of detection. Further, many times these professionals are not well known or are related to the promoter. You should demand to see audited financial statements from a reputable accounting firm and have your own trusted professional review all documents presented to you.
  • You know others that have invested and they have received their investment returns on time. Many times this is a good thing and should not sound alarm bells. But be aware that fraudulent promoters are excellent at infiltrating ethnic communities, religious groups, senior groups or social clubs. This is done by design as the fraudulent promoters know that people are more likely to trust someone that is supposedly well known in the community. Most importantly, do not assume that because you know somebody who has already invested with the promoter, that they did their own due diligence. A well run Ponzi scheme can pay investors for long periods of time before the scheme collapses. Do your own research before investing.
  • Urgency and secrecy. This is another common and telling sign. Run if you hear words like, “This opportunity is only available if you invest today and only by invitation.” If the promoter does not have the time to provide you with written information (such as financial statements, business plan, etc.) or does not provide you with a reasonable amount of time to review and discuss the opportunity with others, there is a good chance the opportunity is not legitimate. 

Originally published in the Spring 2013 issue of Comments.

This article has been prepared for the general information of our clients. Specific professional advice should be obtained prior to the implementation of any suggestion contained in this publication.

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Hans Rizarri
Hans Rizarri
Partner, Corporate Recovery & Turnaround