15/07/2024 2:22 PM


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Investor Fraud – Anatomy of a Con – Identifying a Ponzi Scheme and Scam Artists – Part II of III

8 min read
Investor Fraud – Anatomy of a Con – Identifying a Ponzi Scheme and Scam Artists – Part II of III

Following the onset of 2009’s Great Recession, one didn’t need an expert to identify a confidence man and his Ponzi scheme: the outbreak was splashed across front pages of every major newspaper in the United States and abroad. Arrest and prosecution of pin stripped con men has been epidemic.

The Ponzi scheme defined is the model of simplicity: the con man uses money from new investors to pay return on investment to original investors, rather than pay out ROI from revenue earned in legitimate investment or venture work. In short, the sole source of revenue is the investor group. There is no actual investment of that money or lawful business model that yields 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 investor pool in order to pay returns to original investors. The original investors may see dividends, but will never see return of the principal, as part of that goes into the con man’s pocket with the rest used to pay false dividends to fellow investors. The investor pool is the lone source of revenue from which dividends are paid. The more investors there are, the greater the annual dividend payments, the more new investors are required to satisfy promised returns and keep the ruse alive.

The thin margins involved in the scam more often than not result in an end game where the con man either exhausts his bluff and leaves town to begin the Ponzi scheme anew in fresh hunting grounds, or is arrested with little to no identifiable assets from which to order restitution or award civil damages. This common scenario is one of the primary reasons this crime is such an insidious type of financial fraud: even after prosecution and conviction of the perpetrator, the victim is seldom made whole.

Scam artists, just like their Ponzi schemes, take many forms. A serial con man must avoid a criminal pattern that could identify him as author of a new financial fraud. They must be discrete, inconspicuous and chameleon like, with ever changing personal and professional personas. Since a Ponzi scheme in its pure form is simple in structure and easily detected, the skill of the confidence man behind the scam determines its success. If the hustler is adept at his art, investors are both unaware and uninterested in the specifics of his “business”; the inner workings that would identify it as a Ponzi scheme.

One of the red flags signaling a financial fraud is the absence of a business plan — details and specifics. Keeping things nebulous allows the con man to avoid accountability. This is often accomplished by inculcating an air of exclusivity, privilege and mystique around the business model. By so doing, prospective investors are less likely to ask the hard questions. Through social engineering and charisma, the con man persuades his mark that he will be party to an investment opportunity only extended to a select few. This psychological manipulation can be achieved in an number of different ways, one of which is the affinity con, where the con man will target those of like ethnicity, race or religious persuasion. Often times there will be a staged vetting of the prospective investor, presumably to determine whether or not he is qualified under SEC guidelines; that is, whether the investor possesses the net worth and/or sophistication, comprehension and experience required as a pre-condition for participation in a given investment fund. In reality, this pre-qualification is an empty exercise — posturing to reinforce the firm’s trappings of legitimacy. The reality is that the con man’s only concern is that the mark is willing to part with his money; not whether 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 there are services and products to sell. Because financial fraud can take a limitless number of forms, it’s impossible to craft an all encompassing guide book to avoiding it. The better way to vigilance is to remain alert to the presence of the con man and not the con, itself. If one can identify a con man, you can avoid the con.

Demeanor: Look to the suspected con man’s demeanor and be attuned to any evasiveness when he is asked pointed questions. Look for concrete answers to concrete 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 specifics of his investment model — walk away. Remember that vetting goes both ways: just as the money manager has a responsibility to qualify investors, the investor has every right to check the broker’s references and audit his track record on Wall Street or Main Street. If nothing else, run all contracts and documentation by a trusted securities attorney and an accountant that is a certified financial planner.

Discretion and professionalism: While an asset manager is not obliged to release his client list to you, if he is a confidence man with an A-list client base he will often take pains to do just that. This absence of discretion distinguishes him from legitimate brokers, and is part and parcel of creating a mystique around the investment firm. You will find that most confidence men choose marks that are either neophyte investors or possess only a rudimentary knowledge of stocks, bonds and portfolio management. They may be A-list celebrities, but they are seldom A-list financiers and businessmen. Madoff was master of this calculated discrimination, turning away more sophisticated investors that may have realized the “emperor had no clothes”, and embracing less savvy celebrities whose star power would be a draw for other deep pockets.

Promise of inflated returns: The old adage, “if it’s too good to be true, it probably is” applies here. A ROI that is unrealistic most likely is. Madoff guaranteed select investors in his fund annual gains upwards of 46%. An absurd figure that should have triggered skepticism and more aggressive scrutiny by regulatory agencies.

There is no one thing a good con man will say or do that will identify him as such. This is the challenge: their entire approach is based on stealth like manipulation of perception, ingratiation, charm and deceit. It’s a form of psychological warfare, and one reason con men prey upon vulnerable populations in society like pensioners. They also frequently pander to narcissistic tendencies in their investors which is one reason actors are such easy marks. The art of the con 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 a few truisms. If you take anything from this think piece, let it be this truism: a skilled con man is one who identifies a need in his mark and convinces the mark that he can meet that need.

The reality is that the con man seldom has the intent, ability or desire to deliver on his promises, but does have the intent and ability to string along his mark in believing that a big payday is a certainty in the near future.

Bernard Madoff and Allen Stanford set the bar high for institutionalized graft with cons that yielded as much as $65 billion USD. It was not merely the size of the take but the longevity and complexity of these cons that set them apart. They represent an extreme end of the continuum in both scale of economy and enormity of crime. One would think the klieg lights directed at these men and their very public pillaring would have had a chilling effect on similarly minded corrupt money men. That was not the case. Shortly after Madoff and Allen’s apprehension, scam artists Paul Greenwood and Stephen Walsh were arrested for the bilking of $554 million from their investors.

Climate and Zeitgeist: As with staving off any plague, the best way to guard against the threat is to ensure a robust immune system that is not attractive to the virus. Over the past two decades, growing deregulation and lax enforcement of rules that did exist created a climate ideally suited for defrauding experienced and novice investors, alike. It has been a breeding ground for con men and Ponzi schemes.

We the People: The governmental agencies chartered to safeguard the public trust were afflicted with the paralysis of politics, inaction and indifference. They became more concerned with public relations than policing Wall Street. The Securities and Exchange Commission and Federal Trade Commission doubled as preparatory schools for future Wall Street financiers. The agencies became revolving doors for federal employees seeking better 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 as a job interview. I can tell you from firsthand experience in my efforts to bring a high profile con man to justice that the SEC’s approach to investigation of investor fraud bears more resemblance to a 1950’s “duck and cover” school room drill than a serious minded, probative and aggressive inquiry into the possibility of criminal conduct. Arguably, these past two decades such agencies, whether by design or negligence, served only to insulate the corrupt and criminal from scrutiny and exposure. Inaction is action. These past twenty years of deregulation, that inaction often rose to the level of criminal co-conspiracy, but for the absence of intent. The FTC, Treasury Department and SEC were mere impotent organs of a diseased, incestuous Wall Street culture that led to a crisis condition.

The very fact that the biggest con man in our nation’s history, Bernard Madoff, enjoyed a term as chairman of Nasdaq and had a niece in bed, literally, with an SEC regulator is damning evidence of a fractured foundation. When on occasion the SEC was jolted from its hard-wired state of nepotism, lethargy and active avoidance of disrupting the status quo, its chronic delinquency left it at the scene of the crime as coroner to record time of death — and not in its intended role as sheriff to deter the homicide. The SEC’s function was too often that of an undertaker tagging and bagging bodies, falling considerably short of its intended function as defined by section 4 of the Securities Exchange Act of 1934.

Part III of III in this series of articles on Ponzi schemes will examine a real world, ongoing scam, the con man behind it and the investors victimized by the criminal enterprise.

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