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Record Year For Ponzi Schemes

by Gary D. Halbert
January 19, 2010


1.   Ponzi Schemes Exposed Nearly Quadruples

2.   Why Are So Many Investors Fooled?

3.   Ways to Help Avoid Ponzi Schemes


A year ago, my January 20, 2009 E-Letter discussed how Bernard Madoff had been accused of running a fraudulent Ponzi scheme that could lead to investor losses of up to $50 billion.  Little did we know at that time that 2009 would come to be known as a year that saw over 150 such fraudulent schemes exposed and shut down by regulators and law enforcement officials.

However, what really got my attention was news that an investment firm just down the street from our offices here in Austin had been taken over by regulators just a few weeks ago.  It’s frustrating knowing that local investors, maybe even some people that I know, might have been the target of this alleged fraudulent investment scheme right here in my own back yard.

I am now in my 8th year of writing this E-Letter and, over that period of time, I have identified several topics that I feel bear repeating from time to time in order to make sure investors stay fully informed.  One such subject pertains to investment scams and fraud, and how to avoid becoming a victim of the hucksters that prey upon the fear and greed of their targets. 

It’s probably too late for the many people who were lured into fraudulent investments to get any meaningful recovery of their money.  However, their misfortune can prove to be instructional for those of us who are willing to learn from their mistakes.

Before I begin, it’s also important to remember that being accused of running a Ponzi scheme or other investment scam is not the same as being convicted.  Many of the accused masterminds of these programs have pleaded not guilty and will have their day in court.  That being said, let’s move forward with our analysis.

Ponzi Schemes Galore

According to the Securities and Exchange Commission (SEC), a Ponzi scheme is an investment scam “where new investor money is used to make payments to earlier investors to give the false illusion that the investment is successful. This ploy is used to trick new investors to invest in the scheme and to lull existing investors into believing their investments are safe and secure. In reality, the fraudster almost always steals investor money for personal use. Both types of schemes depend on an unending supply of new investors - when the inevitable occurs, and the supply of investors dries up, the whole scheme collapses and investors discover that most or all of their money is gone.”

According to recent research by the Associated Press (AP), the number of Ponzi schemes uncovered in 2009 almost quadrupled from 2008 levels.  Based on AP’s research, more than 150 Ponzi and other fraudulent investment schemes were exposed in 2009, compared to only 40 or so such scams uncovered in 2008.  AP searched criminal and civil cases at the federal and state level, as well as FBI and civil actions to determine the number of fraudulent investment schemes uncovered during the year. 

AP also estimates the amount of money lost by the thousands of investors in these various investment scams was in the neighborhood of $16.5 billion.  And remember, this total doesn’t include the apprx. $50 billion Madoff scandal, since it was discovered back in 2008.

So, did regulatory and law enforcement officials suddenly become better able to spot fraudulent schemes in 2009, or was there something else at work?  In a way, the Madoff scandal did probably make regulators more wary of outlandish promises by investment promoters.  However, had the market not dipped in 2008 and early 2009, causing investors to make fewer new investments and to even take money out of existing investments, these scamsters would likely still be in the business of ripping people off.

How can a bear market lead to exposing a fraud that law enforcement can’t seem to catch?  The answer is based on the way such schemes operate.  As noted above, the classic Ponzi scheme simply uses money from new investors to pay off earlier investors that may choose to leave.  However, because Ponzi schemes typically claim to produce too-good-to-be-true returns, few investors cash in their accounts and there’s always a steady stream of new investors chasing returns.  Those investors who do cash out are often barred from re-entering the investment, which also helps to keep redemptions to a minimum.

And what happens to the money not used to pay off earlier investors?  Unfortunately, much of it is used to fund a lavish lifestyle for the scam artists.  While some scamsters’ money can be reinvested in the program occasionally just to give the appearance of legitimacy, the remainder is typically blown on living the good life.  Money is also sometimes used to prop up related business entities that are incurring large losses.  The key, however, is that the money is not used for the purposes sold to the investors.

Given that most Ponzi schemes don’t retain investor funds, they typically operate on a somewhat thin margin, but because the phantom returns are so great, there’s usually no problem with incoming investments being sufficient to fund any investors that may have to cash out.  However, all of this changes when the market takes a dive.

During major corrections and bear markets, investors often become more nervous about their investments, even if they are reportedly doing well.  Plus, the economic environment sometimes makes it necessary for investors to redeem all or part of their portfolios.  Add greater redemptions to the tendency of investors to be less likely to fund new investments, and you get a “perfect storm” for the Ponzi promoter (as apparently was the case with Bernie Madoff).

Once the operator of a Ponzi scheme can’t pay off investors, the game is usually over.  Investors who are unable to get to their money call in law enforcement and regulators and the Ponzi scheme unravels pretty quickly.  As noted above, this sequence of events happened 150 or so times in 2009, with losses that the Associated Press estimated to be in the $16.5 billion range. 

While victims of investment fraud typically don’t get very much (or any) of their money back, civil cases do seek to attach the assets of convicted scam artists.  However, it can take many years of court action to achieve any sort of settlement.  I am aware of an independent trust company in Illinois that was closed by regulators back in 2000 for perpetrating a fraud something akin to a Ponzi scheme, and there is still ongoing civil litigation seeking retribution from the crooks who are, incidentally, now busy serving their prison sentences.

Since there is little chance of recovering money stolen by a scam artist, it becomes even more important to be able to spot the common characteristics of such schemes and avoid them.  However, doing so requires that you suppress the emotional triggers that the purveyors of fraudulent investments seek to use against you.

Why Are So Many Investors Fooled?

So, how can so many investors be fooled by scam artists?  It’s not because they are unsophisticated, since Bernie Madoff’s client list was a virtual who’s who of the rich and famous, many of whom had extensive investment knowledge and experience.  Instead, scam artists use well-known emotional triggers to get you to invest.

These triggers are innate in all of us and are often the cause of rash investment decisions.  However, the scam artists know how these emotions work and how to push the right buttons to get the response they want.  A while back, I wrote an article about how various tribes in Africa catch monkeys by knowing about and using the monkeys’ own innate tendencies.

It seems that once a monkey grabs hold of a piece of food, it will not let go of it.  I guess we could call this a sort of primate greed.  Hunters know of this trait and will hollow out logs or termite mounds just big enough so that a monkey’s open hand can go in, but a fist full of food can’t be withdrawn.

As much as they might not want to admit it, victims of Ponzi schemes are often trapped just like those monkeys.  The greed for outsized gains outweighs the common-sense admonition that if something sounds too good to be true, it usually is.  However, greed is only one emotional trap that scamsters use to attract victims.  The following are a variety of other emotional snares that a skillful criminal can use to gain access to funds from even the most experienced of investors:

  1. Fear – The recent subprime crisis and credit crunch, complete with unprecedented governmental intervention and huge spending deficits has created no shortage of investment scams based on fear.  The fear may be that the dollar is going to lose all of its value, or that the global economic system as we know it will soon cease to exist.

    Whatever the fear trigger, the Ponzi scheme promoter has a solution available for the gullible investor.  You and I might think that the best fear reaction would be to retreat to the safety of cash, but skillful promoters of fraudulent investments are able to convince their victims that even going to cash is too risky, especially if the entire banking system fails.

    Sadly, the thing that investors in such schemes fear most actually comes to pass when the promoters skip town with their money.

  2. Affinity – An affinity scam can take the form of a Ponzi scheme or any number of other bogus investments.  By definition, an affinity scam calls upon trust built by being a member of a common organization, interest group, profession, etc.  Unfortunately, many affinity frauds are sold through religious affiliations.  The promoter first gains the trust of the congregation, and then starts to systematically drain investment money away from them.

    Some promoters even claim a special gift from God for managing money that makes it possible for them to attain phenomenal results.  In many of the cases of affinity fraud, the victims can’t believe that the promoter actually stole their money; such is the level of trust established through being part of the same fellowship of believers. 

    Many victims of affinity fraud are the elderly, who are least able to recover from a loss of their nest eggs.  Like all scam artists, Ponzi scheme promoters have no conscience and do not hold back from taking advantage of the most vulnerable members of society.  Bernie Madoff, the poster child for Ponzi schemes, used this tactic by preying upon the Jewish community, even going so far as to drain funds from prominent Jewish charities and institutions.

  3. Celebrity – Celebrities, often the victim of various Ponzi schemes, are now also being used to promote these scams.  A growing number of Ponzi schemes are now using the star power of celebrities to help bilk investors of their hard-earned money.  Sometimes, the celebrities are not even aware that they are helping to perpetrate a crime, and usually are counted among the victims of the scam investments they help to promote.

    The recent Ponzi scheme uncovered here in Austin was reportedly such an operation.  The promoter used the lure of former professional athletes to attract money into what regulators are now calling a fraudulent investment scheme.  After all, who wouldn’t want the prestige of investing alongside a sports hero?

    A recent article in our local newspaper discussed the thrill some investors got from being able to walk into their investment advisor’s office and see past Heisman Trophy winners walking around in the halls.  Of course, the Heisman isn’t awarded for financial acumen, so just because a celebrity is involved with an investment doesn’t mean that it’s a good one.

    Plus, it also helps to know that an Investment Advisor registered with the Securities Exchange and Commission (SEC) cannot use testimonials of athletes, celebrities or anyone else.  Thus, if you are attracted to an investment because of a glowing testimonial from a celebrity or other satisfied client, this may be a hint that the promoter is willing to break other rules in order to get (and keep) your money.

  4. Charisma – Many times, promoters of Ponzi schemes and other investment scams are described as having a great deal of personal charisma.  Bernie Madoff was reportedly among this group, according to many of his investors.  His past involvement in the development of the NASDAQ stock market and a variety of other responsible positions likely made his pedigree beyond reproach.

    Charismatic Ponzi scheme promoters often create an aura of “exclusivity” around their investments in an effort to make investors feel like they are being deemed worthy of participating in the investment.  By doing so, this action also cuts down on questions since asking too many questions may cause the promoter to refuse your investment.

    However, don’t let this be your only guide.  Not every charismatic investment sponsor is a scam artist, just as not every scam artist is charismatic.  The key is to not be swayed by the power of personality, but rather analyze investments based on their true potential. 

Avoiding Ponzi Schemes

The old tried-and-true advice in relation to avoiding bogus investment schemes is that if it sounds too good to be true, it probably is.  This is still the “gold standard” of analysis as far as I am concerned, but as I read about the various Ponzi schemes that have defrauded investors, I find it rather amazing as to what some people will choose to believe.

Plus, Ponzi schemes are evolving to address some of the warning signs.  For example, when most investors think about too-good-to-be-true performance, they usually think about high double-digit or maybe even triple-digit returns, year after year.  However, not all Ponzi schemes operate this way.  Again, Bernie Madoff is a good example.  His fraudulent investment didn’t promise pie-in-the-sky returns, but rather offered consistent, reasonable returns over a long period of time.  With Madoff, the amount of the return wasn’t suspect, but the consistency was.

In any investment that involves taking risks, it’s difficult to provide consistently positive returns each and every month for over a decade.  Madoff’s investors (or, more accurately, victims) thought he was so smart that he could structure an investment that would payoff like clockwork.

There are a number of other common characteristics of Ponzi schemes and other investment scams.  Below, I will outline some of these characteristics and ways to spot questionable investments and avoid being a Ponzi scheme victim:

  1. Complexity – It is often difficult, if not impossible, to understand the business or trading model that the promised high returns are based upon.  Sometimes, Ponzi schemes are based on traditional types of business such as making loans, and they simply overstate the amount of interest that can be charged and allowed to flow through to investors.  In other cases, promoters create a bogus trading system that sounds so complex that no one can figure it out (this was apparently the case with Madoff). 

    Ponzi schemes are sometimes hard to spot because there are legitimate investments that also have complex trading systems that may be difficult for the average investor to understand.  That’s why it’s often a good idea to run the strategy by a trusted financial advisor to see if it’s on the level.

  2. Minimal Disclosures – In most Ponzi schemes, specific information about trading, historical track records or other matters surrounding the investment are often hard to obtain.  Legitimate Investment Advisors usually welcome questions and will spend the time necessary to insure you understand your investments.  Scam artists, on the other hand, will often be unwilling to offer much in the way of details about how their investments work.

    You should be aware, however, that there are also many legitimate Investment Advisors and money managers who guard their trading systems carefully.  These Advisors are often found in hedge funds and have developed quantitative strategies that take advantage of perceived market inefficiencies.  If others in the market become aware of the trading strategies, these inefficiencies might disappear.

    So, how do you tell the difference between a scam artist and a legitimate quantitative asset manager?  I’ll have to admit that it’s not always easy to tell.  This is especially true in regard to hedge funds, where managers often employ complex trading models that must remain hidden from public scrutiny. 

    The best answer I can give you is to keep the warning signs I have given you close at hand.  Having just one of these characteristics doesn’t make an investment a Ponzi scheme.  However, if you find an investment has two or more of these warning signs, it may be best to pass it by.  The Internet can also be a valuable source of information.  Just type in the description or name of the investment, and you can usually find out whether these terms have been associated with a Ponzi scheme or other investment scam.

  3. Secret Sauce – Many times, Ponzi scheme promoters insist that they have a secret way to produce phenomenal returns on money.  It may be a special type of investment you’ve never heard of, or a super-secret “insider” who provides tips on the market’s direction.   Either way, it’s important to remember that there are few, if any, secrets in the investment world.  Therefore, be wary of money managers who claim to have a secret source of investment knowledge or an inside track on matters that will affect the market.  Trust me, they don’t.

  4. Custody of Funds – Custody refers to where the money is held and is often most easily determined by asking who the check will be made payable to.  Many Ponzi schemes are successful because the person selling the investment is the same person to whom checks are made payable.

    However, you actually have to go a step further than this.  There may be a custodian in place that appears to be independent, but is really an affiliate of the Ponzi scheme promoter.  Again, Bernie Madoff is a prime example because his investment firm used the services of a broker/dealer also owned and controlled by Madoff to help perpetrate the fraud.

    Therefore, always check out all of the parties involved with an investment transaction.  Just be aware that many Ponzi scheme promoters expect this scrutiny and surround themselves with a complex structure of business entities.  This alone can be a warning sign, so make sure to drill down to the actual owner of each of these entities.  If all trails lead back to the same individual, you probably want to pass on the investment.

  5. Testimonials - Beware of investments using testimonials from satisfied clients and/or celebrity endorsements.  As I noted above, the use of testimonials is generally improper for Registered Investment Advisors and may be indicative of a scam.  Also, never let a recommendation keep you from doing your homework, even if it’s from a friend.  Remember that scam artists let some early investors win so that they’ll tell their friends about the great investment they’ve found.

  6. Not Registered with Regulators – Most securities transactions require that the seller be registered as either a broker-dealer or Investment Advisor under applicable federal and/or state laws.  Therefore, if an investment sounds too good to be true, ask the promoter if he or she is registered with the SEC, the Financial Regulatory Authority (FINRA) or state regulators.  If an individual is a registered representative of a broker/dealer firm, their business card should say “Securities offered through XYZ Financial.”

    There are resources available on the Internet that allow you to check to see if someone trying to sell you an investment is registered with the SEC, FINRA and/or with your state securities board.  Go to the following websites and follow instructions for finding a representative or advisor.  It will be well worth your time:

    For broker/dealer registered representatives:

    For SEC registered Investment Advisors:

    Some smaller Investment Advisors are registered at the state level rather than nationally.  If a promoter claims state registration, contact your local state securities department or agency to verify credentials.  If the person you are dealing with claims to be a life insurance agent, then you should check with your local state Department of Insurance to verify licensing.

    Be aware, however, that not all investment opportunities involve registered securities or require that sales personnel be registered.  That’s why many Ponzi schemes dwell in the netherworld of unregistered investments.  Often these are promissory notes, legal settlements and sometimes even physical assets such as equipment that the promoter claims to be exempt from SEC, FINRA or state registration and regulation.

    Again, it’s hard to characterize all unregistered investments as scams since that’s clearly not true.  It is, however, one of the warning signs that you should be aware of.  Be sure to ask questions about registration with appropriate regulatory entities and check the investments and promoters out with federal and/or state regulators.

  7. Lavish Lifestyles – Many Ponzi scheme promoters enjoy a lavish lifestyle, complete with fancy offices and cars to match.  This is obviously done to convince prospective investors that the promoter is successful and just may be able to provide the same level of success to investors. 

    Obviously, not every flashy dresser is a crook, and everyone with opulent office space isn’t necessarily out to rob you.  However, this is just another warning sign that you should be aware of.  If you are confronted with a promoter with a lavish lifestyle and fancy offices, ask yourself whether the promoter’s business model lends itself to providing funds for conspicuous consumption.  Sadly, many times the expensive trappings surrounding the Ponzi scheme promoter are provided by the funds investors thought were being put to work on their behalf.

It all comes down to never thinking that you are so sophisticated or intelligent that you can’t be scammed.  Remember that Bernie Madoff’s victim list included many of the best and brightest in both the financial services industry and educational institutions.  You should never do less homework on an investment just because the promoter is large and successful.  It’s also important that you not be intimated by a charismatic promoter so that you feel uncomfortable asking questions.

Most of all, however, you should seek to fully understand each prospective investment you are asked to consider so that you know what to expect.  For example, some investors think that any investment they can’t cash out immediately is a scam, but this is not the case.  Some investments, especially hedge funds, have periods of time when you cannot request redemption of your account.  This period of time is called a “lock-up period,” and is typically used by funds that invest in property or other assets that do not lend themselves to being sold quickly on the open market.  But a lock-up period does not mean the investment is necessarily a scam.


If nothing else, the greater number of Ponzi schemes that have been exposed has helped to create a more cautious investor.  Hearing stories of how investors, often friends and family of the crooks, have lost their entire nest eggs naturally makes investors more wary of investments that sound too good to be true.

However, one thing we know about human nature is that lessons learned in the short term don’t always lead to modified behavior in the long term.  As time goes by, investors will forget about the large number of Ponzi schemes discovered in 2009 and again become potential prey for those who would steal their nest eggs. 

In fact, I’d be willing to bet that, even now, investors are falling for new Ponzi schemes designed around the current economic woes of the country.  Securities regulators are already warning of bogus investments to provide heavy equipment to construction firms working in Iraq, and the earthquake in Haiti will also likely spawn scams in the name of providing needed aid to those suffering from the aftereffects of this disaster.  While the latter isn’t an investment scam, it is a way for an unscrupulous promoter to separate you from your hard-earned money without helping anyone but the crooks.

That’s why I continue to run periodic articles about avoiding investment scams so that my readers will always know to exercise caution when evaluating investments.  While the topic of this discussion may seem repetitive to my long-term readers, my hope is that this periodic review will keep you from falling victim to those in the investment industry who would seek to do you harm.

Plus, this article is an excellent source of information for new investors or other friends and family who may benefit from this knowledge.  Please feel free to forward this E-Letter to anyone you know who may benefit from it.

Wishing you safe and sound investments,

Gary D. Halbert


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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