The Elusive Carlo Ponzi

Ponzi pyramid schemes are the cancer of frauds, lurking beneath the quiet surface of the investor’s  financial world; often ( as in the case of Bernie Madoff) for years,  before unraveling  and utterly destroying their victims financial hopes and dreams.  Fraudsters like Madoff, Alan Stanford and a host of others over the last decades  have promised their current  victims better than average returns that are actually paid from the monies put in play by their new investors.  It’s impossible to definitively say that Ponzi fraudsters are all sociopaths  but it’s quite safe to say that they’re all criminals.  Someone capable of quietly going about the business of ruining those who trust her for years and even decades demonstrates a callow contempt for the feelings and well being of others and the capability to put her own wish for personal gain above all else, regardless of the human cost.  But all Ponzi schemes fail because a scheme that starts with a few investors quickly doubles and then doubles again… by the time the schemer has reached the 11th level, the number of people who would have to be paid back exceeds the population of the United States; that’s why its called a pyramid.

But individual investors don’t have to be Ponzi victims and their line of  defense is straight forward.  Tell your clients that before they  invest in any proposed investment opportunity,  the first thing they should do is determine who the offeror firm’s auditors are and, most importantly,  if they employ an internal auditor; then request and read all the audit reports for the last five years  That simple step would have revealed that Bernie Madoff had no internal auditor and that his external auditor was a single-practitioner who,  a captive of Madoff, lacked any experience in auditing similar billion dollar investment enterprises.

And there are a number of red flags that are almost an automatic tip off that your business client investor may be dealing with a Ponzi scheme.  The biggest, reddest flag that should  be an alarm bell to all would-be investors is when the overall rate of  return for any proposed investment opportunity greatly exceeds the norm, not for just a quarter or even a year but potentially for decades.  In Madoff’s case he promised his investors that he would return them a steady one percent per month and that there was no risk (another red flag of a Ponzi)  because he had taken out protective stock put options that ensured them against losses.  What made Madoff’s scheme a little different, and successful for so long, was that he was careful to show relatively modest returns year in-year out that weren’t so high as to create immediate suspicion.

There is also always a mystique that the Ponzi fraudster projects about his investment methods… they are always complicated and secret; something no one else knows how to put in practice…what’s more, the schemer is doing the victim a favor by letting him into a closed and exclusive circle.  Most Ponzi’s also make irregular interest payments and feature irregularly timed account earnings statements and reporting that’s uniquely tailored to each investor victim.  Another tip-off is the often inordinate delay in making fund withdrawals and the fact that all investor assets are held internally by the fraudster (Madoff often had investors make out checks to him personally).

The bottom line is that the Ponzi schemer doesn’t have to be the smartest guy or gal in the room; s/he just needs to be smarter than her investors.  Fraud examiners and auditors of all types can play a vital role in protecting our clients from the thousands of these schemes which emerge, all around the world, each year.  Educate your clients and they won’t be victims.

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