Tag Archives: ponzi schemes

Just Like Me

Posted by on August 5, 2019 Comments Off on Just Like Me

During a joint training seminar between our Chapter and the Virginia State Police held a number of years ago, I took the opportunity to ask the attendees (many of whom are practicing CFE’s) to name the most common fraud type they’d individually investigated in the past year. Turned out that one form or another of affinity fraud won hands down, at least here in Central Virginia.

This most common type of fraud targets specific sectors of society such as religious affiliates, the fraudster’s own relatives or acquaintances, retirees, racial groups, or professional organizations of which the fraudster is a member. Our Chapter members indicate that when a scammer ingratiates himself within a group and gains trust, an affinity fraud of some kind can almost always be expected to be the result.

Regulators and other law enforcement personnel typically attempt to identify instances of affinity fraud in order to prosecute the perpetrator and return the fraudulently obtained goods to the victims. However, affinity fraud tends to be an under reported crime since victims may be embarrassed that they so easily fell prey to the fraudster in the first place or they may remain connected to the offender because of emotional bonding and/or cultivated trust. Reluctance to report the crime also frequently stems from a misplaced belief that the fraudster is fundamentally a good guy or gal and will ultimately do the right thing and return any funds taken. In order to stop affinity fraud, regulators and law enforcement must obviously first be able to detect and identify the crime, caution potential investors, and prevent future frauds by taking appropriate legal actions against the perpetrators.

The poster boy for affinity fraud is, of course, Bernard Madoff. The Madoff tragedy is considered an affinity fraud because the vast majority of his clientele shared Madoff’s religion, Judaism. Over the years, Madoff’s list of victims grew to include prominent persons in the finance, retail and entertainment industries. This particular affinity fraud was unprecedented because it was perpetrated by Madoff over several decades, and his customers were defrauded of approximately twenty billion dollars. It can be debated whether the poor economy, lack of investor education, or ready access to diverse persons over the internet has led to an increase in affinity fraud but there can be no doubt that the internet makes it increasingly easy for fraudsters to pose as members of any community they target. And, it’s clear that affinity frauds have dramatically increased in recent years. In fact, affinity fraud has been identified by the ACFE as one of the top five investment schemes each year since 1998.

Affinity frauds assume different forms, e.g. information phishing expeditions, investment scams, or charity cons. However, most affinity frauds have a common element and entail a pyramid-type of Ponzi scheme. In these types of frauds, the offender uses new funds from fresh victims as payment to initial investors. This creates the illusion that the scam is profitable and additional victims would be wise to immediately invest. These types of scams inevitably collapse when it either becomes clear to investors or to law enforcement that the fraudster is not legitimate or that there are no more financial backers for the fraud. Although most fraud examiners may be familiar with the Madoff scandal, there are other large scale affinity frauds perpetrated across the United States almost on a daily basis that continue to shape how regulators and other law enforcement approach these frauds.

Perpetrators of affinity frauds work hard, sometime over whole years, to make their scams appealing to their targeted victims. Once the offenders have targeted a community or group, they seek out respected community leaders to vouch for them to potential investors. By having an esteemed figurehead who appears to be knowledgeable about the investment and endorses it, the offender creates legitimacy for the con. Additionally, others in the community are less likely to ask questions about a venture or investment if a community leader recommends or endorses the fraudster. In the Madoff case, Madoff himself was an esteemed member of the community. As a former chair of the National Association of Securities Dealers (NASD) and owner of a company ranked sixth largest market maker on the National Association of Securities Dealers Automated Quotations (NASDAQ), Madoff’s reputation in the financial services industry was impeccable and people were eager to invest with him.

The ACFE indicates that projection bias is yet another reason why affinity fraudsters are able to continually perpetrate these types of crimes. Psychological projection is a concept introduced by Sigmund Freud to explain the unconscious transference of a person’s own characteristics onto another person. The victims in affinity fraud cases project their own morals onto the fraudsters, presuming that the criminals are honest and trustworthy. However, the similarities are almost certainly the reason why the fraudster targeted the victims in the first place. In some cases when victims are interviewed after the fact, they indicate to law enforcement that they trusted the fraudster as if they were a family member because they believed that they shared the same value system.

Success of affinity fraud stems from the higher degree of trust and reliance associated with many of the groups targeted for such conduct. Because of the victim’s trust in the offender, the targeted persons are less likely to fully investigate the investment scheme presented to them. The underlying rationale of affinity fraud is that victims tend to be more trusting, and, thus, more likely to invest with individuals they have a connection with – family, religious, ethnic, social, or professional. Affinity frauds are often difficult to detect because of the tight-knit nature common to some groups targeted for these schemes. Victims of these frauds are less likely to inform appropriate law enforcement of their problems and the frauds tend to continue until an investor or outsider to the target group finally starts to ask questions.

Because victims in affinity frauds are less likely to question or go outside of the group for assistance, information or tips regarding the fraud may not ever reach regulators or law enforcement. In religious cases, there is often an unwritten rule that what happens in church stays there, with disputes handled by the church elders or the minister. Once the victims place their trust in the fraudster, they are less likely to believe they have been defrauded and also unlikely to investigate the con. Regulators and other law enforcement personnel can also learn from prior failures in identifying or stopping affinity frauds. Because the Madoff fraud is one of the largest frauds in history, many studies have been conducted to determine how this fraud could have been stopped sooner. In hindsight, there were numerous red flags that indicated Madoff’s activity was fraudulent; however, appropriate actions were not taken to halt the scheme. The United States Securities and Exchange Commission (SEC) received several complaints against Madoff as early as 1992, including several official complaints filed by Harry Markopolos, a former securities industry professional and fraud investigator. Every step of the way, Madoff appeared to use his charm and manipulative ways to explain away his dealings to the SEC inspection teams. The complaints were not properly investigated and subsequent to Madoff’s arrest, the SEC was the target of a great deal of criticism. The regulators obviously did not apply appropriate professional skepticism while doing their jobs and relied on Madoff’s reputation and representations rather than evidence to the contrary. In the wake of this scandal, regulatory reforms were deemed a priority by the SEC and other similar agencies.

Education is needed for the investing public and the regulators and law enforcement personnel alike to ensure that they all have the proper knowledge and tools to be able to understand, detect, stop, and prevent these types of frauds. This is where CFEs and forensic accountants are uniquely qualified to offer their communities much needed assistance. Affinity frauds are not easily anticipated by the victims. Madoff whistleblower Markopolos asserted that “nobody thinks one of their own is going to cheat them”. Affinity frauds will not be curtailed unless the public, we, the auditing and fraud examination communities, and regulators and other law enforcement personnel are all involved.

#We Too

Posted by on July 30, 2018 Comments Off on #We Too

The #Me Too phenomenon is just one of the latest instances of a type of fraud featuring a betrayal of trust by a fellow community member which is as old as humanity itself. The ACFE calls it affinity fraud, and it is one of the most common instances of fraud with which any CFE or forensic account is ever called upon to deal. The poster boy for affinity frauds in our time is, of course, Bernard L. Madoff, whose affinity fraud and Ponzi scheme ended with his arrest in 2008. The Madoff scandal is considered an affinity fraud because the vast majority of his clientele shared Madoff’s religion, Judaism. Over the years, Madoff’s clientele grew to include prominent persons in the entertainment industry, including Steven Spielberg and Larry King. This particular affinity fraud was unprecedented because it was perpetrated by Madoff over several decades, and his investment customers were defrauded of approximately twenty billion dollars.

But not all targets of affinity fraud are wealthy investors; such scams touch all genders, religions, age groups, races, statuses, and educational levels. One of the saddest are affinity frauds targeting children and the elderly.

Con artists prey on vulnerable underage targets by luring them to especially designed websites and phone Aps and then collecting their personal information. TRUSTe, an Internet privacy seal program, is a safe harbor program under the terms of the Children’s Online Privacy Protection Act (COPPA) administered by the U.S. Federal Trade Commission. This was the third safe harbor application approved by the Commission. Safe harbor Aps and programs are submitted by the Children’s Advertising Review Unit (CARL) of the Council of Better Business Bureaus, an arm of the advertising industry’s self-regulatory program, and the Entertainment Software Rating Board (ESRB), which were both previously approved as COPPA safe harbors. Sadly, in spite of all this effort, data collection abuses by websites and Aps targeting children continue to increase apace to this day.

Then there’s the elderly. It’s an unfortunate fact that elderly individuals are the most frequent targets of con artists implementing all types of affinity frauds. Con artists target the elderly, since they may be lonely, are usually willing to listen, and are thought to be more trusting that younger individuals. Many of these schemes are performed over the telephone, door-to-door, or through advertisements. The elderly are especially vulnerable targets for schemes related to credit cards, sweepstakes or contests, charities, health products, magazines, home improvements, equity skimming, investments, banking or wire transfers, and insurance.

Fraudsters will use different tactics to get the elderly to cooperate in their schemes. They can be friendly, sympathetic, and willing to help in some cases, and use fear tactics in others. The precise tactics used are generally tailored to the type of individual situation the con artist finds herself in in relation to the mark.

Ethically challenged fraud practitioners frequently focus on home ownership related schemes to take advantage of the vulnerable elderly. The scammer will recommend a “friend” that can perform necessary home repairs at a reasonable price. This friend may require the mark to sign a document upon completion confirming that the repairs have been completed. In some cases, the elderly victim later learns that s/he signed the title of his house over to the repairman. In other cases, not only is the person overcharged for the work, but the work is not performed properly or at all.

Another frequent scheme targeting the elderly involves sweepstakes or prizes. The fraudster continues to influence the elderly victim over a period of time with the hope that the victim will eventually win the “grand prize” if they will just send in another fee or buy a few more magazines.

Fraudsters also frequently solicit the elderly with “great” investment opportunities in precious metals, artwork, securities, prime bank guarantees, futures, exotics, micro-cap stocks, penny stocks, promissory notes, pyramid and Ponzi schemes, insurance, and real estate. Other common scams involve equity skimming programs, debt consolidation offers, or other debt relief services which only result in the loss of the home used as collateral if the victimized debtor misses a payment.

The societal effects of affinity fraud are not limited solely to the amount of funds lost by investors, churches, the elderly or by other types of victims. Once these frauds are uncovered, investor confidence can diminish the financial and other legitimate markets, and a general level of distrust can decrease the government’s ability to provide protection. Loss of confidence manifested itself after the Madoff fiasco with such negative effects evident throughout the economy. Unfortunately, affinity fraud erodes the trust needed for legitimate investments to occur and grow our economy. Essentially, affinity fraud victims of all types become less likely to trust any future monetary request and honest charitable organizations suffer from a loss of endowments. Subsequent to a large affinity fraud being discovered, time is spent by regulators and law enforcement not only prosecuting these cases but also in the expenditure of endless taxpayer dollars assessing what went wrong. Time consuming, expensive investigations generally also include implementation of regulatory changes in an attempt to assist in detection of these frauds in the future, another costly burden on taxpayers.

Once affinity fraud offenders have targeted a community or group, they seek out respected community leaders to vouch for them to potential victims. By having an esteemed figurehead who appears to be knowledgeable about the investment or other opportunity and endorses it, the offender creates legitimacy for the con. Additionally, others in the community are less likely to ask questions about a venture or investment if a community leader recommends or endorses the fraudster. In the Madoff case, Madoff himself was a highly esteemed member of the community he victimized.

Experts tells us that projection bias is one reason why affinity fraudsters are able to continually perpetrate these types of crimes. Psychological projection is a concept introduced by Freud to explain the unconscious transference of a person’s own characteristics onto another person. The victims in affinity fraud cases project their own morals onto the fraudsters, presuming that the criminals are honest and trustworthy. However, the similarities are almost certainly the reason why the fraudster targeted the victims in the first place. In some cases when victims are interviewed after the fact, they indicate to law enforcement that they trusted the fraudster as if they were a family member because they believed that they both shared the same value system.

Because victims in affinity frauds are less likely to question or go outside of their group for assistance, information or tips regarding the fraud may not ever reach regulators or law enforcement. In religion related cases, there is often an unwritten rule that what happens in church stays there, with disputes handled by the church elders or the minister. Once the victims place their trust in the fraudster, they are less likely to even believe they have been defrauded and also unlikely to investigate the con.

The ACFE tells us that in order to stop affinity frauds from occurring in the first place, one of the best fraud prevention tools is the implementation of increased educational efforts. Education is especially important in geographical areas where tight-knit cultural communities reside who are particularly vulnerable to these frauds. By reaching out to the same cultural or religious leaders that fraudsters often target in their schemes, law enforcement could launch collaborative relationships with these groups in their educational efforts.

In summary, frauds like Madoff’s occur daily on a much smaller scale in communities across the United States. The effects of these affinity frauds are widespread, and the emotional consequences experienced by the victims of these scams cannot be overstated. CFEs, assurance professionals, regulators and law enforcement and investigative personnel need to assess the harm caused by affinity fraud and continue to determine what steps need to be taken to effectively confront these types of scams. State and Federal laws should be reviewed and amended where necessary to ensure appropriate enhanced sentencing is enforced for all egregious crimes involving affinity fraud. Regulators and law enforcement should approach fraud cases from different angles in an attempt to determine if new methods may be more effective in their prosecution.

Additionally, anti-fraud education as provided by the ACFE is needed for both the general and investing publics and for regulators and law enforcement personnel to ensure that they all have the proper knowledge and tools to be able to understand, detect, stop, and prevent these types of scenarios. Affinity frauds are not easily anticipated by the victims because people are not naturally inclined to think that one of their own is going to cheat them. Affinity frauds can, therefore, only be most effectively curtailed by the very communities who are their victims.

In Plain Sight

Posted by on April 29, 2017 Comments Off on In Plain Sight

By Rumbi Petrozzello, CPA/CFF, CFE
2017 Vice-President – Central Virginia Chapter ACFE

Recently, I was listening to one my favorite podcasts, Radiolab, and they were discussing a series on Audible called “Ponzi Supernova”. Reporter Steve Fishman hounded infamous Ponzi schemer, Bernie Madoff, for several years. One day, Bernie called Steve, collect, and thus began the conversations between Madoff and Fishman that makes this telling of the Madoff Ponzi scheme like none other.

The tale is certainly compelling (how can a story of the largest known Ponzi scheme not be fascinating) and hearing Bernie Madoff talking about what he did and hearing what he says motivated him makes this series something I listened to from beginning to end, almost without taking a break. Through it all, as had happened just about every time I read or heard about Madoff, I was amazed that he was able to perpetrate his fraud for as long as he did, which, depending on who you believe, started somewhere between the early 1960s and 1992 (even Madoff gives different dates for when he started). This is no surprise. All too often, when fraudsters are caught, they try to minimize the extent of their wrongdoing. If they know that you’ve found $1,000, they’ll tell you that $1,000 was all they took. If you go on to find more, then the story will change a little to include what you’ve found. It’s very rare that a fraudster will confess to the full extent of her crime at the first go around (or even at the second or third).

As I listened to the series, something became very apparent. Often when people discuss the Madoff Ponzi scheme, one tends to get the feeling that, for decades, he took money from new investors to pay off old investors and carried on his multi-billion-dollar scheme without a single soul blowing the whistle on him. But that’s not the case. In a 477-page report from the U.S. Securities and Exchange Commission Office of Investigations (OIG) entitled “Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme – Public Version”, between June 1992 and December 2008, the Securities and Exchange Commission (SEC) received “six substantive complaints” regarding Madoff’s company and some of these complaints were submitted more than once.

One complaint mentioned in the report was received three times, with versions submitted in 2000, 2001 and 2005; the 2005 version was even entitled “The World’s Largest Hedge Fund is a Fraud”. This complaint series was submitted by Madoff’s most well-known nemesis, the whistleblower, Harry Markopolos. But, there were at least five other individuals who shared their concerns and suspicions about Madoff with the SEC. Three of these specifically used the words “Ponzi scheme”, including the first complaint, in 1992. Based on these complaints, the SEC conducted two investigations and three examinations and, even though the complaints explicitly stated that they suspected that Madoff Investments was a Ponzi scheme, none of the investigations or examinations concluded that Madoff was operating a Ponzi scheme. To add to this, the SEC was aware of two articles that questioned Madoff’s returns. Over the years, several investment companies performed their own due diligence and decided that Madoff’s company did not make sense and they believed that investing with Madoff would be a violation of their fiduciary duty to their clients. Despite all of this, none of these investigations or exams contained a finding of fraud.

Whether you’re a Certified Fraud Examiner (CFE) or a CPA, Certified in Financial Forensics (CFF), the work that you do is governed by a set of professional standards that help establish a performance baseline. This begins with competence. This means that those taking on an assignment should be able to complete the assignment successfully. This does not necessarily mean that whoever is leading the job needs to know how to do everything. It does mean that they should ensure that there is the right skill set working on the job, even if it means the use of referrals or consultation. Too many times, while reading the OIG report, the reader confronts the mention of a lack of experience. Listening to Ponzi Supernova, I learnt that at least one examiner was only three weeks out of school. The OIG report stated that, for one examination, because the person leading the investigation had no knowledge of how to investigate a suspected Ponzi scheme, they decided to just not investigate that claim; they decided instead to investigate what they knew, and that was front running (though even that investigation was carried out poorly).

Another ACFE professional standard is that of due professional care. Due professional care “requires diligence, critical analysis and professional skepticism”. It also means that any conclusion that a CFE reaches, must be supported by evidence that is relevant, sufficient and competent. Several times during the various investigations and examinations, SEC staff would ask Madoff or his employees questions and then accept any answers they were given without seeking any third-party confirmation. Sometimes, even when third-party confirmation was sought, the questions asked of those third parties were not the correct ones. Madoff himself tells the story of how, in 2006, Madoff testified that he settled trades for his advisory clients through his personal Depository Trust Company (DTC) account and he even gave the SEC his DTC account information. At this point Madoff was sure that, once the SEC checked this out, his fraud would be discovered. Instead, the SEC merely asked the DTC if Madoff had an account, and nothing more. Had they asked about account activity, they would have then discovered that Madoff’s account, even though it existed, did not trade anywhere near the volume purported by his statements. This brings up other aspects of due professional care; adequate planning and supervision. With proper supervision, the less experienced can be trained not just to ask questions, but to ask, and get adequate answers to, the correct questions. The person reviewing their work would be able to ask them, “did the answer that you got from the DTC answer the question that we are asking? Can we now confirm not that Madoff has an account with the DTC but, instead, that he is trading billions of dollars through these accounts?”

Time and time again, in the OIG report, the SEC stated that they did not have experienced and adequate staff for their examinations and investigations of Madoff. This was an excuse that was used to explain why, for instance, they did not send out requests for third-party confirmations, even after drafting them. In one case, staff stated that they did not send out a request to the National Association of Securities Dealers (NASD) because it would have been too time-consuming to review the data received. Adequate planning would have made sure that there was sufficient, qualified staffing to review the data. Adequate supervision would have ensured that this excuse for not sending out the request was squashed. However, it is not the case that no third-party confirmation requests were sent out. Some were and some of those sent out received responses. Responses were received from the NASD and other financial institutions These entities all claimed that there was no activity with Madoff on the dates that the examiners were asking about. Even with that information, there was no follow-up on the part of the examiners. At every turn, there seemed to be a lot of trust and just about no verification. This is even more surprising when you hear that the examiners would write notes about how Madoff was obviously lying and how many people had reported to the SEC that Madoff was running a dishonest business. Even with so much distrust, and so many whistleblowers, it turned out that those sent to shine a light on Madoff’s operations all seemed to be looking in all the wrong places.

Part of planning an investigation is determining what is being investigated and how the investigation is going to be executed. A very important part of the process is determining, beforehand, what will be done with negative results. When third-party responses were received and they all stated Madoff had not done business with them as claimed, the responses appear to have been filed and no further action taken. When responses were not received, the SEC did not follow up to find out why nothing had been returned. They likely would have found that the institution had not responded to the inquiry because there was nothing to respond about. There does not appear to have been a defined protocol on what to do when the answer to the question, “did this happen” was “No.”

I urge you to, at the very least, read the executive summary of the OIG report. For me at least, what Madoff could get away with, time and time again, with each subsequent SEC examination or investigation, is jaw-dropping. The fact that 1) several whistleblowers shared their concerns and even accompanied them with a great deal of detail and 2) that articles were written and yet, 3) those with access to the information that could prove, with very little effort, that Madoff was not doing what he claimed to be doing, found nothing of concern is something I struggle to comprehend. This whole sad history does underline the importance of referring to, and abiding by, our professional standards, to minimize the risk of missing a fraud like this one. Most importantly, it reduces the risk that someone might get an aneurism trying to wrap their mind around how, even when so many others could see that something was amiss, the watchdog missed it all!

Getting it Back

Posted by on June 3, 2014 Comments Off on Getting it Back

couple-sailing-12“We are again honored to have a fourth guest post from our friend and Richmond Chapter member, Rumbi Bwerinofa, CPA/CFF.  Rumbi is a Director of the Queens/Brooklyn Chapter of the New York State Society of CPAs and a member of the NYSSCPA Litigation Services Committee. She is the editor of TheFStudent.com, where she discusses financial forensic issues.” – Charles Lawver-2014 RVACFES Chapter President…”

Financial Frauds come in many shapes and hues but at the end of the day, money is come by through some devious means employed by the ethically challenged. During trying financial times, all the many varieties of the classic Ponzi scheme have proven especially popular.  As exampled by the shenanigans of Bernie Madoff and/or the bitcoin investment schemes recently in the news, the mechanics of this devastating con always work in essentially the same general way. A charismatic person with a great sounding get-rich-quick pitch enters on the scene. Her presentation can be as various and sophisticated as the imagination of the fraudster or the gullibility of the mark can make it and, indeed, may vary in particulars of content, but one thing never varies; guaranteed financial returns way above market rates. Always the promised returns are so good as to induce incredulity even in the most vulnerable or desperate would be investor, but, if the Ponzi is to succeed, the allure of the pitch has to be strong enough to overcome any doubts. In the end, people sign up and pass over their hard earned money by the hand-full.

The charismatic salesman takes the money, uses part of it to pay the fantastic returns promised to some of the initial investors and a large percentage of the rest to fund the extravagant lifestyle expected of a super successful business person. By continuing to charm and attract new investors, cash flow is soon surging through the scheme at an ever increasing rate as more and more would-be investors are attracted by the news of such a fantastic level of return.  Because the claimed returns aren’t being made our fraudster is soon in constant need of new funds to pay existing investors and to carry that ever more extravagant lifestyle. This cycle can sometimes go on for a surprising length of time but the longer it goes on, the more money the fraudster needs to take from her new marks just to make her nut. Although 18 months is the median time a Ponzi scheme typically lasts before discovery, a sophisticated, charismatic operator like Madoff can operationally carry one (or several) for decades.   We now know that the Madoff scenario apparently started somewhere between 1970 and the early 1990’s, depending on whose version of the depressing story you’re inclined to believe.  However, at a certain point, sooner or later,  the Ponzi is discovered and the fraudster inevitably must face the arm of law enforcement and defend against whatever charges are brought.

Had you have been tracing the flow of the money through the Ponzi, you would have quickly noticed that our salesman is only continuing the monotonous process of  taking money from Peter in order to pay Paul, never failing to skim his commission off the top. Since the point of the whole exercise is the financing of a life style not about investing, no returns are being earned on the money taken in and the business plan has to be about recruiting more people in order just to keep the scam going. This means that, when she or he is inevitably caught and everyone finally sees and can discuss the fruits of the extravagant shopping sprees – fancy homes, expensive cars, the boat – the pricy adventures – trips by private jet, membership in exclusive clubs, the rubbing of shoulders with celebrities – his immoral ways – his hubris, his dishonesty and maybe even his pornography … I’m willing to bet that not once will you hear mention of his investment acumen  and the smart ways he made his ill-gotten gains grow!

Yet when our fraudster is convicted and sentenced to some kind of punishment, you will also always learn that he has been ordered by the court, and agreed, to make restitution; to pay back all that money wrongfully taken from so many people over all those years. At times, there is even a fine added to the restitution amount. It looks good on paper but it begs the question – from whence is all the money to pay these penalties supposed to come?

Let’s look at a real case that made the news recently. Sandy Jenkins plead guilty to embezzling over $16 million from Collin Street Bakery, where he worked as the corporate controller from 1998 until 2013 (when his fraud was discovered). While employed by the bakery, his annual salary was never more than about $50,000 per annum. With the money he stole, he and his wife lived lavishly, buying a vacation home, taking flights on private jets and indulging in all kinds of expensive luxuries. In addition to facing up to 60 years in prison, Jenkins was fined up to $2.75 million, over and above the money he stole from his employers. As part of his plea deal, Jenkins additionally agreed to pay full restitution. Prosecutors will certainly seek to get back as much as they can from the property they seized from Jenkins and his wife (she too faces charges) but I, for one, will be shocked if the value of all their property comes anywhere near the $16 million dollars he stole.  As with the majority of such cases, the bulk of the money stolen was spent in ways never subject to reclamation; on vacations, private jet flights and luxury cars that started to lose value as soon as they were driven off the lot.  In light of all this, it’s hardly surprising then that the Association of Certified Fraud Examiners (ACFE) reports that 58% of defrauded organizations recover none of their losses and only 14% make a full recovery (the median recovery amount is 20% of the value of the assets stolen).

The fact that money stolen will not likely be recovered, can only emphasize the importance of fraud prevention and, if fraud should occur, of early detection. It makes sense that the earlier a fraud is discovered, the smaller the losses will be and, of course, if fraud is prevented in the first place, there no losses will be suffered at all.  As fraudsters continually seek new ways to perpetrate their crimes, it’s vital that forensic accountants and fraud examiners constantly improve and develop methods of fraud prevention and detection. It’s equally important that organizations understand that employing effective fraud prevention and detection measures will save them many times the cost of such measures in the long run. Forensic accountants have the skills and training to perform the very difficult, and often expensive, task of tracing money and assets that have been acquired through dishonest means, but they can’t re-manufacture the funds already lost to fraud. After all, we’re not magicians.

Ponzi or Pyramid?

Posted by on April 24, 2013 Comments Off on Ponzi or Pyramid?

file-folders-4One question I get over and over again, especially when giving presentations on common frauds and scams to senior citizen groups  is, “What’s the difference between a Ponzi scheme and an illegal pyramid?”  Which is certainly an understandable question since seniors are prime targets for investment scams of all kinds.

Both Ponzi’s and pyramids use the money of investors to make promised payoffs to other investors.  But they’re run very differently by their promoters and legally they’re prosecuted under different laws.  A very important distinction to make is between legal and illegal pyramid schemes.  Ponzi schemes and illegal pyramids are the same, only somewhat different.

The promoter of an illegal pyramid generates revenue by continually recruiting new members.  The different operations may offer goods or services for sale, but it’s important to keep in mind that the only significant revenues come from new recruitments.  Some legitimate sales companies use a pyramid structure to rank their employee-owners and calculate their compensation.  So when does a legal pyramid structure become illegal?   That happens when the company makes its money primarily by recruiting people.  Instead of selling a product or service, the group deals primarily in new memberships.   Joining the group allows the new member to profit by personally signing up new members.  The process continues until the available pool of new members is drained, which always happens a lot faster than most people think.

As a rule of thumb, courts in the U.S. apply the 70% rule.  This requires that at least 70 percent of the distributor’s profit come from actual retail sales.  Is this rule hard to verify?  You bet.  Distributors often sign falsified compliance statements because promoters warn that if they don’t authorities will shut the whole thing down and everyone will lose.  So the bottom line as to legality hinges on what the pyramid operators emphasize… if the company emphasizes the recruitment of new members over the sale of products, and if the only way to recognize the promised return is through additional recruitment, then the operation will likely be classified as an illegal pyramid.

Illegal pyramids are promoted as pyramids… Ponzi schemes are promoted as investment opportunities.  The key element in the Ponzi is that initial investors are paid with subsequent investors’ money.  There is little, if any, legitimate commerce.  In an illegal pyramid no one is really selling that much of the product; they’re coaxing new people to put up money.  The original members of the pyramid get rich on subsequent investors’ money…so, a pyramid is a Ponzi scheme.  Is a Ponzi scheme a pyramid?  In the sense that it requires exponential growth to avoid a collapse, a Ponzi scheme is a pyramid scheme.  The difference is that in a pyramid scheme, each member financially gains from personally recruiting additional members, but in a Ponzi scheme, all proceeds are pooled and participants are not directly rewarded for recruiting additional members.

The Elusive Carlo Ponzi

Posted by on November 27, 2012 Comments Off on 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.