Investment Fraud – Do We Ever Learn?

The Ponzi fraud is a classic example of an investment fraud. It dates back to early last century when Charles Ponzi came up with the idea of conning investors by using their own funds to pay interest. I am willing to bet that he was not the first to see the potential in dishonestly circulating capital funds to increase income in an investment fraud.

The trouble is, the very principle underling the Ponzi investment fraud also underpins the fundamental concept of banking. If you go into you local branch of Barclays you can pay £500 into your savings account. Then, somebody else coming into the branch might ask to make a £500 withdrawal. Your £500 is given to this other person. Don’t worry, your account shows another £500 has been added whereas the other person’s will show a withdrawal. But the point is that a bank does not have enough funds to cover everything invested. Typically it will lend out a multiple of the liquid funds its holds in the expectation that it will never be called upon to repay all its investors at one time (i.e. a run on the bank).  The recent economic problems coming to light in 2008 with the crash of Lehman Brothers Bank has shown how illiquid the banks were becoming and survival of the whole Western banking industry became dependent on the massive bailouts by the taxpayers.

The principle used by the Ponzi investment scam is similar to basic banking, the only difference being is that a bank aims to make a profit with the money invested, by investing the money itself at a higher rate than it is paying out to its customers. It is effectively making a margin between the rate it borrows at and the rate it lends. It is supposedly a commercial proposition. The true Ponzi scheme will not be interested in making a profit from such “buying and selling” of funds. It will be simply looking for as many people to invest as it can, and keeping those investors happy by returning some of their capital to them every now and again as “interest”. So long as too many people do not want to make withdrawals (i.e. there is a “run”on the scheme) and the message of high returns peculate to the investors, there is a good chance that more funds will come in than are going out – yet no real investment activity will be going on.

There are shades of grey of course – where we get the investment fund that operates like a Ponzi but tries to invest the funds. Perhaps it is investing in a bigger Ponzi scam itself, expecting a return on its own investment. Perhaps it is simply making poor investment decisions (shades again of the Credit Crunch) and is having to repay its own investors out of capital. There are so many similarities between the way the mainstream banking sector was operating during the times of high credit availability and Ponzi scams, that the general public have a right to be angry at the scale of the banking sector’s bonuses.

Every year we hear of new Ponzi scams that have come to light, perhaps when the schemes begin to crumble when more than just a few investors want their capital back. The biggest recently by far was the Madhoff affair involving billions of US dollars, pounds sterling and other currencies that had supposedly been invested for lucrative rates of return. If you check the news archives, fraud blogs and other reports you will see that there are dozens of these scams emerging every year. This is clearly a situation where greed gets the better of sense!

Last year I worked on a reasonably large case that had been brought by the Serious Fraud Office in the UK against a couple of businessmen based in the Midlands. This case has been reported in the press and involves around $200 million of investors funds that the authorities say were invested by UK victims who, once the scheme folded, lost their money.

The UK arm of the alleged Ponzi fraud was part of a much larger investment scheme being headed by somebody in the USA – which had already led to a plea bargain situation for the main perpetrator. Of course pleading guilty gave the UK perpetrators little chance of reprieve – yet they had believed that the USA arm was going to repay them with interest. Gullible perhaps, criminal…maybe.  At the time I remember doing a bit of research on Ponzi frauds and being amazed about the number of current cases that were being investigated or being dealt with by the courts!

Now I am faced with yet another case this week where I am asked to look at the professional conduct of an accountant recruited by the operators of an investment fund. If the fund was a Ponzi, should the professional have known about it and reported under Money Laundering Regulations to the Serious and Organised Crime Agency in the UK? Should he have known that funds he was holding were proceeds of crime?

I am not in a position to report about this at present as there are court reporting restrictions – however we certainly have what looks like another Ponzi scheme. Effectively there is a large number of ostensibly rich investors looking for a larger return than expected from a bank or other mainstream investment opportunity. Why do people keep on investing in such a way. Promises of several % interest each month abound and it is not easy to see why people do not approach these investment opportunities with more caution. Do people never learn?

The problem is of course, these High Yield Investment opportunities are indeed based on a shred of truth. There is a backbone of legitimacy behind the very idea that you can find investment opportunities offering higher returns than other more recognized sources such as the banks. It is this very element of secrecy and intrigue, I believe, that encourages the unwary to fall for the scams! Whereas there might have been, and some say still are, high yielding returns to be made for massive investments used effectively as global hedge funds by a number of altruistic and very rich organisations and individuals – these are likely to spawn glamorous tales of rich pickings to be had even when they do not exist anymore.

Remember, the UK and USA have injected trillions into the economy over the last year or so – have you ever wondered how much back room/under the table dealing has gone on around these incomprehensible figures?

The trouble is that if the climate is ripe for such massive movements of money then the fraudsters see the opportunity to start weaving their spells again! It is a setting for even more Ponzi scams to be generated.

As a forensic accountant and fraud investigator, a scam such as a Ponzi fraud is a classic example to me of the reason why fraud flourishes. Ask yourself if greed might have something to do with it – of the fraudsters and the victims alike!

DEFENDING ALLEGATIONS OF OPERATING A FRAUDULENT INVESTMENT BUSINESS

Not all investment businesses are operated as frauds, yet given the authorities propensity for jumping to the wrong conclusion it is often possible for the unfortunate manager, sharp practitioner or even negligent (but not necessarily criminal) businessman to come under scrutiny.  In such a case – Mark Jenner & Co is able to unpick the complex network of investment transactions, clarify the reality of the investment scheme being operated and present its findings in such a way that any mistakes or business errors can be identified and viewed separately to a potentially viable business proposition.

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About Mark Jenner

Mark Jenner is an experienced forensic accountant specialising in fraud and white collar criminal matters. He provides independent financial investigation and expert accounting witness services to police forces, fraud regulators and criminal defence lawyers, also providing assistance and solutions to organisations embroiled in financial disputes.

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