Ponzi Scheme

13/11/2012 by Michael Jones

Overview

In the 1920’s an Italian emigrant in the United States by the name of Charles Ponzi perpetrated a number of frauds against fellow Italians emigrants in the Boston area in the United States of America.

The frauds committed by Ponzi were many and various but his most successful schemes related to the genre that now bears his name.

The essential element in the Ponzi scheme involves the offer and often payment of extremely high returns from doubtful sources in circumstances particularly where the investors who come into the scheme at the beginning are paid their investment returns using funds raised from investors who subsequently come into the scheme.

Mr. Ponzi did not in fact invent the swindle.  In all probability similar schemes had been around since the beginning of commercial activity.

Of recent years in Australia, we have seen the unique adaptation of the scheme to various property investment companies.

The collapse of West Point, Fin corp and Australian Capital Reserves all has very similar elements to the original Ponzi scheme methodology.  In each of these companies we see the return to investors promoted widely particularly in the media and the investment returns are advertised at significantly higher rates than generally available in the market.

When these companies have collapsed, the investors are often left wondering what happened to all of their money.

Separate and apart from these spectacular crashes, my firm has been involved with a number of smaller property investment groups operating under similar rules.

Set out below are some of the characteristics that we have observed that seem to encompass many of these investments scams.

High Rates of Return

As previously indicated, all of the schemes offer extraordinary high rates of return.  Clearly this appeals to the investor’s greed, as all investors wish to receive the best rate of return possible in the market place.  However, the recent property collapses also use the media to convince the investor public that not only is the rate of return extremely high, but the investment is extremely safe.  For the investor, the investment is simple.  All they have to do is hand over their money.  No where in any of the documentation or any of the publicity or in any of the marketing surrounding the investment scheme is there any mention of the word “risk”.  The whole concept that the high the return, the higher must be the risk is very well disguised.

High Returns are Actually Paid

This is the next key element of Ponzi style investment schemes.  It is important to send a message to the investor public that not only is the yield high, but the return is secure.  In order to do this, significant returns either by way of dividend or interest are paid to the initial investors.  The initial investors of course then tell all of their friends and family about how attractive the investment opportunity is.  This has the effect of sending a message of high confidence to their friends and associates and networks, enabling and encouraging particularly more investors to come into the scheme.  Of course, the schemes rely of fresh investors coming in all of the time to continue with the high yield returns back to the investors.

Network Marketing

The scheme operators frequently target special interest groups into which to market the investment schemes.  The matters that I have handled seemed to have a high number of particular professions or groups as victims amongst the shareholder, investors.  It is not uncommon to see a disproportionate number of teachers or policemen or nurses within a particular group of investors.  Similarly, it is also not uncommon to see a disproportionate number of members of particular church groups or other specialist interest groups.  This is consistent with the points above, that is to say because the initial investors in the scheme seem to be receiving a good return and they tend to spread the word amongst their networks and groups.  Little do they know that they are really setting up their friends and families and associates to a major disaster.

Sophisticated Seminars

One of the methodologies used to promote these schemes is with the use of sleek and sophisticated “evangelical” seminars.

The presenter is extremely experienced at playing to an audience.  The message is extremely polished and manages to play on the emotions of the audience.  Church groups are particularly vulnerable to this type of presenter, because the presenter often stylises himself after some of the motivational characters that are often associated with evangelical churches.  The presenters are expert at plugging in to the needs of the investors.

The underlying need, that is pure greed, is on its own an irristable force; however this motivation on the part of the investors is cleverly disguised by the presenters so that the investors seem to going into the scheme for other “higher reasons”.  The scheme presenter will plug in to other emotions for example,

Envy                             –           Everybody else is making this money, why don’t you,

Urgency                      –           Whilst ever you sit back and do nothing, other people are doing well,

Need                             –           What happens if a member of your family needs an urgent and

expensive overseas operation?

Charity                        –           How are you going to help your children buy their first home?

Security                      –           Have you got enough to retire on in your old age?

Financial Freedom –           Don’t you just hate your current job?

The presenter manages to convince the audience that all of the above problems can be solved simply by putting your money into the investment scheme.  It is so simple and foolproof.  Again the concept of risk is never discussed.

The Underlying Investments are Obscure

This is a critical part of the scheme and it involves the mixing up and merging the various corporate structures.  Principally, the underlying investment, that is the properties that the investors believe that they are funding are often in a completely different geographical location to where the investors reside.  This of course prevents the investors from having a very close look at the progress of their investment.  This is particularly useful when the investment involves a property development involving multi story developments.  Further obscurity is provided by holding these properties in complex and unintelligible corporate and trust structures such that the investor has no real idea of the legal ownership of the underlying assets

Unclear Documentation

This follows from the previous point.  It is extremely common for the investors to have no real idea of the nature of their investment.  Sometimes the investment is referred to as shares, other times it is referred to as units, sometimes the investors believe they have security or equity in the underlying properties but on investigation and review, the investors are shown to be clearly nothing more than unsecured creditors in some entity.  This creates further confusion because often times, it is very unclear on a complete analytical review exactly which entity the investor has a relationship with.  The investor may have relied on various advertising literature, or representations made by the company representative, or representations made by his friends and associates, or information he may have received at a promotional seminar.  Usually the investor simply signs some form which is often changed and amended from time to time depending on the circumstances.

It is also very rare for the promoters of these schemes to provide any information or meet with solicitors or accountants or other advisers to the investors.  Clearly if the investors are not prepared to put their money into the scheme at the point of sale, there is a very strong chance that that they may have second thoughts. This of course does not suit the promoters.  It is often the lack of documentation and the overall lack of clarity concerning the specific nature of the investment and the entity to which the investor is a party that causes the most grief to the investor when it comes to a later recovery.  When the company ultimately collapses, and the investor is invited to a creditor’s meeting, it can even be difficult to ascertain which entity within complex groups the investor in fact has a claim.

Substantial Fees taken by the Promoters

Another curious observation in relation to these schemes is that the promoters of these schemes seem to be able to persuade the investors to pay them substantial fees for the privilege to put their money into the schemes.  Often the investors are so enthusiastic about the opportunity that they fail to critically analyse the value of the promoter’s services.  Ironically when a subsequent liquidator is appointed, the liquidator’s own fees for doing that work is put under substantially more scrutiny than the originally promoter’s fees.

Conclusion

The recent property collapses are somewhat more complex than the early Ponzi Schemes, and in general particularly in relation to the very large matters, there is at least an apparent attempt to be commercially realistic about the underlying investment strategy.  In most case there are usually a number of property developments under way, however, the ultimate profitability or viability of these schemes usually does not stand under any degree of professional scrutiny.  In most cases, the investments strategies of these property companies are flawed and their ongoing survivability again depends on large numbers of new investors coming into the scheme to bankroll the operation.  In the meantime the company directors and other promoters of these businesses manage to extract large amounts fees in the form of management fees, director’s fees and other such emoluments.  Sadly many professional advisers to these schemes do very well, also at the expense of the investors.  Such advisers rarely if ever are put under the microscope.