The Ponzi scheme is alive and well, and investors should beware. That is the message from lawyers, regulators and new data on the prevalence of this infamous fraud.
It is almost a decade since Bernard Madoff was arrested for masterminding one of the biggest Ponzi schemes in history. While it is unlikely that any are as big as Madoff’s $65bn fraud, there are hundreds of similar schemes operating across the US.
Named after Charles Ponzi, an early 20th century swindler, the ruse works like this: operators promise victims high returns on their investments — but instead of investing their funds, the perpetrator uses their commitments to pay off earlier backers and takes a cut for themself. As the scheme progresses, the number of victims and the size of their combined losses grow exponentially.
Last year 59 such schemes were uncovered in the US with losses totalling $2.4bn, according to data compiled by website Ponzitracker. Jordan Maglich, the site’s creator, says the number of Ponzi schemes discovered has stayed reasonably consistent over the past five years, as has the number of perpetrators sentenced.
Mr Maglich, an attorney at Tampa firm Wiand Guerra King, says since 2012 an average 65 Ponzis a year have been discovered, with a median scheme size of around $6m. But last year Mr Maglich noticed the median size shrank to $3.5m.
“The slightly smaller size of schemes could suggest regulators are doing a better job rooting out frauds before they get too big,” he says, adding that since being criticised for not catching Madoff earlier, regulators have beefed up their compliance and enforcement.
The US Securities and Exchange Commission and the Financial Industry Regulatory Authority (Finra) run whistleblower programmes and complaint hotlines. “In the Ponzi schemes we’ve been helpful in uncovering, our investigation has usually started with a victim who’s frustrated that they can’t get their money back,” says Cameron Funkhouser, head of Finra’s Office of Fraud Detection and Market Intelligence. “These investigations sometimes don’t require a lot of digging. It can simply be a matter of applying common sense to the situation and asking simple questions.”
Often advertising, promotional material or a website can draw the regulator’s attention. Perpetrators “need to attract victims, so they tend to have some sort of outward-facing presence,” says Mr Funkhouser. Such a display can give fraudsters an air of legitimacy and keep victims compliant.
Highly educated people are often victims of these frauds. “Criminals target people with money,” says Owen Donley, chief counsel of the SEC’s Office of Investor Education and Advocacy. “The people who run these are often very charismatic.”
The SEC’s investor protection website outlines how investors can identify a Ponzi scheme. Top of its red flags is the promise of high returns with low risk, or suspiciously consistent returns. “Markets go up and down. No one is consistent over long periods. If someone claims otherwise they’re probably lying,” Mr Donley says.
He warns investors to ensure the investment and its seller are registered with the SEC. Through the SEC’s website or Finra’s Brokercheck investors can verify the legitimacy of an adviser.
Investors also need to watch for complex, secretive or bizarre strategies. One recent Ponzi promised to make money from the secondary market for tickets to Hamilton, the Broadway musical, as well as for performances by Bob Dylan, The Rolling Stones and Adele. The SEC alleges $81m was defrauded from some 125 investors in the case.
Another scheme offered investors a slice of securitised loans to professional athletes. The Ponzi was marketed by Will Allen, a former New York Giants American football player. His co-conspirator was an adviser whose Brokercheck record showed she had left the industry in 2010. Allen was sentenced to a six-year jail term in March.
For victims, financial crime is often revealed at the worst possible time. Ponzis are mostly uncovered during extended market downturns as nervy investors try to divest to protect savings. When the next bear market comes, Ponzi discoveries will probably rise with increased redemption requests, warns Mr Maglich.
Ira Sorkin, Madoff’s defence lawyer, agrees that Ponzis are not usually discovered in an extended bull run. “If the market is going down, the schemer can’t raise money. Madoff was only found out when he couldn’t pay redemptions,” says Mr Sorkin, a partner at Mintz & Gold, a law firm.