Ponzi Schemes Continue to Thrive: Investors Need to Watch for 10 Signs That an Investment May Be Too Good to Be True
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Ponzi schemes are back--or perhaps more accurately, they never left. Investors need to exercise their own due diligence to make sure they're not caught up in a "too good to be true" financial fraud.
The Ponzi scheme is a classic con that typically surfaces in economic downturns. Ponzi-style fraud made a dramatic reappearance in landmark cases involving now-convicted financier Bernard Madoff, who defrauded investors of an estimated $65 billion, and Robert Allen Stanford, who stands accused of falsifying financial statements to investors who bought $8 billion worth of certificates of deposit said to be "inflated"; he is currently in prison awaiting trial.
These high-profile frauds are just the tip of the iceberg, however. According to the U.S. Department of Justice's 2010 Annual Statistical Report, during a three-and-one-half month period in 2010, 343 criminal defendants in 231 criminal cases were charged, convicted or sentenced for participation in investment fraud schemes, including Ponzi schemes, resulting in $8 billion in losses to investors. In addition, there were more than 60 civil enforcement actions involving an additional $2.1 billion in investor losses. In all, there were more than 120,000 victims.
Ponzi schemes typically start in an economic boom, then are exposed when the economy stalls and investors demand return of their capital--which of course no longer exists because it has been used to pay fraudulent "dividends" and "interest" to new investors.
Because conditions are still ripe for the emergence of Ponzi schemes, and because fraud as a whole is much more widespread, investors need to be ready to protect themselves by performing their own due diligence. The first step is to watch for these 10 warning signs that a Ponzi scheme may be in play:
1. High returns with little risk --Be wary of investments with high yields that have little or no risk. There is no such thing as a guaranteed return.
2. Investments with too-consistent returns --Be highly suspect of investments that generate consistently positive returns regardless of economic conditions. No investment is immune to economic effects.
3. Investments you don't understand --Stay away from complicated investments that are difficult to understand. Complex, obscure strategies can be a cover for fraud.
4. Not getting enough information --Be wary if you are consistently requesting information about an investment and the investment representative is not being responsive or is avoiding you.
5. Inaccurate or questionable investment account statements --Miscalculations on statements may be a sign that you need to start asking questions. They may also indicate that the investments may not be used for their intended purpose. Of course, finding miscalculations requires that you review your statements in detail--something that should be done with every investment account, but it's a step that too many investors skip.
6. Difficulty receiving payments --Be extremely concerned if you are not receiving payments on your investment, or if there are problems cashing out the investment.
7. Funds that are not deposited in a separate custodian account --If funds are being deposited directly with the investment advisor, it means that he or she has access to the funds. And that in turn means that the advisor has the opportunity to commit fraud.
8. Statements that are sent directly from your investment advisor --In any legitimate investment, you would receive monthly statements from a third-party custodial institution rather than directly from the investment advisor. That's because these functions should remain separate. If the advisor sends statements directly, there is cause for alarm.
9. You're told that you are now part of an exclusive investment club --If someone approaches your client and tells you that you can be part of an exclusive investment--be suspicious. That's a classic fraud approach--the idea that you're getting privileged information or access. Skepticism is in order.
10. The advisor is recommended by word of mouth --Friends and acquaintances can provide legitimate advice. But often, enthusiastic friends serve as unwitting recruiters for Ponzi schemes. The person recommending the investment may be getting high returns, but may not have done any due diligence. You need to do your own.
In spite of high-profile convictions and prosecutions, the danger of encountering a Ponzi scheme or other fraud is still out there. Investors need to protect themselves by maintaining a healthy skepticism, and subjecting every investment opportunity to due diligence. It's important to remember the tried-and-true warning: Investments that seem to be too good to be true usually are.
Sareena Malik Sawhney, MBA, CFE, CFFA is a director in the Litigation and Corporate Financial Advisory Services Group of New York accounting firm Marks Paneth and Shron LLP. She has more than 10 years of litigation experience. Ms. Sawhney focuses on providing forensic services in the areas of complex fraud investigations, including white-collar crimes, and forensic accounting examinations. Ms. Sawhney has served as a testifying expert witness and has worked with legal counsel to develop case strategies, assisted counsel with depositions and with preparing reports and exhibits for trial. She is a member of the Association of Certified Fraud Examiners and the National Association of Certified Valuation Analysts. Contact: email@example.com.