Ponzi Schemes

Spotting Red Flags of Investment Fraud (Ponzi Schemes)

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There is no shortage of allegations of investment fraud since the stock market tanked in 2008.  Are there more investment scams occurring, or have market conditions just led to the discovery of more of these schemes? I’ll guess the latter, although no one really knows for sure.

The beauty of fraud is that so much of it goes undetected. Those involved in financial fraud actively conceal their schemes and their involvement, so it’s impossible for fraud investigators to know exactly how much fraud is happening. For example, perpetrators go so far as to pay others to participate in the scheme and cover up phony financials and non-existent promissory notes. This kind of concealment leads to more investors putting money in a scheme, and ultimately creates ever larger financial losses.

In the end, however, it doesn’t necessarily matter if we can put our finger on exactly how many of these investment schemes are out there. What really matters is being able to identify the hallmarks of such schemes so that investors can avoid them like the plague.

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Investigating Investment Frauds and Schemes

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Despite the proliferation of information available about phony investment schemes and the dire warnings given regularly by news reporters, consumers continue to become victims of these scams on a regular basis. The perpetrators of investment schemes dream up stories explaining their unusually high rates of return on money, and people with money to invest with them.

These high investment returns typically amount to guarantees in excess of 10% per year. Often they are to the point of ridiculous, offering a 30% or 40% annual return. As a fraud investigator, it is clear to me that these offerings are bogus, because any investment that legitimately generated such returns would not be much of a secret to the rest of the world. But consumers, who are often eager to protect and grow their nest eggs, are all-too-willing to believe that such an investment is the answer to their money problems.

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Typical Red Flags of Ponzi Schemes

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Last week the FBI posted an article on its site, A Pyramid of Lies, that told the story of the Gentry Ponzi scheme in rural Tennessee. Ponzi schemes are pretty easy to spot if you know the red flags. Even if you don’t know FOR SURE that an investment “opportunity” is a Ponzi scheme, if you see enough of the red flags, you should be smart enough to walk away. Better to be safe than sorry. Invest your money in something that isn’t showing these signs.

Jeffery Gentry stole more than $10 million with his investment scam. Let’s run through the red flags that popped up in the article:

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TelexFree: MLMs are Pyramid Schemes

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This week we heard news of $20 million (hidden in a box spring) being seized by the federal agents in its ongoing investigation of TelexFree, a multi-level marketing company that the government says was a massive Ponzi scheme. You can read all about the TelexFree case on Patrick Pretty’s blog.

News reports about TeleFree refer to it as a Ponzi scheme (also called pyramid scheme). What isn’t mentioned anymore is the fact that it operated as a multi-level marketing company, just like Amway, Mary Kay, Herbalife, LuLaRoe, and hundreds of other companies you hear about on a daily basis. While it is NOW acnowledged that TelexFree was a Ponzi scheme, there was a time when it operated exactly as these other MLMs do.

The FBI says the following about TelexFree:

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Unraveling Ponzi Schemes

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Ponzi Scheme Forensic AccountantIt has become commonplace to hear news stories of Ponzi schemes being uncovered. Investment scams and Ponzi schemes are all too common. Investors are lured in with promises of high returns. People in or nearing retirement find these investments enticing, especially as their retirement funds in the stock market have taken many hits in the last few years.

As I wrote in my book Expert Fraud Investigation: A Step-by-Step Guide, investors are becoming victims of these scams despite the proliferation of information available about phony investment schemes and the dire warnings given regularly by news reporters.  Perpetrators of investment schemes dream up stories explaining their unusually high rates of return on money, and get high net worth people to invest with them. Often these people are investing their entire savings with scammers.

These high investment returns typically amount to guarantees in excess of 10% per year. Often they are to the point of ridiculous, offering a 30% or 40% annual return. As a fraud investigator, it is clear to me that these offerings are bogus, because any investment that legitimately generated such returns would not be much of a secret to the rest of the world. But consumers, who are often eager to protect and grow their nest eggs, are all-too-willing to believe that this investment is the answer to their money problems.

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Google Your Financial Advisor BEFORE Investing

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jimmy-sodhi-investment-fraud
Jimmy Sodhi / Jimmy Singh

Investors are nearly $2.4 million poorer and Janamjot Singh Sodhi has earned himself an almost 5 year stay at Club Fed, thanks to a Ponzi scheme carried out through a company called Elite Financial Inc.  The fraudster also used the names Jimmy Singh or Jimmy Sodhi.

The scheme ran from 2005 through September 2011, Like any typical Ponzi scheme, Sodhi solicited investors with the promise of high rates of return, and used new investor money to pay “returns” to old investors. At the same time, Sodhi siphoned off money for himself.

Here’s where it gets interesting… Sodhi previously had a license to sell investments, but it was revoked in 2005. In 2006, he was permanently debarred by the New York Stock Exchange. And in 2009, Jimmy Sodhi was ordered to cease and desist all investment advisor activity in California.

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The Mormon Madoff: How Shawn Merriman Scammed Millions

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Jenna Martino, CNBC Associate Producer

Shawn Merriman was head of an investment firm and lay bishop in the Mormon church who persuaded friends, family, and church members to invest with him. It turned out to be a big scam, taking in more than $21 million. Among victims: his own mother.

What Merriman did is considered affinity fraud — where a perpetrator tries to swindle a specific group out of money. While Merriman was already a long-standing member of the Church of Latter-day Saints, other fraudsters have been known to specifically infiltrate a group with the sole mission of perpetrating a scam.

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Bank Liability for Ponzi Schemes

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An article in a recent edition of the Bloomberg BNS Banking Report on Ponzi Schemes and bank liability referred to an article I wrote on recognizing red flags of Ponzi schemes:

Under each, a plaintiff must account for both the plaintiff’s failure to investigate the would-be fiduciary before investing with the fiduciary and the plaintiff’s failure to monitor the fiduciary’s activities subsequent to the investment. As to the first, there are often many red flags to alert an investor to a Ponzi scheme that reasonable investors should notice and that many investors choose to ignore in pursuit of high returns. Fraud detection expert Tracy Coenen has noted more than fifteen red flags signaling a Ponzi scheme that any investor could spot with a reasonably diligent (and fairly simple) investigation. These items include:

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Red Flags Pointed Directly to Madoff

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It’s hard to believe that a Ponzi scheme as massive as the one perpetrated by Bernard Madoff got by anyone. Surely he was the most clever criminal alive, and was ingenious at hiding his fraud. There couldn’t have been any signs of the scam he was running. Or were there?

It turns out there were plenty of red flags pointing squarely at the scheme Madoff was running. It was clear years ago to Harry Markopolos, the author of “No One Would Listen: A True Financial Thriller.”Markopolos was the whistleblower who went to the Securities and Exchange Commission on several occasions with his suspicions about Bernie Madoff. But he wasn’t an investment expert who was “just jealous” of Madoff’s apparent success in generating high earnings for his clients quarter after quarter. He was a numbers wizard who had concrete proof the Madoff’s “investment strategy” couldn’t be anything like what he (or others) said it was.

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Ponzi Scheme and Investment Fraud Red Flags

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Charles Ponzi

How do you know if you’re considering investing in a Ponzi scheme? The promoters will never come out and tell you they are running a pyramid scheme, so the investors have to be smart enough to recognize them on their own. The good news is it is easy to spot a Ponzi scheme.

Now I don’t mean that it’s easy to prove in a court of law that something is a Ponzi scheme. In a civil or criminal case, there are certain standards of proof that need to be met. But you’re not a court. You’re simply an investor. Whether you have $10,000 to invest or $10 million to invest, your money is probably pretty important to you.

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