Deep Dive: Ponzi Schemes, Then and Now

EDITOR’S NOTE: This is a guest post by Bryce Welker, who is an active speaker, blogger, and tutor on accounting and finance. As the founder of Crush The CPA Exam, he has helped thousands of candidates pass the CPA exam on their first attempt. The views expressed in this article are solely those of Mr. Welker.


Although they’re almost 100 years old, Ponzi schemes will never die. Here’s why:

There will always be people who want the benefits of hard work without having to do any hard work themselves. It’s human nature to follow the path of least resistance. However, what stops most people from doing this is a sense of morality, empathy, and respect for other people and their money.

But what about the people who don’t have any scruples? For aspiring thieves, the next biggest hurdle is intelligence. That’s because most people with money work very hard to protect it from thieves, con artists, and criminals. This is why there are thriving industries of professionals like Certified Internal Auditors, whose jobs involve searching for and preventing fraud

However, there are some people who not only lack moral character but are also intelligent enough to successfully fulfill their devious desires. These are the rare people who are bold enough (and smart enough) to exploit professionals and institutions who are otherwise extremely competent. And the most successful method of doing this —both now and in the last century— has been to run a Ponzi scheme.

What Isn’t a Ponzi Scheme?

In order to understand what a Ponzi scheme is, and how to avoid falling for one yourself, it’s important to understand what a Ponzi scheme isn’t.

  • A Ponzi scheme isn’t a pyramid scheme. Also known as a multi-level-marketing or MLM scheme, this involves generating money by charging new members who then attempt to recruit other people so they can make money. Although similar in terms of recruitment, MLM is different from Ponzi schemes in terms of structure and payouts.
  • A Ponzi scheme also isn’t an investment bubble. Although Ponzi schemes take the form of investments, and people can lose their life savings due to an investment bubble, the two are not the same. Investment bubbles don’t necessarily involve fraud; they’re simply a case of assets being priced artificially high, usually due to high demand, and then being corrected by the market.

Despite being fundamentally different from both, a Ponzi scheme can resemble an investment bubble or a pyramid scheme. In fact, this confusion is usually a key factor in pulling off a successful scheme, and it’s also why they can be so difficult to catch.

What IS a Ponzi Scheme?

Put simply, a ponzi scheme is a scam disguised as an investment. Victims are convinced to “invest” their money into funds or businesses —that usually aren’t real— with the promise of extremely high returns. In reality, the only money being generated by these schemes are from new “investors,” which are constantly being recruited by the scammers. Essentially, it’s a flavor of securities fraud.

Another reason why Ponzi schemes are so deviously successful is that they can actually pay out to some investors. In order to prevent bad publicity, many practitioners of this scheme will pay out some of their early investors with a small portion of the money gathered by new ones. At the same time, clever social engineering can dissuade other investors from asking for payouts, allowing the scam to continue.

Confused? Take a look at some of the biggest Ponzi schemes in the past century and you should start to see the big picture.

Biggest Ponzi Schemes of the 20th Century

6 biggest ponzi schemes of 20th Century

What Do 20-Century Ponzi Schemes Have in Common?

While this is far from a complete list of all Ponzi schemes perpetrated in the 20th century, it is essentially a list of the greatest hits. Hence, drawing comparisons between these six scams can help us identify some key factors that go into successful frauds. That way, you can hopefully avoid falling for the next one!

So what are some similarities between these Ponzi schemes? Here are a few worth mentioning:

They’re Backed by “Experts”

Many successful Ponzi schemes are perpetrated by individuals and companies that have the appearance of authority in their industry. These figures and institutions tout their expertise in the fields of finance and business, promising to leverage these assets for their investors to yield high rewards.

In the case of Moneytron, the scam’s ringleader Jean Pierre Van Rossem appealed to investors by touting his academic education in economics; he was often referred to as a “stock market guru.” Towers Financial Corporation’s owner Steven Hoffenberg boasted a similar level of expertise in the field of business, since he previously made a high-profile attempt to purchase the New York Post in order to save it from bankruptcy.

However, the most surprising example of a scam’s successful appeal to expertise is in the case of MMM, the biggest Ponzi scheme of the 20th century. Even after being exposed as a scam, Russian citizens were still interested in investing because of how good MMM was at scamming people!

They Appeal to Charity

When it isn’t possible to run a fraudulent enterprise from a position of expertise or authority, the next best method used by schemers is charity. This is textbook manipulation right out of Niccolo Machiavelli’s playbook:

Niccolo Machiavelli quote

Appealing to people’s moral compass is how Gerald Payne was able to run a wildly successful Ponzi scheme through Greater Ministries International. He invoked religious imagery by quoting Bible verses in order to convince over 20,000 churchgoers to hand over their mortgages, retirement funds, and life savings.

A similar story can be heard regarding the Caritas scam. The way that Ioan Stoica managed to attract investors to his scheme was by promising struggling Romanian citizens the ability to afford basic amenities and household appliances. He even went so far as to name his company after the Latin word for charity!

They Keep Going Up (Until They Don’t)

Even the most secure financial investment in the world won’t see perpetual gains. Any legitimate business enterprise is going to encounter ups and downs as a reaction to competitors, overall economic health, and other forces out of their control. However, Ponzi schemes only go up until they’re exposed— which is usually followed by declaring bankruptcy.

The European Kings Club scheme perpetrated by Damara Bertges promised investors consistent returns of 70% annually. That means investors were promised to increase their investment by 70% every year with no dips. 

Compare that to the performance of 2019’s top-rated mutual funds. These are generally considered to be the safest and best-performing investments, and they only provide average annual returns of 15-20% over ten years. This means much smaller gains over a much longer period of time, accounting for the aforementioned market forces out of the fund manager’s control.

A general rule with any investment is that high risk is an instrumental aspect of high reward. Hence, it’s a good idea to assume that any investment promising high rewards also guarantees high risk. However, if they offer high rewards with little to no risk, it’s almost definitely a scam!

Now let’s take a look at how these schemes have changed over time.

Largest Ponzi Schemes of the 21st Century

largest ponzi schemes of the century

What Do 21st-Century Ponzi Schemes Have in Common?

Just like before, this list is far from complete. However, it does showcase the most notorious and noteworthy examples of modern Ponzi schemes. Before going into the ways these scams compare and contrast to ones in the past, here are some things these six have in common:

They Incorporate New Strategies and Technologies

In order to successfully pull the wool over the eyes of shrewd investors who would otherwise have learned from the past, many of these modern scams involved unconventional investment techniques or cutting-edge technology. That way, any perceived inconsistencies with their business strategy could be excused as a layman’s misinterpretation of a highly technical and complex system.

Take Bitconnect for example. One reason why this scam was able to exist in the first place was due to the “wild west” nature of cryptocurrency. With the hyper volatility of currencies like Bitcoin, and a general public lacking adequate knowledge of blockchain technology, the staggering gains promised by this company seemed more reasonable. Furthermore, the lack of regulation makes it fertile ground for all kinds of scams.

Another common strategy for modern Ponzi schemes is to disguise themselves as lesser-known business and investing strategies. In the case of Mutual Benefits Company, Peter Lombardi was able to scam investors through an obscure (and morally questionable) practice known as viatical settlements. By cashing out life insurance policies early at a fraction of their value, this scheme capitalized on business ignorance and desperation to generate its money.

They React Poorly To Recessions

ponzi schemes and recessions

Eventually, Ponzi schemes will fall apart on their own as the perpetrators either successfully skip town or get busted by law enforcement. However, there doesn’t seem to be a set lifespan for a Ponzi scheme, although it’s rare for them to last longer than a few years.

That being said, one thing that clearly stops a scam like this dead in its tracks is an economic recession. Because they only have enough money to pay off a select few investors, the massive rush of people trying to cash out will lead to a premature collapse.

For example, look at the biggest Ponzi Scheme in U.S. history. Bernie Madoff’s financial racket only began to unravel as a result of the 2008 market downturn. As former Madoff investor Burt Ross stated in a PBS Frontline documentary, “He easily could’ve gone through his life without this being found out. The only reason that this ended was because… the economy did so badly that people wanted —needed— to get money out of Madoff’s investments.”

Although this can’t be confirmed, it’s possible that this same financial crisis was the catalyst for Tom Petters’ Ponzi scheme to unravel as well. After all, his co-conspirator Deanna Coleman cooperated with law enforcement in 2008 to expose this fraudulent scheme, as reported by the U.S. Department of Justice. Although she hasn’t confirmed this in any subsequent interviews, it’s entirely possible that she turned herself in because she could see the scheme unraveling due to the recession in a similar manner to Madoff’s.

They’re Hard To Stop

No matter how clever the perpetrator of a scam may be, there’s always going to be skeptics pointing fingers before the jig is up. Especially with such a rich history of Ponzi schemes in the past, it’s fairly common to hear accusations of fraud directed toward many successful business ventures. However, accusations are one thing; convictions are another.

In the case of Bernie Madoff, one financial investigator named Harry Markopolis had accused him of foul play as far back as 1999. From that point, a lengthy battle between private investigators and the SEC vs. Madoff’s team of personal auditors and bribed associates ensued for nearly a decade before arrests were made.

To add insult to injury, sometimes the reason for these schemes taking so long to bust is negligence or sabotage. This was apparently the case with regards to the second biggest Ponzi scheme in U.S. history. Although Allen Stanford was arrested in 2009 and convicted in 2012one SEC inspector alleged that the federal agency was aware of misconduct as early as 1997, but didn’t act for so long due to internal issues.

How Do I Avoid Falling For a Ponzi Scheme?

Now that you’re well aware of the concept, practice, and most notable cases of Ponzi schemes, the only thing left is to learn how to avoid falling for one yourself. Here are some general tips that should help you avoid falling for this century-old trap:

Do Your Research

If you’re approached with a tempting investment opportunity based on cutting-edge technology, unconventional business practices, or philanthropy, don’t take the pitch at face value. These cases don’t necessarily indicate a scam, but they should be grounds for skepticism. Avoid putting any money down if you can’t find satisfactory answers to these questions:

  • Does this charity have a well-documented financial history that’s free of any accusations of fraud?
  • Does this technology have documentation (like a whitepaper) that clearly explains how it works and how it makes money?
  • Do the people running this unconventional business strategy have a history of successful enterprises, even during a recession?

Be Logical

Another common way for all kinds of scammers to trick victims into giving up their money is by exploiting logical fallacies. These arguments and justifications may seem rational at first, but won’t hold up if you really break them down. Analyze any interesting business investment pitches for fallacious arguments like these:

  • Appeal to authority: Although it’s a good sign that a business is affiliated with an expert in their field, that shouldn’t be their only selling point. See Bernie Madoff and Moneytron for examples of this fallacy at work.
  • Bandwagon: It means nothing if a large number of people are investing in one business. Popularity has absolutely nothing to do with legitimacy; just look at MMM and Bitconnect for examples.
  • Appeal to emotion: Just because an investment pitch tugs on your heartstrings, it doesn’t mean it’s legit. This was the case with Caritas, Mutual Benefits Company, and Greater Ministries International.

Contact The Authorities

contact the authorities for ponzi scheme

If you’ve examined a business or organization and have a strong suspicion that it may be a Ponzi scheme, tell someone!

Speaking out sooner rather than later can prevent more people from losing their life savings. It may take a long time for justice to be served, and it may even be a false alarm. Regardless, it never hurts to be careful. Consider contacting one of these organizations if you’re suspicious:

  • FBI: If you go to the Federal Bureau of Investigation’s Tips page, you don’t have to provide your name when reporting someone you suspect is committing a federal crime. However, you may have to provide some extra information; additionally, submitting multiple false claims on purpose can have consequences.
  • IRS: If you or someone you know has already invested in a Ponzi scheme, the Internal Revenue Service has a page with forms you can fill out in order to claim your losses and request restitution. They also have a detailed Q&A section with more details.
  • SEC: After the embarrassingly drawn-out situation with Bernie Madoff, the Securities and Exchange Commission now takes accusations of Ponzi schemes very seriously. In fact, submitting a legitimate tip through their Whistleblower program could even earn you a monetary reward.

Originally published on https://crushthecpaexam.com/deep-dive-ponzi-schemes-then-and-now/

In the Decade Since Madoff, Ponzi Schemers Try New Tactics

EDITOR’S NOTE: This is an excellent article that appeared in the New York Times today. I am posting it here because it contains some information about some of the new tactics that perpetrators of these schemes are using to avoid detection. They are offering products not typically associated with a Ponzi, such as financial services, insurance and real estate, and offering lower returns in order to avoid detection.

But some things haven’t changed at all. Schemers still raise money through friends, family and acquaintances, and victims still rarely get their money back. The good news is that the SEC is bringing more Ponzi cases and prosecuting them more aggressively.


In the Decade Since Madoff, Ponzi Schemers Try New Tactics

The S.E.C. has prosecuted 50 percent more Ponzi cases in the last 10 years. Those scams cost their victims $31 billion.

By Angela Wang. Published Sept. 22, 2019

Jaleen Dambrosio, left, and Jane Naylon were caught up in what the Securities and Exchange Commission said was a $100 million Ponzi scheme.
Jaleen Dambrosio, left, and Jane Naylon were caught up in what the Securities and Exchange Commission said was a $100 million Ponzi scheme.CreditCreditJoshua McFadden for The New York Times

It has been more than 10 years since Bernard L. Madoff was caught running the biggest Ponzi scheme in history, a case that became a cautionary tale for investors and a call to action for regulators. The Securities and Exchange Commission made changes in its enforcement division to better detect fraud, established specialized teams and even revamped its system for handling tips from the public.

But the prosecution of Mr. Madoff — who took investors for more than $50 billion — was not the Ponzi case to end all Ponzi cases. The S.E.C. brought 50 percent more Ponzi prosecutions in the decade after Mr. Madoff’s arrest than in the 10 years before, according to a New York Times analysis of the agency’s enforcement announcements.

Whether the increase is the result of enhanced enforcement or a proliferation of scammers, records show that Ponzi victims lost $31 billion in the decade beginning 2009, more than three times the amount lost in non-Madoff schemes in the previous decade. (The figures are not adjusted for inflation.)

Sioux Schaefer was one of those millions of victims, and her case demonstrates one of the ways scammers have changed tactics in hopes of ensnaring unwary investors: Instead of pitching secretive, market-beating stock strategies as Mr. Madoff did, schemers are more frequently selling esoteric investments like natural resource mining and cryptocurrencies.

Ms. Schaefer, a horse trainer and photographer from Santa Cruz, Calif., was recently widowed and wondered how to leave an inheritance to her daughter and grandson. A friend told her about investing in gold mines with Daniel Christian Stanley Powell, a gregarious Cornell graduate and the founder of a Los Angeles investment company, Christian Stanley.

As she spoke with Mr. Powell on the phone, they bonded over a shared love of horses. He promised her a 10 percent return on her money, and she gave him $175,000.

The payments Mr. Powell promised never came. Federal prosecutors said he had victimized Ms. Schaefer and dozens of other investors through false promises of profits from gold mines, coal leases and a business for which he had trademarked the term “reverse life insurance.” Instead, they said, Mr. Powell used new investors’ money to pay the old — skimming off a healthy cut to buy a luxury apartment, sports cars and other items — including $5,000 for cowboy boots.

“In my mind, in my spirit, it just knocked everything out of me,” Ms. Schaefer said. “How could I be so gullible?”

Bernard L. Madoff was accused of running a $50 billion Ponzi scheme on Dec. 19, 2008, a fraud so enormous that it prompted the Securities and Exchange Commission to reorganize its enforcement division. Since the start of 2009, Ponzi scheme prosecutions have increased by nearly 50 percent, with much greater losses.

PRE-MADOFF

301,000 investors in 195 cases

POST-MADOFF

4.3 million investors in 291 cases


The S.E.C.’s enforcement announcements demonstrate how scammers’ offerings have evolved to take in people, like Ms. Schaefer, who might otherwise be wary of a pitch involving traditional investment funds. Half the 291 cases brought in the past decade involved schemes promoting untraditional products. In the decade before the Madoff case, about 38 percent did.

“Fraudsters are trying to wrap themselves in new products to garner the attention of investors,” said Jeff Boujoukos, director of the S.E.C.’s Philadelphia regional office.

It’s not the only way that scammers have sought to distinguish themselves. Some victims said they had been fooled by pitches offering modest returns, which made them seem more believable than promises of astronomical profits.

The scheme that Christopher Parris has been accused of running leaned on more traditional Ponzi pitch tactics; the investments were said to be in businesses including financial services, insurance and real estate. Jaleen Dambrosio of Rochester entrusted to him her life savings — $600,000 — and for a few years received steady returns that assured her that she had made the right investment.

But Mr. Parris and an associate, Perry Santillo, were actually running a Ponzi scheme that defrauded more than 600 investors, the commission said. The money Ms. Dambrosio had given him was gone, along with about $100 million that others had invested.

The men had spent lavishly on themselves, including commissioning a song that Mr. Santillo had performed at a party he threw at a Las Vegas nightclub, according to the commission. “Ten-thousand-dollar suits everywhere he rides,” the song went. “Pop the champagne in L.A., New York to Florida; buy another bottle just to spray it all over ya.”

“It was like somebody punched me in the face,” said Ms. Dambrosio, who had retired from Kodak, where she was a purchasing manager. “Everything stopped.”

Ms. Dambrosio — who has gone back to work, at a Walmart deli counter — lost an unusually large amount for a Ponzi victim. The average loss for Ponzi victims in the decade after Madoff was $150,000, according to an analysis of S.E.C. data, compared with $80,000 in the previous decade for non-Madoff scams.

Jane Naylon, who had taken music lessons from Mr. Parris’s father while growing up in the same Rochester neighborhood, contacted the S.E.C. after growing suspicious of Mr. Parris and Mr. Santillo. Some of the accusers have spoken to the F.B.I.

“Why are these guys walking around free?” asked Ms. Naylon, who declared bankruptcy after losing her $105,000 investment. “They froze their assets, but they still seem to have money.”

Lawyers for Mr. Santillo did not respond to repeated requests for comment. Court records do not list an attorney for Mr. Parris; messages and emails to him were not returned.

All Ponzi schemes — whether they make international headlines or minor headaches for a handful of investors — have the same basic shape: They use new investors to pay the old ones. That type of scheme long predates its current name, which comes from Charles Ponzi, whose 1920 investment scam brought in millions of dollars.

Perpetrators’ outreach methods are still often the same as they were in the days of Ponzi. Friends, family and acquaintances are common targets, and word of mouth helps recruit new investors — a trait that was on display in the cases involving Mr. Powell as well as Mr. Santillo and Mr. Parris.

“These are investors who didn’t even know where to begin doing due diligence,” said Scott Silver, a Florida lawyer who has assisted dozens of people who contend they were victims of Mr. Santillo and Mr. Parris. “A lot of the traits of this scheme have become very typical of what we’ve seen over the last decade.”

Another thing that hasn’t changed: Victims rarely get their money back.

Some accusers of Mr. Parris and Mr. Santillo — although not Ms. Dambrosio and Ms. Naylon — have sued Bank of America. They claim that the bank enabled the fraud by providing the defendants with dozens of accounts and facilitating transactions between them. The bank has asked a judge to dismiss the case, calling it “a misguided attempt to hold Bank of America responsible for the misdeeds of its customers.”

Ms. Schaefer, who was caught up in the gold-mine scheme, has less reason for hope. In 2015, Mr. Powell was sentenced to 10 years in prison and ordered to pay $4.4 million in restitution to his victims — a judgment that has yet to be fulfilled.

“He could have stayed out, for all I care,” Ms. Schaefer said. “Just as long as we got our money back.”

Mark Pugsley and Aaron Hinton Prevail on Fraud Case in Third District Court

RQN lawyers Mark Pugsley and Aaron Hinton, together with their co-counsel Kevin Simonof Strachan Strachan & Simon, P.C, won a significant victory after a 5-day trial in Utah State Court.  In a detailed opinion issued last week Judge Matthew Bates awarded their clients compensatory damages in excess of $3 million, $2 million in punitive damages, and attorney’s fees. 

The case, tried in Third District Court for the State of Utah, involved allegations of fraud, constructive fraud, breach of fiduciary duty, negligent misrepresentation, promissory estoppel and unjust enrichment against the clients’ tax advisor.

In ruling in their favor, Judge Bates found that the Defendant “took Plaintiffs’ money under false pretenses, invested it in a way that benefited him substantially, and kept all the proceeds when the loan defaulted.  He bore no risk and kept most of the benefit. Then at trial, he attempted to change the terms of the agreement. Despite the plain and unambiguous language of the emails he sent to Plaintiffs, [Defendant] claimed that Plaintiffs were purchasing property in Minden, Nevada, not investing in a secured construction loan. The torts that [Defendant] committed in this case were willful and malicious, and his conduct was intentionally fraudulent.”

Mark Pugsley said, “This case represents a vindication of our client’s position after many years of litigation.  We appreciate Judge Bates’ professionalism and attention to the details of the case.  We are thrilled that our clients have finally been able to obtain justice.”

Kevin Simon said, “I echo my co-counsel’s sentiments in every regard and I am thankful for Judge Bates’ hard work.  This is a deeply satisfying result and goes a long way in correcting a devastating wrong.”

Discussion of Investment Fraud in Utah on KSL’s Sunday Edition with Doug Wright

Editor’s note: I was interviewed on KSL’s Sunday Edition with Doug Wright last week. The discussion about Ponzi Schemes and affinity fraud in Utah happens at 8:18. I appreciate KSL Television’s willingness to engage in a frank discussion about why affinity fraud is a particularly vexing problem here in Utah, and to help get the word out on how to prevent these scams.

My Interview with ‘Trib Talk’ on Why Utah is Home to So Many Ponzi Schemes

‘Trib Talk’: Why is Utah home to so many Ponzi schemes?

(Steve Griffin | Tribune file photo)

Editor’s Note: This is an interview I did yesterday for the “Trib Talk” podcast from the The Salt Lake Tribune .

The sentencing of convicted fraudster Rick Koerber was delayed — again — this week, adding another chapter to a 10-year legal saga for one of Utah’s most notable Ponzi schemes.

But while the Koerber case is unique for its circuitous route to justice, Koerber’s underlying crimes and use of religion to target victims, are relatively common in The Beehive State, according to national statistics and the experience of local attorneys.

On this week’s episode of “Trib Talk” Tribune legal affairs reporter Jessica Miller and Salt Lake City attorney Mark Pugsley join Benjamin Wood to discuss Utah’s high rate of Ponzi schemes and why the state’s residents are particularly vulnerable to affinity fraud.

Click here to listen now. Listeners can also subscribe to “Trib Talk” on SoundCloudiTunes and Apple Podcasts, Google PlayStitcherSpotify and other major podcast platforms.

“Trib Talk” is produced by Sara Weber with additional editing by Dan Harrie. Comments and feedback can be sent to tribtalk@sltrib.com, or to @bjaminwood or @tribtalk on Twitter.

Finally It’s Confirmed: Utah Has More Ponzi Schemes Per Capita Than Any State in the Country. By Far.

I frequently speak to groups about investment fraud and one of the questions I often get asked is whether it’s true that Utah has the highest rate of Ponzi schemes and affinity fraud in the country.

In the past I haven’t been able to say for sure.  There aren’t any good studies that have reached that conclusion, and so I have to just rely on anecdotal evidence. 

Well, now we have proof.  Jordan Maglich, who runs the website PonziTracker.com, just released an epic ten-year survey of Ponzi schemes in the United States.  He found that there were over 800 Ponzi schemes reported publicly from 2008-2018 and that they collectively caused a jaw-dropping $60 billion in financial destruction.  I believe this is the first database compiling publicly-reported Ponzi schemes and sentences during the “Madoff Era.”

And the survey contains very bad news for Utahns.  Utah had the sixth-highest number of Ponzi schemes despite ranking 31st in population.  So when I ran a per-capita analysis of the numbers Jordan reported it turns out that Utah has the highest rate of Ponzi schemes per capita in the country by far, at 1.35 Ponzi schemes per 100,000 people.  And the next highest state (Florida) is nearly two thirds lower at .51 per 100,000 people.  (Chart)

If you take out the massive Madoff Ponzi scheme in New York ($17 billion), Utah also has the highest loss per capita of $502 per person – which is more than double the next highest state! 

Overall, Utah investors lost over $1.5 billion to these schemes in the last ten years.  And that number does not include other affinity frauds and other investment scams which undoubtedly account for another $500 million in losses to Utah residents over the last ten years (at least). 

How would $2 billion benefit our economy?  What is the collateral impact of these scams?  Here are a few thoughts:

  • Millions in state and federal resources are consumed by the victims of fraud who no longer have means to support themselves in retirement, including paying their medical bills and other living costs.
  • The families of fraud victims often have to step in to house and support their parents or children who have been wiped out financially.
  • Banks, investment advisors and stock brokers lose significant revenue when people liquidate their IRAs and 401K to invest with some unlicensed scammer.

The list goes on… 

Why is Utah’s problem so much worse than any other state?

This is a complicated problem, and there is no clear answer.  But after helping people recover losses from investment fraud for 25 years my view is that people in Utah are simply too trusting, particularly when the person soliciting an investment is in their ward or shares their religious affiliation.

If someone pitching you an investment casually mentions that they used to be the bishop or in some other church position, watch out!  Church callings and temple worthiness are not relevant to investment decisions, so beware of those who bring these issues up in an investment pitch.

Also, it may seem like doing business with someone you know and trust would be safer, but that is simply not true.  All investing involves risk, and just because you trust the individual soliciting the investment does not mean that the investment itself is good.  Trust but verify; and if things go badly do not hesitate to aggressively protect your interests.

Finally, investment decisions should never be made based on feelings.  Just because it feels legitimate, or feels like a good idea does not make it so. 

Here are a few things you can do to avoid getting scammed:

Do your homework.  Run a simple Google search on the company and its managers, or the individual pitching the investment.  You might be surprised by what you find. 

Hire an attorney. An experienced lawyer can help you perform due diligence into the company and individuals offering a private investment.  You need to carefully evaluate the risks and determine whether the offering complies with state and federal statutes.  It is far cheaper to hire an attorney on the front end of an investment like this – when your money is gone it gets very expensive. 

Get it in writing.  I am amazed how often people will give hundreds of thousands of dollars to someone on nothing more than a handshake.  The terms of your deal should always be put in writing, and those terms should be reviewed by the competent attorney you hired. 

Read the Paperwork.  Investors in a private investment opportunity should receive a detailed lengthy disclosure document called a private placement memorandum (PPM).  Take the time to review it before you invest.  Like a prospectus, a PPM contains detailed information about all aspects of the business including the business model, financial history, risk factors, biographical information on the managers, and the terms and conditions of the private investment, among other things.  If you don’t understand these things, hire a professional who does.

Work through licensed stock brokers or investment advisors. Even private (unregistered) investments generally need to be sold by licensed stock brokers.  Every investor should look at the employment and disciplinary history of their broker or investment adviser, which is available on FINRA’s BrokerCheck website

And most importantly, if it sounds too good to be true it probably is. If you are thinking about putting money into an alternative, unregistered, or unusual investment that promises abnormally high returns (like anything higher than 10 to 15% per year), watch out.  And if someone promises you a “guaranteed” return on any investment that ought to be a red flag — investments are rarely guaranteed and investments that offer unusually high returns are more risky, not less. 

State Population Schemes Schemes per 100,000 people Total Losses Losses per capita
Utah 3,101,833 42 1.35 $1,558,325,000 $502.39
Florida 20,984,400 107 0.51 $5,893,496,000 $280.85
New York* 19,849,399 90 0.45 $21,707,050,000 $1,093.59
Illinois 12,802,023 53 0.41 $523,400,000 $40.88
Calif 39,536,653 151 0.38 $3,889,700,000 $98.38
Texas 28,304,596 76 0.27 $8,372,900,000 $295.81
*New York (without Madoff) 19,849,399 89 0.45 $4,307,050,000 $216.99

NOTE: The per capita analysis in this table is mine.  The underlying data comes from this website:  Ten Years After Madoff, Updated Ponzi Database Shows Schemes Are Thriving

Copyright © 2019 by Mark W. Pugsley. All rights reserved.

The Growing Problem With Sales of Unregistered Securities

Recently I have been busy working to recover losses for a large number of investors who lost money in unregistered investments offered by Woodbridge and Future Income Payments or FIP. In many cases these investments were recommended by insurance agents who were not licensed to sell securities, and did not perform adequate due-diligence on these companies before they made the recommendation.

FIP offered pensioners upfront, lump-sum payments in return for a portion of their monthly pension payments over a specific term, often three to five years. FIP then used these pension payments to fund a monthly income stream back to the investors who put up the money for the lump-sum payments. In July of 2018 Scott Kohn, the 64-year-old felon who started the company, closed the doors and disappeared leaving investors with more than $100 million in losses.

Subsequently the SEC filed charges against thirteen individuals and ten companies who recommended and sold Woodbridge, including Utah-based Aaron Andrew and Live Abundant. Live Abundant and its agents were not licensed to sell securities, and yet they recommended both FIP and Woodbridge to hundreds of people here in Utah and throughout the western United States. Our lawsuits against Live Abundant and the individuals and entities who perpetrated this scheme are ongoing.

The common link between these two fraud schemes is that investments in FIP and Woodbridge were not registered with the SEC. These are sometimes referred to as private placements or unregistered offerings.  Generally, a company may not offer or sell securities in the United States unless the offering has been registered with the SEC or an exemption from registration is available. For more information about exempt offerings I recommend you look at this article on the SEC’s website.

Below is a repost of an article from Investment News that highlights some of the challenges for individual investors from these investments, and for the firms that offer them.


Sales of Unregistered Securities are a Growing Problem That’s Harming Investors — and the Industry

By Bruce Kelly

To an investor, Castleberry Financial Services Group’s promise of up to a 12.2% annual yield on the alternative investment fund it was selling might have seemed awfully tempting. So might the assurance that your principal would be insured and bonded by well-known insurance companies CNA Financial Corp. and Chubb Group.

In promotional materials, Castleberry claimed to have invested almost $800 million in local South Florida companies and to have a portfolio of real estate holdings that was generating $2.8 million in rental income annually.

But in late February, the Securities and Exchange Commission went into court to shut the company down, claiming it was all a fraud, including the involvement of CNA and Chubb.

Before the SEC acted, though, it said that Castleberry had managed to raise $3.6 million from investors, some of which was used to pay the personal expenses of its principals. Other funds were transferred to family members or other businesses the principals controlled, according to the SEC.

By all indications, the marketplace for all types of private, unregistered securities, including private placements sold to wealthy investors and institutions, is thriving. But what’s growing alongside this legitimate, if risky, market is a seedy side of the financial advice industry. Investment funds promising above-market returns that employ networks of brokers, former brokers, insurance agents or others lurking on the fringes of the industry to sell their investments are taking advantage of unsuspecting investors.

Add in the ability to offer private securities over the internet and solicit clients via social media, and unregistered, private securities being sold to less-than-wealthy investors, many of them senior citizens, are becoming increasingly dangerous. Fraudulent securities are damaging the reputation of the legitimate financial advice industry,​ and the industry itself might serve as the best solution to safeguarding the investing public.

“I’m seeing more of it:​ the spike in the sale of nontraditional investments,” said David Chase, a former SEC staff attorney who’s now in private practice and based in South Florida.

Sales soar

The proliferation of potentially fraudulent schemes comes at a time when the sale of legitimate private securities, which are exempt from having to be registered if they meet certain SEC guidelines, has taken off. While the annual amount of public stock offerings has remained relatively steady over the past decade, the sale of new private stock offerings has soared.

The most popular of these, known as Regulation D offerings, have more than doubled, from 18,295 in 2009 to 37,785 in 2017. Those deals, along with other types of private offerings, raised a total of $3 trillion in 2017.

Brokers and advisers can sell private, unregistered shares to only the wealthiest clients; investors need a net worth of $1 million or an annual individual income of $200,000 to buy in. But the public disclosure is negligible, making the securities opaque, some sources said, and that is hazardous.

The game plan of the fraudulent unregistered securities schemes currently roiling the investment advice market is simple. An investment manager claims to have an alternative investment to the stock market that beats the return on bonds or bank deposits. The investments are heavily marketed with investment seminars, dinners, and ads on radio and in local newspapers.

James Park, securities professor at UCLA, said the internet is giving the promoters one more outlet to sell their fraudulent investments.

“It’s now possible to get investors from everywhere,” he said. “In the old days, brokers would have to call up people to convince them to invest or put on a road show. Now it’s normalized with online platforms.”

In one of the largest recent cases,​ the SEC said the owners of Woodbridge Securities raised $1.2 billion over a five-year period by claiming they were selling loans to real estate developers.Source: North American Securities Administrators Association

Promising returns of 10%, the scheme reeled in 8,400 investors, many of them senior citizens, with the help of a network made up mostly of insurance agents and former stock brokers, according to the regulator. Woodbridge’s owners kept the scam going, the SEC said, by using money from new investors to pay off old investors — a classic Ponzi scheme.

Without admitting or denying the allegations, Woodbridge and its former CEO Robert Shapiro settled with the SEC for $1 billion in disgorgement and fines. Ryan O’Quinn, a lawyer for Mr. Shapiro, did not return a call seeking comment.

Beyond FINRA’s reach

One of the reasons these cons take time to detect is because the agents selling them mostly work outside the supervision of licensed broker-dealers, who are under the purview of the Financial Industry Regulatory Authority Inc. This gives the fraud ample time to flower before the SEC or a state regulator gets a complaint from an investor, investigates and shuts it down.

The largest Ponzi schemes in general are those that have tapped into a very successful and productive line of independent sales agents who typically have long-standing relationships with clients,” Mr. Chase said. “They sell the deal, and clients get defrauded.”

The SEC did a better job of shutting down what it said was a fraud in the case of Castleberry Financial Services Group after only a year in business. In February, the SEC was granted a temporary restraining order and temporary asset freeze against Castleberry and its principals.

​ Among other allegations, the SEC said the firm’s president, T. Jonathon Turner, formerly known as Jon Barri Brothers, had falsely claimed to have had extensive finance industry experience, an MBA degree and a law degree, while concealing that he had served 18 years in prison for multiple fraud, theft and forgery felonies.

Attorneys for Castleberry Financial and its executives did not return calls seeking comment.

State enforcement

In 2017, state regulators reported that enforcement actions against unregistered brokers and salespeople increased at a faster pace than actions taken against registered individuals. That means the risk from salespeople on the fringes of the financial advice industry is growing. And they are the type of people who often sell scams that are being marketed as unregistered securities.

“[The] enforcement survey reflects a large increase in enforcement actions against unregistered individuals and firms,” according to an October 2018 report from the North American Securities Administrators Association. Members of the group reported actions in 2017 against 675 unregistered individuals and firms — an increase of 24% over the prior year — and 647 registered individuals and firms — a 9% increase.

“The surge in cases against unregistered actors reversed a two-year trend in which registered individuals and firms in the securities industry, broker-dealers and investment advisers, had constituted the majority of respondents in state enforcement actions,” according to NASAA.

Perhaps the poster boy for selling phony unregistered securities is Barry Kornfeld, a leading seller of the Woodbridge Ponzi scheme.

The SEC barred Mr. Kornfeld from working as a broker in 2009. Regardless, he continued to sell private securities; he and his wife allegedly solicited investors at seminars and a “conservative retirement and income planning class” they taught at a Florida university, according to an SEC complaint.

From 2014 to 2017, he and his wife received $3.7 million in commissions after selling more than $60 million of the Woodbridge private securities, according to the commission. Mr. Kornfeld reached a settlement in January with the SEC, agreeing to be barred for a second time from the securities industry. Robert Harris, a lawyer for Mr. Kornfeld, did not return a call seeking comment.

Registered reps involved

Unregistered reps aren’t the only ones selling fraudulent securities. Registered reps working at broker-dealers also are involved.

“We’re starting to see more sophisticated means for registered reps within the broker-dealer space to get investors to invest in private securities,” Thomas Drogan, senior vice president at Finra, said in testimony last year about investor fraud before the SEC’s Investor Advisory Committee. “The challenge in that space has been reps encouraging their customers, for example, to send money from their brokerage account to their bank account. And once the money gets to the bank account, instructing the customer to then send the money to the individual reps’ outside business activity. This creates a problem. This creates a very big challenge for broker-dealers to conduct surveillance on.”

The practice, known as “selling away,” can be grounds for disciplinary action if the broker-dealer employing the broker has not approved the broker’s actions. Unregistered firms and individual topped the list of disciplinary actions by state securities regulators in 2017.

Advisers at independent broker-dealers are commonly paid 7% commissions when selling private placements, clearly on the high end of a broker’s pay scale.

“What’s driving this?” asked Adam Gana, a plaintiff’s attorney. “It’s commissions, commissions, commissions. Brokers think they can get away with selling whatever they want on the side.”

Even though these dubious private securities are creating havoc for investors and the financial advice industry, regulators may soon change the rules about how private securities transactions are supervised.

Simplify supervision?

Last year, Finra proposed rule changes that are intended to simplify how broker-dealers supervise a hybrid rep’s outside business activity and sale of private securities. The new rule focuses on the rep’s RIA firm and decreases some of the responsibility the broker-dealer has to watch over that separate line of business. It would cut costs for the firm and the broker. But some think these changes could prove dangerous.

William Galvin, secretary of the Commonwealth of Massachusetts and the most feared regulator in the securities industry, does not care for the Finra rule proposal.

“Finra claims that the proposed rule will strengthen investor protections, but it is not at all clear how investors will be protected by the removal of supervisory oversight,” Mr. Galvin wrote in a comment letter last April about the proposed rule. “The absence of proper oversight of outside business activities will increase the risk of fraud and abuse.”

Can financial advisers and the financial advice industry do anything to contain this problem?

Local investment advisers are often the best cops on the beat for detecting such frauds. Their knowledge often comes from clients who are being pitched such deals at “free” steak dinners that are provided to get them in the door for a presentation.

Advisers have the responsibility to report a suspicious private securities deal to their firm, said Mr. Chase, the former SEC attorney.

“If brokers get wind of these types of deals, they’ve got to go to the broker-dealer’s compliance department and report to the SEC or Finra,” he said. “They have the ability and obligation to report. There’s nothing wrong with putting these suspicious deals in front of regulators.”

BREAKING: Vescor Ponzi Mastermind Val Southwick Has Been Paroled

Val Southwick, who was convicted of defrauding more than $140 million from hundreds of Utah residents, was quietly paroled last month after serving just ten years, according to KSL News. He pleaded guilty to nine counts of securities fraud, each second-degree felonies, and was sentenced to serve anywhere from 9 to 135 years in Utah State Prison.

Apparently he was a model prisoner.

Mr. Southwick’s case was somewhat infamous in this state because at the time it was the largest Ponzi scheme in Utah history, and because he was so blatant in his use of his LDS faith to convince others to invest.

In its summary of the case the Utah Division of Securities alleged that Southwick “emphasized his membership and ecclesiastical roles in The Church of Jesus Christ of Latter-day Saints during solicitation of meetings with investors.”

“Southwick showed his LDS temple recommend, or mentioned its existence, to several investors, and his office contains LDS ‘memorabilia,’ all of which appeared designed to breed a sense of trust between Southwick and investors.” Investigators said Southwick touted himself as a “respectable LDS gentleman, who was more concerned about the consequences of the after-life than those in this life if he lied to investors.”

The receivership case was finally closed in 2011.

Stay tuned for more information.

FIVE QUESTIONS TO ASK BEFORE YOU INVEST

Whether you’re a first-time investor or have been investing for many years, there are some basic questions you should always ask before you commit your hard-earned money to an investment.

Question 1: Is The Seller Licensed?

Research shows that con-artists are experts at the art of persuasion, often using a variety of influence tactics tailored to the vulnerabilities of their victims. Smart investors check the background of anyone promoting an investment opportunity, even before learning about opportunity itself.

  • Researching brokers: Details on a broker’s background and qualifications are available for free on FINRA’s BrokerCheck website.
  • Researching investment advisers: The Investment Adviser Public Disclosure website provides information about investment adviser firms registered with the SEC and most state-registered investment adviser firms.
  • Researching SEC actions: The SEC Action Lookup – Individuals allows you to look up information about certain individuals who have been named as defendants in SEC federal court actions or respondents in SEC administrative proceedings.

If you are not sure who to contact or have any questions regarding checking the background of an investment professional, call the SEC’s toll-free investor assistance line at (800) 732-0330.

Question 2: Is The Investment Registered?

Any offer or sale of securities must be registered with the SEC or exempt from registration. Registration is important because it provides investors with access to key information about the company’s management, products, services, and finances.

Smart investors always check whether an investment is registered with the SEC by using the SEC’s EDGAR database or contacting the SEC’s toll-free investor assistance line at (800) 732-0330.

Question 3: How Do The Risks Compare With The Potential Rewards?

The potential for greater returns comes with greater risk. Understanding this crucial trade-off between risk and reward can help you separate legitimate opportunities from unlawful schemes.

Investments with greater risk may offer higher potential returns, but they may expose you to greater investment losses. Keep in mind every investment carries some degree of risk and no legitimate investment offers the best of both worlds.

Many investment frauds are pitched as high return opportunities with little or no risk. Ignore these so-called opportunities or, better yet, report them to the SEC.

Question 4: Do You Understand The Investment?

Many successful investors follow this rule of thumb: Never invest in something you don’t understand. Be sure to always read an investment’s prospectus or disclosure statement carefully. If you can’t understand the investment and how it will help you make money, ask a trusted financial professional for help. If you are still confused, you should think twice about investing.

Question 5: Where Can You Turn For Help?

Whether checking out an investment professional, researching an investment, or learning about new products or scams, unbiased information can be a great advantage when it comes to investing wisely. Make a habit of using the information and tools on securities regulators’ websites. If you have a question or concern about an investment, please contact the SECFINRA, or your state securities regulator for help.

Editor’s note: This is a repost of an article from the SEC’s
investor education website. I have a more extensive checklist of my top ten ways to avoid getting caught in a financial scam that is still highly relevant today. If you have questions about an investment or knowledge of ongoing fraud please contact me.

Broker Imposter Scams: Remember To Ask And Check

Editor’s note: This is re-post of an investor alert that recently appeared on FINRA’s website. This is a good reminder of the need to “trust but verify” the credentials of your investment professional.

FINRA recently issued an investor alert on fraudsters impersonating FINRA executives, offering bogus investment “guarantees” to investors as part of an advance-fee scam. But regulators are not the only ones who need to worry about someone trying to steal their good name.

We are aware of a recent scheme that involved an unregistered individual impersonating a registered investment professional to lure in potential investors. This scammer created a fake version of a public FINRA BrokerCheck® report of a legitimate broker—picking an experienced broker with a spotless regulatory record.

The doctored BrokerCheck report was emailed to potential “clients” using the name and CRD number of a registered investment professional, and a company that is not registered as a broker-dealer with FINRA. The solicitation included other documentation and a request for investors to respond with a photo of their driver’s license and other personal information. Here are some of the red flags we spotted on the doctored report:

Broker Imposter Scams: Red Flags of Doctored BrokerCheck Report

Here are six tips to keep your money and personal information safe from these types of scams.

1. Go to the source. FINRA encourages investors to “ask and check” by using BrokerCheck before investing with an investment professional. Don’t assume that the information you receive in an investment pitch is legitimate. Go directly to the sources that collect the regulatory information to produce these reports, including FINRA’s BrokerCheck, the SEC’s Investment Adviser Public Disclosure, and state registration databases. You can search both professionals and firms not only by name, but also by their registration number—known as a CRD number.

2. Look for things that appear out of place. Compare whatever BrokerCheck report or other documentation you receive from an individual or firm soliciting your business with the real reports you obtain yourself from BrokerCheck or the sources in Tip 1. Be wary of typos, and look for differences in the reports. For instance, in a recent scam, the doctored information was in fonts that were different from fonts used in other parts of the report, items appeared to be pasted into the document, and the state of the branch office address was not included in the list of states where the individual was licensed.

3. Verify information with an internet search. Take a few moments to use a common search engine to type in the name of the individual who is soliciting your business and the firm name, and see what comes up. Does it match the information provided to you, including the contact information? If something doesn’t look right, do a little more digging, including a map search on the address or a reverse lookup on the phone number. Be sure to check all this information against a reliable source such as BrokerCheck. When scanning LinkedIn profiles, be aware that scammers often copy select information from a registered person’s LinkedIn profile to create the appearance of legitimacy.

4. Do not send money or personal information without verifying the recipient. In the scam described above, investors were asked to send a driver’s license photo and other personal information in response to an email solicitation. Don’t ever send money or personal information, such as your driver’s license, passport, social security number, date of birth, or bank account information, until you verify who contacted you, as described in Tip 3.

5. Beware of the use of personal contact information. Sometimes a scammer will ask you to send money or personal information to a personal (not firm) email address or to respond to phone numbers that are not listed as official firm contacts. One general rule all investors should follow: if you invest through an account at a financial firm, use BrokerCheck to verify that the firm is registered and send all deposits directly to the financial firm. If an individual pitches an investment opportunity that requires you to write a check directly to him or to a third party, proceed with caution.

6. Be alert to the red flags of fraud. Be cautious of guarantees, unregistered products, overly consistent or high returns, complex strategies, missing documentation, account discrepancies and pushy salespeople. The vast majority of investment professionals are trustworthy individuals, but there are always exceptions who might look to take advantage of your trust. Practice spotting the persuasion tactics that con artists use, and always exercise healthy skepticism. For instance, be wary of sales pitches that make exaggerated claims about performance. This is a red flag of fraud.

If you are suspicious about information you receive from an individual or firm soliciting your business, contact FINRA or another regulator BEFORE you send any personal or financial information. If you are an investment professional and have concerns that someone is using your name or information as part of a potential scam, contact your firm’s compliance department, and alert FINRA by calling our BrokerCheck hotline at (800) 289-9999, or emailing BrokerCheck@finra.org.

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