Why Investors Buy Into Ponzi Schemes and Frauds

Posted by Kim Luu in Investment | 6 comments

Many people have heard about Bernard Madoff and how he arguably pulled off the longest and biggest Ponzi scheme in history.  It spanned decades.   Madoff used his professional reputation in the beginning to dazzle investors and lure them into his net.  However, as time went on, what drew people in was their own greed.

You may think that Ponzi schemes and frauds are rare, but they’re not.  Everyone from ordinary people to millionaires and celebrities fall prey to them all the time.   These schemes succeed because they are designed to feed upon the emotions.

Often these frauds disappear before anyone realizes that they are frauds.  The government can’t possibly monitor your every move and tell you, oh watch out.

You need to be your own guard.   Basic common sense will do the majority of the work and an expert can help with the rest.

Here are four methods frequently used by con artists to ensnare unsuspecting victims.   I’ve seen all four in my experience with cleaning up the financial fallout.

PLAYING ON GREED

If we’re honest, everyone has a bit of greed in them.   It’s just human nature and there’s nothing wrong with it.   The key is to be aware of your own level of the greed and prevent it from destroying your life.

Scammers understand that greed can blind an investor and to ignoring otherwise obvious warning signs.  They focus on pushing those buttons.

I was introduced to a woman executive a few years ago at a minority business conference in Washington DC.   She was the head of the procurement department for a large multi-national public company.  She was smart, savvy and tough.   She earned her way up the ladder and was about four years from retirement.   She wanted to retire on time and open a business with her daughter.

She decided that she needed an advisor to help her with growing her retirement portfolio larger after handling them herself for years.   She prided herself on being able to do it all herself.   The problem was that retirement was near and she did not have enough to live the retirement lifestyle that she wanted.

At the very beginning of the conversation, she informed me that she would give me a couple of hundred thousands dollars to invest so she could test me.  However, the bulk of her portfolio was committed to another investment.  I asked her where and who it was with.  This lady then pulled out an orange flyer from her purse.  It was an advertisement for an investment guaranteed to return 13%.

She was about to invest $450,000 in this investment once she flew home to Texas.  She had met with the advisor in the flyer several times.  She went to the seminar that was advertised in the flyer.

First of all, the flyer itself screamed red flag.  No respectable advisor can promise guarantee return on any investment at any time.   I explained this to her along with all the other red flags.

1.   Promising guarantee returns was against the law

2.   13% annual return was excessive since the best average at the time was 7% unless you have very specific sector investments.

3.   The investment was an annuity at a company that I had never heard of.   More research needed to be done.

4.   A quick search of the advisor on FINRA’s website turned up the fact that he was sanctioned in 14 other states.   This was a HUGE warning sign.

Despite all these red flags that I went over, this smart executive chose to invest close to half a million dollars with a shady person who has a record of hitting a state collecting money and then disappearing.   All she focused on was the 13% return.

I made a call to the State of Texas Insurance Department at the time to alert them but nothing got done.  It was the investor’s decision to invest.

TRUST

Often times we follow the advice of advisors blindly, especially that of our accountant.   Con men know this and they target the advisors first.  Once they make the advisors into believers, they’ve got you.   This is partly how Madoff obtained his victims.    Thousands of trusting or lazy advisors around the world advised their clients to invest with Madoff.

Here are some of the failed investments that CPAs have recommended to investors and I had the privilege of spending months to research and file paperwork years later to certify the investments as total losses for tax writeoff.  Were they frauds?  I have no idea, as by the time I got involved, these businesses no longer exist in any way and none of the principals can be traced.

1.   Oil wells in Oklahoma

2.  Coffee plantations in South America

3.  Resorts in Florida swamps (This was my dad’s)

4.  Nuclear plants in China

5.  Hydroelectric dams in China

6.  Waste processing plants in California

7.   A slew of internet or tech businesses – this is a popular scheme.

NEIGHBORS

We trust our neighbors, especially if we have a relationship with them or have lived in the neighborhood a long time.   This also includes one’s church congregation.  When neighbors get involved, it’s a validation in our mind.

My own father fell victim to this situation.   The situation was compounded by the fact that he was an immigrant and English was something that was hard for him when it came to financial complexities.   He depended on his advisors and his American neighbors as a screen for certain situations.

I can still remember that night in high school when my parents got scammed.   Mr. Davis, our accountant and neighbor hosted a neighborhood get-together.   Mr. Davis’ daughter, Karen, and I were also best friends.    We sat there listening to Mr. Davis and the salesperson explain about building resorts in Florida.  There was a whole rush at that time because Disney was expanding in Florida.

What we heard didn’t make sense to us but the adults were all nodding their heads.   I couldn’t see how the cost of emptying out swamp lands could be recouped by the rebuilding.  There were many other things that made me extremely suspicious as well.

After the meeting, Karen and I tried to talk our parents out of investing any money.   No one listened to us because we were fourteen year-old kids.

My parents eventually invested $50,000 which they lost in full.  Mr. Davis lost $10,000.  Our neighborhood lost collectively over a million dollars of hard earned savings.    All these people were hard working middle class individuals like my parents.

That resort development in Florida?  It never existed except on paper with a lot of pretty color brochures.

Beyond the money, relationships were destroyed.   Mr. Davis was fired as our accountant.  My parents never talked to him again but they allowed me to keep seeing Karen.   Karen and I lost touch after her dad was forced to move out of state to restart his accounting business.   Our neighbors rarely talked to each other afterward because no one wanted to be reminded of that investment.    We moved to another part of town a couple of years later.

COMMUNITY

People are often susceptible to scams from within their own ethnic group.   People tend to automatically trust people who look or sound like themselves.   Many of the situations that I was brought in to fix came about from an investor working with someone within their social or ethnic group.

Often it has to do with language.   The longer it takes an immigrant to learn English and the culture, the more likely that they will depend completely on the advise of someone who speaks their language.

Here are a couple of examples:

Excessive costs

My business comes from referrals.  One day, a Vietnamese loan broker brought in a loan package for a Vietnamese doctor.  He had heard that I had access to a short term program that waived loan fees at the time.    I agreed to accept the package and called the doctor.   During our conversation, I found out that the broker told him that I charged 3% for loan fees and he signed an agreement to pay the broker that money.   I told the doctor that my lender doesn’t charge any loan fees at the moment and I would be glad to forward his application to the lender for free.  I advised that 3% was excessive.  I felt that he should pay the loan broker for finding him the loan but the standard fee was 1% for the industry.  Unfortunately, since he had signed an agreement, he was now bound to pay the 3%.

I also informed the broker that I found his 3% fee to be excessive and that it was inappropriate for him to lie to the client and claim the fees were mine.   This broker then pulled the loan and placed the client with a small community bank.  A year later, the doctor called me to review his loan after he found out that he was paying 12% versus the regular rate of 8% on a commercial building.   When I looked into it, his prepayment penalty was so high that it would cost him an additional $450,000 in penalties to refinance his $675,000 mortgage.   There was nothing we could do to fix the situation.

Blind Trust

I find that people give instant trust to someone who speaks their language.   They immediately volunteer extremely sensitive information such as social security number without verifying anything.   The second I speak on the phone or in person with someone in their language, they stop thinking but only reacts.

I always have to tell people to stop giving me information, to look at their statement for my number and then call me back on that number.   My call is legitimate but not everyone who calls in to them will be.

It’s not easy to reach out outside of your community.   I had clients who belonged to male centric cultures and it was very hard for them to get used to working with a woman.  It takes efforts and years from both of us to build a trusting relationship.

I would recommend that when you work with anyone, focus on their ability and skills over any culture or ethnic considerations.    Choose the best person whether they be purple, blue or pink.    It doesn’t matter if they don’t speak your language, your children with their fluent English can always help out.

When it comes to frauds or Ponzi schemes, your common sense is the best defense you have.   If something sounds too good to be true, it usually is.   Take time out and think about things.   Consult an expert.   If it’s your advisor who is recommending it to you, have they really researched it?  Ask lots of questions.

If you feel uncomfortable about something, be frank about it.  It is your life after all.

Dear readers, have you or anyone you know experienced frauds or Ponzi schemes?  If so, what other tricks do investors need to watch out for?

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