by Sherry McCourt, CFE

Simplifying the definition of a Ponzi scheme – Ponzi schemes are orchestrated by using the monies invested by an individual to pay returns to themselves or another investor rather than from actual profits from the investment.

In today’s world most people think of Madoff when they hear the word Ponzi but did you know that ponzi schemes have been around since the 1920’s. In fact the first documented ponzi scheme was perpetrated by a man by the name of Charles Ponzi who became famous for using this technique thus the term “Ponzi scheme”.

Interesting side note: Charles Ponzi did not create the scheme, Charles Dickens wrote Little Dorrit in 1857 which described such a scheme.

Let’s fast forward to 2009 – while the basics of the scheme remain the same the opportunity for new, larger and far reaching schemes are obtainable through the growth of the financial industry and available investment vehicles thus disguising, if only for awhile, the scheme.

I recently read a very good article from Mark Scott, J.D written in the ACFE (Association of Certified Fraud Examiners) August Newsletter, highlighting the “Red Flags of Ponzi Schemes”

In part:
…the following red flags that may signal fraudulent investment operations.

Sounds Too Good to Be True
If an investment sounds too good to be true, it probably is. This old saying is perhaps the easiest way to spot a Ponzi scam.

Promises of Low Risk or High Returns
Any legitimate investment involves risk; guarantees that an investment will perform a certain way are a clear warning sign of fraud.

History of Consistent Returns
Any firm that generates remarkably consistent returns regardless of market conditions should raise suspicions.

High-Pressure Sales Tactics
Reputable investment firms and agents do not push potential investors to act immediately, and legitimate investment opportunities are rarely that time sensitive. Furthermore, agents need time to research the individuals and firms selling the investments and review any proposed investment vehicles and strategies before recommending them to clients.

Pressure to Reinvest
Often, fraudsters keep Ponzi schemes alive by convincing investors to reinvest their profits rather than take a payout. Therefore, any promoter who pressures investors to roll over their profits should raise suspicions.

Complex Trading Strategies
Legitimate agents should be able to provide clear explanations about their strategies. Therefore, investors should avoid anyone who promotes using a highly complicated investing strategy that is impossible to explain in layman’s terms.

Lack of Transparency
Any secrecy or lack of transparency in the operations of an investment company or an investment process should be treated as a red flag (e.g., lack of detailed information in writing, investment is not evidenced by a statement, investment is evidenced by an unsecured note, investors do not have online access to their accounts, etc.).

Lack of Segregation
Lack of job segregation is another red flag that should raise concerns about a company’s investment operations. Be concerned about any financial managers who manage, administer, and retain custody of the fund in question because the opportunity for fraud is high in these situations.

Public Information
Public information can be particularly crucial in helping fraud examiners determine the legitimacy of an investment. It is important to research the investment company, as well as the promoter’s background.
Some other typical red flags to watch out for include investments that are not properly registered, agents with criminal records, unexplained gaps in a promoter’s work history, prior customer complaints, regulatory problems, questionable credentials, lack of background information on the company website, and generic contact information such as a Yahoo! E-mail address.

Conclusion
Understanding the red flags of the various fraud schemes is a key area of knowledge necessary to succeed as a fraud examiner. With Ponzi schemes on the rise in our increasingly complex investment markets, learning to identify the red flags of fraudulent investment operations will help fraud examiners minimize investor loses, and may even allow them to prevent future Madoff-style investment schemes from occurring.

Be Safe
Sherry

This entry was posted on Sunday, August 9th, 2009 at 8:09 pm and is filed under fraud. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.