Back to basics: Ponzi schemes are here to stay

July 2016  |  SPECIAL REPORT: WHITE-COLLAR CRIME

Financier Worldwide Magazine

July 2016 Issue

As might be expected, over the past few decades white-collar crime has evolved and become increasingly sophisticated through the use of advanced technology and the advent of cyber fraud. However, alongside the increase in the sophistication of fraudulent schemes, there also appears to have been a return of a classic – the Ponzi scheme. The last decade has seen some of the largest Ponzi schemes in history and there appears to be no slowdown on the horizon. It seems that, though new technology has created many new complicated and technical ways to perpetuate fraud, the basic and simple exploitation of trust-based relationships central to Ponzi schemes continues to be an incredibly lucrative way for fraudsters to earn money.

The classic Ponzi scheme

The term ‘Ponzi scheme’ comes from a fraudulent arbitrage scheme orchestrated in Boston by Charles Ponzi beginning in 1919. Through his scheme, Ponzi claimed that investments would be used to purchase discounted postal reply coupons from overseas, which would then be redeemed at face value in the US. However, there were not enough postal reply coupons to fund the returns promised by Mr Ponzi and, ultimately, new investor money was paid out to old investors in order to keep the scheme running. At its height, Mr Ponzi was earning over $1m per week (equivalent to over $12m per week in today’s dollars). Eventually he was unable to keep up with the promised returns and was forced to declare bankruptcy. In the end, he was arrested, charged with 86 counts of fraud and sentenced to 14 years in prison.

Ponzi schemes can take many forms but the basic structure is that the perpetrator creates a fake investment opportunity which promises very high returns. Investors are initially given returns as promised or better and, thus, become keen to invest more money. New investor money is then used to make payments to old investors and the scheme sustains itself for as long as new investments continue to pour in. The real hallmark of Ponzi schemes is that investors do see a big return early on and excitedly tell their friends and family about the “great investment opportunity”, further perpetuating the scheme. The Ponzi scheme is thus built up and perpetuated on intimate trust – something difficult to replicate via digital media alone.

The modern Ponzi scheme

A more recent and well-known Ponzi scheme was perpetrated by Bernie Madoff who orchestrated the largest investment fraud in American history. The total of the fraud, including fabricated gains, is estimated at $65bn, but the actual losses are expected to be closer to $18bn. As a result of his fraudulent actions, Bernie Madoff was arrested in 2008 and is now serving a 150-year prison sentence. Mr Madoff, a reputedly intelligent and charismatic man, is a perfect example of the classic Ponzi fraudster since his charming personality and long background in finance and investment allowed him to gain the trust of investors for years before his scheme came crashing down.

Though Mr Madoff’s Ponzi scheme remains the largest in history, this type of simple fraud seems to have only become more prevalent since his arrest, with several of the largest Ponzi schemes in history having been revealed within the past two years.

In February 2015, Gary Sorenson and Milowe Brost, two men from Calgary, Alberta, Canada were convicted of fraud in one of the largest Ponzi schemes in Canadian history. The two defrauded more than 2400 investors from around the world of between CAD$100m and $400m in a scheme which involved a fraudulent mining investment opportunity which promised safe, high interest returns. In July 2015, the two men were sentenced to 12 years in prison and were fined CAD$54m in a related Alberta Securities Commission case. Despite their conviction, most of the money remains unrecovered and is thought to have been spent on the lavish lifestyles of the two fraudsters, hidden offshore, or paid out to early investors.

On 26 May 2016, a former Vancouver notary, Rashida Samji, was found guilty of 28 counts of fraud in a Ponzi scheme involving over CAD$110m and over 200 defrauded investors. From 2003 to 2012, Ms Samji solicited funds from investors who believed their money was being used as collateral to allow a winery group to finance its expansion. In reality, new investors’ money was being used to directly pay out early investors. At the time of her criminal conviction, Ms Samji had already been fined CAD$33m by the BC Securities Commission in connection with this scheme; she now faces up to 14 years in prison.

In March 2016, a series of civil claims were filed alleging that West Vancouver couple Virginia Mary Tan and Patrick Eng Tien Tan are at the centre of a Ponzi scheme which during the past two decades brought in over CAD$40m. Funders believed they were investing in a short-term loans business and were attracted by the promise of returns of over 20 percent. Like many Ponzi schemes, this scheme involved investors who had convinced their friends, family, and even their priests to invest in the promising investment. In light of the ongoing investigation and trial (and a bankruptcy filing) the couples’ assets (including nearly 30 townhouses) have been frozen but much of the money remains unaccounted for.

In March 2016, the US Securities and Exchange Commission (SEC) launched a lawsuit against Aequitas Capital Management alleging that the Oregon based investment firm perpetrated a $350m Ponzi scheme which defrauded over 1500 investors. The SEC alleges that the firm led investors to believe they were making investments in areas such as healthcare, education and transportation when the funds were in fact being used to support the struggling firm’s payment to existing investors and operating expenses.

In early February 2016, Chinese authorities revealed that Ezubao, a major online finance firm, cheated nearly a million investors out of more than $7.6bn. The scheme involved the peer-to-peer lending firm offering an array of fake investments with the promise of interest rates of up to 15 percent. Senior executives are reported to have spent tens of millions of investors’ money on luxury items for employees to give off the impression of success in attempt to garner trust from investors. Twenty-one senior employees have been arrested from Eastern China where the company is headquartered in connection with this fraud.

These cases are just a small sample of the plethora of new Ponzi schemes that are revealed every month all over the world.

Conclusion

Despite the new tools in the fraudster’s tool kit, it appears Ponzi schemes remain a reliable favourite and are here to stay. Advancements in technology and the advent of cyber fraud may have created many new avenues to perpetuate fraud, but it seems that these sophisticated methods have not diminished the profitability of more simple, basic approaches. Investing today can be a very complicated and technical business and finding trustworthy investment advice is an increasingly difficult task. By convincing a small number of investors of the soundness and the potential of a fraudulent investment and using them to market the opportunity to their personal networks, Ponzi fraudsters are capitalising on the trust these investors have cultivated over many years of intimate personal relationships. Though quite simple, the exploitation of this trust remains a very profitable way for fraudsters to make a living and is likely to allow for the continued success of Ponzi schemes for the foreseeable future.

 

Brigeeta C. Richdale is an associate and Rory Tighe is a student-at-law at Bennett Jones LLP. Ms Richdale can be contacted on +1 (604) 891 5150 or by email: richdaleb@bennettjones.com. Mr Tighe can be contacted on +1 (604) 891 5179 or by email: tigher@bennettjones.com.

© Financier Worldwide

BY

Brigeeta C. Richdale and Rory Tighe

Bennett Jones LLP

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