Eleven years into a 150-year sentence for swindling investors out of nearly $20 billion in an elaborate Ponzi scheme, Bernie Madoff passed away on Wednesday. His arrest and subsequent downfall, during the throes of 2007 – 2009’s global financial crisis, put fraudsters in the spotlight globally. Numerous articles documented the tricks and lies he employed—as well as the signs his was a house of cards. Our firm’s founder and Executive Chairman, Ken Fisher, dedicated an entire book to teaching investors how to spot and avoid crooks: How to Smell a Rat, published in 2009 and still a great read. With the passage of time, Madoff and Ponzis fell out of the headlines. You could be forgiven for thinking his conviction shone a light on the approach, ending them. Sadly, that is far from accurate. Now, with investors growing more optimistic, some ne’er-do-wells likely see opportunity—investors lowering their guard. So, given that, let us once again review the biggest red flags to watch for.
This year alone, numerous examples have hit the headlines. Just last week, a would-be actor was accused of faking a production company, lying about big deals with Netflix, and spending his investors’ money on a lavish home and repaying astronomical credit card debt.[i] Last month, a San Diego woman was sentenced for bilking investors out of $400 million, claiming she would generate huge returns by extending high-interest loans to restaurants seeking liquor licenses.[ii] Prosecutors in Indiana just charged a man with wire fraud over elaborate schemes involving life insurance and food exports.[iii] A Nevada court slapped a $32 million judgment on a man who guaranteed investors 300% returns trading cryptocurrency options, then stole their money.[iv] A guy in North Carolina just got over 10 years in prison and a $6 million fine for telling people his non-profit would invest their money in charitable gift annuities and then, you guessed it, spending it on his extravagant lifestyle instead.[v] Rounding out the recent pack is a West Virginia pharmacist who just received a similar sentence after convincing family and neighbors to invest in a company she owned, claiming it had big contracts with the Department of Defense.[vi]
All of these followed the same basic playbook Madoff … well perfected is the wrong word, but you get the gist. Specifically, there are three common threads running through these and pretty much every Ponzi we have read about ever.
1. They took possession of their victims’ money. Madoff did this via his hedge fund. The actor accused of faking deals allegedly did it by having investors transfer their money to his fake production company. The pharmacist did it by having people invest directly in the private company she and her husband owned. Liquor license lady did the same. Crypto guy pooled people’s money in a faux investment company. Charitable gift annuity guy had people transfer money to his non-profit.
When you give someone else physical custody of your money and discretion to make decisions on your behalf, you remove accountability and oversight. Even if they send you statements, that may be meaningless. Madoff sent his clients very pretty statements with fake returns and account balances. Reputable managers won’t make you transfer your money to them or their company. They will ensure your assets are in a registered, mainstream brokerage firm in an account with your name on it. That company will probably give you online access, which you can use to check on your account at any time and verify every last cent.
2. They hooked people with promises of big or steady returns, using complex strategies normal people couldn’t verify, understand or execute on their own. Usually, this involves a lot of glitz and jargon, combined with promised returns that are far out of step with what volatile markets normally deliver. Madoff boasted double-digit returns year in, year out—even in years the stock market tanked. He claimed it was from an options strategy called split-strike conversion. Anyone versed in options trading would rightly identify this as a risk-management hedge, not something that is going to generate huge steady returns. But Madoff’s clients were experts in entertainment and other arenas, not high finance. As for our smaller, more recent rapscallions, most normal folks wouldn’t know their way around Netflix production deals. Or making high-interest loans to restaurants. Or selling weapons to the Defense Department. Or cryptocurrency options.
Fraudsters rely on that dazzle and complexity to make their victims’ eyes glaze over. They use jargon to sound smart and rely on people not to ask simple questions like “uh what does that actually mean in plain English?” and “can you like explain to me in simple words and short sentences how and why this generates a consistent return?” They blind with flashy tactics and hope that, plus their reputation and purported savvy, is enough to keep the questions at bay. Which brings us to …
3. They used personal connections to gain credibility and attract their marks. Madoff traded on his connections in the Jewish community and his reputation as the head of Nasdaq. Liquor license loan lady owned her own restaurant chain. Actor dude had actual film credits on IMDB. Weapons contract lady owned her company and was everyone’s favorite, trusted neighborhood pharmacist. Crypto guy was, well, into crypto. Food export guy was CEO of a company that specialized in artificial sweetener and pumped his scheme using the media platform that came with his status.[vii] Many, many, many other schemes over the years have flowered in churches, golf clubs, civic organizations and neighborhoods.
Anyone reputable won’t ask you to trust them based on who they are and who they know—in the world of logic, this is called an ad hominem argument, and it is a fallacy. Instead, they will have real credentials and a real performance history you can verify. They will be registered with regulators, and you will be able to look them up—and in doing so, you can find whether they have a history of complaints. They will encourage you to let their verified results and process speak for themselves, and they will not guilt trip you or protest when you do extended due diligence. In other words, they will be professionals. After all, this is business—not personal.
We aren’t naïve enough to think fraud will ever go away. Criminals will always be part of the world—such is the human condition. But the good news is that if you educate yourself and remember how they operate, you can avoid being a victim. Learn from others’ mistakes and protect yourself.
[i] “Actor Accused of Using Money From Ponzi Scheme to Buy $6 Million LA Home, Pay Credit Card Debt,” Elisha Fieldstadt, NBC News, 4/8/2021.
[ii] “San Diego Woman Sentenced for Nearly $400M Ponzi Scheme,” Staff, Associated Press, 3/31/2021.
[iii] “Westfield Man Charged in Ponzi Scheme,” Reed Parker, Inside Indiana Business, 4/1/2021.
[iv] “Crypto Options ‘Ponzi Scheme’ Operator, Firm Ordered to Pay $32M,” Kevin Reynolds, Coindesk, 4/8/2021.
[v] “Wake Forest Investment Advisor Sentenced for Wire Fraud,” Department of Justice, 4/5/2021.
[vi] “Former Pharmacist Sentenced to Federal Prison for a Running Ponzi Scheme,” Jessica Farrish, The Register Herald, 3/18/2021.
[vii] “Stevia Corp. Plots Expansion,” New Hope Network, 9/30/2013.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.