Madoff’s Gone, Ponzis Go On
If you want to know how rampant Ponzi schemes are, just ask Michigan attorney Andrew Kochanowski.
In the spring of 2008, he was working on a class-action lawsuit against a $250 million Ponzi scheme in the Detroit suburbs. At the same time, another Ponzi scheme was operating just down the hall from Kochanowski.
That $53 million scheme, the Billionaire Boys Club, run by a retired police officer, promised victims 8% to 12% annual returns with no fees. But the Billionaire Boys were allegedly spending investors' money on Ferraris, boats and vacation homes.
"It's like the season for Ponzi schemes," Kochanowski says. "It's amazing."
In the wake of the $65 billion Ponzi perpetrated by Bernie Madoff, it's easy to overlook the fact that Ponzi schemes are the most prevalent type of investor fraud. "In my office in Texas, 80% of our cases are Ponzi schemes," says Texas Securities Commissioner Denise Crawford.
In a way, they're the ideal scam for tough times: easy to start, hard to stop, and designed to appeal to all kinds of victims - especially those who want to do the right thing and invest for the long term. "A Ponzi scheme is ideal for that kind of investor," Crawford says.
Although state and federal authorities look hard for Ponzi scams, they're hard to detect until someone complains. Recently, complaints have been mounting as economically pressed investors ask for their money back. But by then, the money is usually long gone. In most cases, if you want to avoid a Ponzi scam, you have to work hard to investigate before you invest - and keep an eye on your investments at all times.
Ponzi schemes, named after 1920s scam artist Charles Ponzi, are remarkably simple to operate. Start with an investment premise. Ponzi promised huge profits from trading international postal coupons. The Billionaire Boys Club said it would make money in real estate. Madoff claimed astonishing prowess investing in the stock market.
Easy to start, hard to stop
The premise for a Ponzi is limited only by the con artist's imagination. Just last month:
Two men were charged in New York with an $80 million Ponzi based on an automated teller machine business.
A former Nebraska police officer pleaded guilty to running a $4 million Ponzi based on golf outings and martial arts apparel.
An Oregon woman was sentenced to five years in prison for a $2 million Ponzi scheme centered around foreign exchange trading.
Once you start a Ponzi, the biggest problem is finding new investors, and that can take work. Madoff's genius was that he created an aura of exclusivity about his scheme: Only the very wealthy and the very well-connected were allowed to invest. People begged to get in.
But most people who create Ponzi schemes have to do some heavy selling, or get others to do it for them.
Frank Bluestein, for example, is accused of selling the Ponzi scheme to the clients that Kochanowski represents. E-M management, a Waterford, Mich., company, allegedly invested in telecommunications equipment for Hilton Hotels, MGM Grand, Tropicana Resort&Casino and Motel 6. Investors could buy into the scheme through nearly 180 private offerings, which were allegedly guaranteed. The problem: There was precious little telecommunications equipment, no deals with the hotels, and the guarantee was worthless.
Bluestein "would send baskets to recent retirees," Kochanowski says. People would feel guilty about getting the fruit basket and turning down an invitation to one of Bluestein's investment seminars, where he would push investments in the bogus securities issued by E-M Management.
Bluestein even pushed elderly investors to mortgage their homes to invest, the SEC says. "His lies, false assurances and unscrupulous tactics put many investors at risk of losing not only their life savings, but also their homes," Merri Jo Gillette, director of the SEC's Chicago Regional Office, said in a statement.
David Foster, Bluestein's lawyer, says that his client wasn't a partner with the designer and creator of the Ponzi scheme, nor did Bluestein have an intent to defraud his clients.
"He invested his own money, as did his family, and they all lost money along with 1,000 other victims," Foster says. And, he says, Bluestein cooperated with the SEC, turning over thousands of pages of documents during the investigation.
The scheme itself, which the SEC shut down in 2007, was allegedly concocted by Detroit resident Ed May and his company, E-M Management. The SEC, which filed suit against Bluestein on Monday, isn't accusing him of running the scheme, but of being remarkably incurious about what he was selling.
For example, investors continued to receive income from a phony project at the Stardust Hotel in Las Vegas, even though the hotel was demolished in a spectacular controlled implosion in March 2007. Bluestein admitted under testimony to the SEC that he didn't know how it was possible to get investment income from a demolished hotel.
As long as new investments continue to flow in, a Ponzi scheme can continue operating. Con artists send out statements showing big profits, and that induces most people to stay. The few that cash out get paid with new investors' money. This can go on for a long time. The Ponzi that Bluestein promoted, for example, ran for 10 years. Until the scheme unravels, investors are happy because they think they're getting rich, and con artists are happy because they are, in fact, getting rich.
Eventually, however, the scam runs out of new investors and collapses. "Once it starts, it's guaranteed to fail," Kochanowski says.
At that point, the money is gone - and so are the con artists.
"With many Ponzis that we investigate, the perpetrators just take off and abscond with the money," says Texas' Crawford. @"We have to go and track them down. We're usually able to get those people, but the money is not recoverable most times."
What gives Ponzi schemes such appeal to investors? Alabama Securities Commissioner Joe Borg ticks off several draws.
"For the 40- to 50-year-old crowd, there's the fear that the Social Security umbrella won't be there," he says. To make enough to retire, they figure they have to turbocharge their investments - and that plays right into the hands of the Ponzi scammer. "Fear is one hell of a motivator."
For retirees, the problem is low interest rates. The average one-year bank CD yields just 0.95%, Bankrate.com says. A $100,000 CD gives you just $142 a month in interest.
Retirees find they can't live off the interest from their savings, and that they have to dip into their principal. "They can't make any money, and they think they're going to outlive their savings," Borg says.
Ponzi scammers can use other methods to get people to invest. Madoff used affinity: He scammed the wealthy. He also used religion: Many of his investors were Jewish.
In the South, many Ponzi scammers use their church affiliations, Borg says. "When you have God on your side, what can go wrong?"
What's particularly insidious about Ponzi schemes is that many people, particularly the elderly, have a hard time admitting they made a mistake, even when the whole scam starts to unravel.
"There's this fear that if the kids find out, it's going to indicate I can't handle my own affairs," Borg says. Sometimes, older investors would rather lose the money than lose their independence.
The recent burst of Ponzi schemes has federal and state authorities on alert.
"There's a significant increase in Ponzi scheme cases this year," says Scott Friestad, associate director of the SEC's division of enforcement. "From our perspective, size isn't important. We're aggressively pursuing Ponzi schemes regardless of size, because the sad truth is that for those caught up in them, they're losing most if not all of their money."
The free-lunch warning sign
How can you keep yourself away from Ponzis? Start by investigating anyone who offers an investment scheme that seems too good to be true. (Be particularly wary of those who offer free lunches while they make their pitches.) The Financial Industry Regulatory Authority's website, finra.org, has a broker check section so investors can type in a broker's name or firm and see any complaints that have been lodged.
But don't stop there. FINRA's database reported no such problems with Bluestein. It did, however, report problems with the brokerage firms he worked for.
Check the broker's record with your state securities administrator. You can find how to contact your state securities administrator at www.nasaa.org. Ask for all materials from the Central Registration Depository (CRD) about your prospective stockbroker. For investment advisers, ask for all materials from the Investment Adviser Registration Depository (IARD).
Check investment advisory firms with the Securities and Exchange Commission at www.sec.gov. "There's an online complaint center," Friestad says. "I'm confident that someone will follow up quickly."
What victims should do
If you think you've been scammed, contact your state securities administrator as soon as possible. They can shut down a scammer quickly: And the sooner they act, the greater chance you have of recouping some of your money. But it's best to avoid a scam entirely.
It's easier said than done. Con artists will say anything to part you from your money. And they know exactly what to say: "They're safe, they're guaranteed, they'll make up for everything you didn't save for the past 30 years," Borg says. But in the end, the Ponzi always collapses and its investors wind up with nothing.