If an Investment Sounds too Good to be True, It Probably Is
An Update on Ponzi Schemes
By Kyle Anne Midkiff, CPA, CFE, CFF, Partner, Advisory Services
Despite plenty of bad press over the years, Ponzi schemes — named after notorious financial fraudster Charles Ponzi — are still regularly unleashed on the public. One of the most famous Ponzi schemes in history was orchestrated by Bernie Madoff, who defrauded investors of an estimated $65 billion. Here’s how Black’s Law Dictionary describes a Ponzi scheme:
A scam which is usually carried out on the general public, by making returns of high promises in a shorter time period. It is primarily based upon paying off the early investors first and the long term liabilities later on. However, the system is susceptible to crash, and usually, the perpetrators abscond before that happens.
Since Madoff’s arrest in 2008, the SEC has worked to strengthen its Enforcement Division — and yet Ponzi schemes still defraud plenty of investors today.
Common Characteristics of Ponzi Schemes
Here’s how to spot a Ponzi scheme:
- The investors typically consist of friends and relatives of the fraudster, or they have some common connection (same religion, favorite causes, or hobbies);
- The fraudster typically refuses to discuss their “complex” strategy;
- Investors are promised very high returns with little or no risk;
- The returns on the investments are extremely consistent and are not subject to typical market volatility;
- It involves unregistered investments and unlicensed sellers;
- Early investors are paid off handsomely;
- Paperwork and documentation is never provided or is falsified; and
- The investors fail to properly research the investments.
Recent Ponzi Schemes
Since Madoff’s billion-dollar operation, a few notable Ponzi schemes have occurred in the mid-Atlantic area1, including the following:
Summit Trust Company (“STC”)
Two Pennsylvania investment advisers, Kevin Brown and his father George P. Brown, settled a civil injunctive action with the SEC for defrauding investors in three offering frauds from 2008 to 2014. The offerings were unregistered and related to securities issued by STC, the Rampart Fund LP (Rampart Fund), and Trust Counselors Network, Inc. (TCN). The SEC complaint alleges that the Browns raised more than $33 million through the offering of STC’s preferred stock. Investors were told proceeds would be used for business expansion and acquisitions, but the Browns used the money to make payments to existing preferred stock shareholders and to cover obligations to their other affiliated entities for speculative investments. The Browns also allegedly raised approximately $8 million through the sale of notes by the Rampart Fund for the purpose of investing in mezzanine debt financing; however, proceeds were used to pay interest and redemptions due to other Rampart Fund investors, and to make investments in the Browns’ affiliated entities. In their third offering, the Browns allegedly raised $12 million in investments in estate planning products affiliated with TCN. Funds from those investors were used to meet TCN’s other obligations.
Ultimately, a receiver was appointed over the assets of STC, TCN, and the Rampart Fund.
Mantria Corporation (“Mantria”)
The founder of Mantria Corporation, Troy Wragg, was charged with defrauding investors of $54 million from 2005 to 2010 with the false promise they would earn 50% or higher returns on their investments. Investors were told that Mantria Corporation had investments in real estate and green energy. The green energy investment was a bogus “trash to green energy” business. Wragg obtained these large investments through co-defendant Wayde McKelvy, who ran unlicensed investment clubs in Colorado. Investors were coached on how to obtain home equity and credit card loans to raise more funds to invest in Mantria. The company then used new investor funds to pay earlier investors. Wragg pleaded guilty to the fraud scheme and was sentenced to 22 years for this and another unrelated scheme. McKelvy was convicted on all counts at trial and was also sentenced to 18 years in prison.
Roaring Investments, Inc.
Through his company Roaring Investments, Alexander S. Rowland defrauded investors of almost $3 million. Rowland falsely represented that he was a licensed investment adviser who would invest their money in stocks and cryptocurrency with returns of 25% to 50% or higher. Rowland used the funds obtained from investors for vacations, jewelry, luxury vehicles, and firearms, and to make payments to the earlier investors. Rowland also provided false account balances to investors. He pleaded guilty to mail fraud, wire fraud, bank fraud, securities fraud, and investment adviser fraud, and was sentenced to nine years in prison. (The name of the company should have been a red flag just by itself.)
Conestoga Partner Holdings
Between 2014 and 2018, George Heckler controlled multiple investment funds. He solicited investors by claiming good returns in his Cassatt fund which, by December 2013, no longer even had a brokerage account for trading. Instead of investing in funds, he diverted investor proceeds to pay out earlier investors for losses suffered by other entities he controlled. To conceal his scheme, Heckler sent out false statements to investors indicating their portfolio values were increasing when they were either non-existent or losing money. After costing investors approximately $20 million, Heckler pleaded guilty to securities fraud and was sentenced to 63 months in prison.
Similarities in the Ponzi Schemes
Although the above Ponzi schemes were much smaller in scope than Madoff’s scam, all were devastating to the victims — many of whom invested their retirement funds in these schemes. Notably, each scheme had several things in common: the use of unregistered securities and unlicensed investments; the promise of incredibly high returns; the falsification of documents; and the payoff for early investors. Once again, investors repeatedly failed to heed the old adage: “If an investment sounds too good to be true, it probably is.”
How to Avoid Ponzi Schemes
Perpetrators of Ponzi schemes tend to be intelligent, articulate, and able to tap into a person’s vulnerabilities or sensibilities. With that in mind, how can you help people avoid being duped into investing with a fraudster? To avoid Ponzi schemes and other investment fraud, it’s important to perform adequate due diligence by thoroughly checking out investment advisors, and money managers. Also, make sure the outside auditors are reputable. For any regulatory and enforcement actions, searches should be performed through the SEC and Financial Industry Regulatory Authority (FINRA) websites. Finally, verify the credentials of anyone involved with your investments. This verification should include employment history, educational background, and civil, criminal, and bankruptcy checks.
In addition to due diligence, you should maintain a healthy amount of skepticism in the following areas:
- Complex financial products;
- Guaranteed returns or risk free investments;
- Investments targeted at a specific group that share common attributes such as religion, ethnicity, and/or age;
- Limited disclosures and statements;
- Returns on investments that are overly consistent even in a volatile market; and
- Unknown investment firms or advisors.
Furthermore, it is critical to diversify your investments. Many investors duped by Ponzi schemes put all their money in the Ponzi scheme and as a result, they lost their life’s savings. It is critical to make sure your assets are held at a legitimate firm (and not one created by the fraudster).
Most importantly, remember that “if it sounds too good to be true, it probably is.”
- These schemes are representative of Ponzi schemes that are occurring all over the country.