April 28, 2009 / 9:21 PM / 10 years ago

Psychology weds finance in Ponzi scheme frauds

MIAMI (Reuters) - Take the malleable clay of human nature, add greed, deceit and manipulation, and you have the basic ingredients for a Ponzi scheme financial fraud.

Throw in ‘bird dogs’, ‘boiler room boys’, socialite philanthropists, ‘front’ companies, slick sales talk and glossy promotion. These are some of the accessories that can turn a simple scam into a persuasive fictional investment vehicle.

As victims and regulators still digest the shock of the recent scandals involving disgraced financier Bernard Madoff or Texas billionaire Allen Stanford, experts are probing the psychological and financial components of Ponzi schemes.

The Ponzi scheme is named after Italian immigrant Charles Ponzi whose 1919-1920 fraud was a cause celebre in Boston.

It works on the simple principle of luring investors by promising attractively high returns, while in fact paying its early clients with the money provided by later investors.

While basically insolvent from the start, it feeds, fraudulently, on the natural desire to obtain financial gain.

“It’s human nature and psychology, it’s preying on individuals that are vulnerable,” Maria Yip, a forensic accounting expert at Yip Associates, told Reuters.

She and other fraud experts explained to an offshore finance conference in Miami on Tuesday some of the common attributes of Ponzi schemes, which have bilked investors in the United States and elsewhere out of billions of dollars.

Successful Ponzi schemes prey on close-knit communities of victims, so-called “affinity groups,” which the perpetrators of the frauds are either already linked to or can tap into.

For example, Madoff, who has pleaded guilty to Wall Street’s biggest ever investment swindle involving $65 billion in client funds, found many of his customers among the wealthy Jewish communities of Florida and New York.

“They are going for groups of people where they can build the trust quickly, it could be synagogues or churches or retirement communities,” Yip said.

Stanford, who is accused by U.S. regulators of an $8 billion fraud, but who denies running a Ponzi scheme, was a “red-blooded American marketing to Americans,” said D.C. Page, a managing partner of Verasys, who sat on the experts’ panel.

While some smaller Ponzi frauds may operate only by word of mouth, larger, more sophisticated schemes often cloak themselves in a facade of respectability, with plush offices, investment advisers, nominal auditors and glossy literature.

Some also involve “bird dog” promoters, who work on recruiting investors, and “boiler room staff,” who work the telephones using lists of potential victims. These lists are sometimes sold on the black market among swindlers.


At the center of the Ponzi scheme is the mastermind, who experts say often poses as a gifted investment strategist, cultivating an air of mystery or cloaking his activities with donations to charity and acts of social philanthropy.

“It’s the guru behind the curtain,” said Michael A. Tessitore, a lawyer who has acted on behalf of victims of Ponzi schemes and frauds in the United States and Latin America.

Investors are often told they are being made part of a privileged group, which maintains an air of cloistered secrecy around the frauds and discourages asking questions.

But the experts say, often one blunt simple common-sense question, ‘Is this too good to be true?’, would have been enough to puncture the deceit surrounding the promises of dazzling financial rewards.

Promises of above-average returns defying market trends are among the biggest “Red Flags” signaling a potential fraud.

“The market place is pretty efficient. If they’re telling you you’ll be getting oddly high returns and that it’s guaranteed, there’s something wrong,” said Mitchell Herr, an attorney and partner at Holland and Knight.

Other tell-tale signs are grandiose, but incomprehensible investment strategies and “unbusinesslike” use of money. Page said one scheme listed investment in “sunken pirate treasure.”

Lack of clear and demonstrable financial oversight should also ring alarm bells, the experts said.

For example, Herr said Madoff’s vast investment empire was served by a “three-person audit shop,” while Stanford’s bank offering high-yield certificates of deposit was nominally audited by a “72-year-old gentleman from Antigua,” who in fact died at the beginning of this year.

Discovery is only the first part of the dismantling of a Ponzi scheme.

The second is the fight between receivers, liquidators and lawyers for what Martin Kenney, an attorney and economic crime expert based in the British Virgin Islands, calls “the dripping roast” of the scheme’s assets and those of its organizers.

“The investigation, the recovery becomes a feeding frenzy of professionals. It is not uncommon for there to be nothing at the end, but the fees to pay the professionals ... that adds insult to injury,” said attorney Tessitore.

Editing by Jim Loney and Andre Grenon

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