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How to Avoid Being Taken in by a Ponzi Scheme
By PAUL SULLIVAN

PONZI schemes are in the news again. The Justice Department announced this week that it had brought criminal and civil cases against more than 500 people for fraud schemes that involved more than $10 billion in losses. At the same time, there has been a flurry of lawsuits from Irving H. Picard, the bankruptcy trustee in the Bernard L. Madoff case. Mr. Picard is hitting a deadline for filing lawsuits seeking to recover money for people swindled in Mr. Madoff’s Ponzi scheme, which came crashing down two years ago today.

But the reality is that small-time Ponzi schemes have been coming to light with regularity since the financial crisis began and investors started asking for their money back. That’s a big problem when an investment scheme is built on paying out old investors with money brought in from new ones. According to data compiled by Investment News, a trade publication, schemes involving $9.244 billion in losses have been revealed so far this year.

Just this week, a former Denver-area hedge fund manager, Sean Mueller, was convicted of running a scheme that bilked some 65 investors out of $71 million. One of those investors, John Elway, the former Denver Broncos quarterback, reportedly lost $15 million.

Mr. Elway, presumably, has other money to live on. But small investors who handed over their life savings to Mr. Mueller or other swindlers, will, in all likelihood, not fare well; they will probably never see that money again.

So with no end in sight to Ponzi schemes, here is a look at what all investors should consider to keep their money safe.

WHAT TO LOOK FOR Sadly, the people who are most likely to involve you in a swindle are friends and relatives. It has become so common that it now has its own name: affinity fraud.

Thomas R. Ajamie, managing partner at Ajamie L.L.P., a Houston law firm that specializes in fraud litigation, and co-author of “Financial Serial Killers: Inside the World of Wall Street Money Hustlers, Swindlers and Con Men,” said he was baffled when television commentators asked, after Mr. Madoff’s scheme collapsed, how a Jew could involve other Jews in his scam. “That’s how it always happens,” he said. “Mormons scam Mormons; Baptists scam Baptists. The reason is we trust people we think are like ourselves.”

He said one of the most egregious recent examples of this involved Imperia Invest IBC, whose assets were frozen by the Securities and Exchange Commission in October. According to the S.E.C., Imperia defrauded some 14,000 investors out of $7 million. About $4 million was collected primarily from the deaf.

“They found some deaf people who would ingratiate themselves into the deaf community,” Mr. Ajamie said. “It was really vicious, but it was very consistent.”

The other big risk is to associate Ponzi schemes with hedge funds. The reality is that Mr. Madoff and the others who have been caught were not running hedge funds; they were running swindles.

Leon A. LaRosa Jr., a partner at EisnerAmper, an accounting firm, said one of the biggest schemes he had investigated involved $400 million in fake real estate investments in Deal, N.J. The targets were all Syrian Orthodox Jews who met the schemer in their synagogue.

Mr. LaRosa said an even simpler example involved the Brandywine Polo Club in Kennett Square, Pa. A member persuaded his fellow equestrians to contribute a total of $50 million through a unit investment trust that purportedly invested in stocks and bonds.

“The common themes were one, I have a complex strategy that I cannot divulge,” Mr. LaRosa said. “And two, I have a strategy that supplies double-digit returns year after year.”

HOW NOT TO GET TAKEN The value of doing research before investing cannot be overstated. But few people take the time to really do it.

One of the first things Mr. Ajamie does when someone who has been conned walks into his office is a Google search of the accused schemer. “It sounds so simple, but you’d never believe how many people have complaints against them,” he said. “I’ll say, ‘Did you even look the guy’s name up?’ They’ll say, ‘No, because this lady at church recommended him.’ ”

So how should people go about researching an investment? Randy Shain, an executive vice president at First Advantage Investigative Services, had several suggestions. First, he said, an investor should ask the manager of the fund what institutions have invested with him. If the manager has been in the business for decades yet has not secured any institutional investments, that should be a warning sign, he said.

Second, people should consider the manager’s pedigree and ask where he learned how to manage money. “I don’t want to hear, ‘I’ve been trading my own account for 10 years,’ ” he said. Related to that is knowing who the manager’s bosses were at those places.

Mr. Shain admitted that such research might be difficult to do. He suggested that potential investors instead go through firms that do the vetting for them. “People are going to say that funds of funds are expensive or consultants charge a fee,” Mr. Shain said. “The answer to that is, of course they do. But what do you care if you end up with more money at the end of the day than you would have had without them?”

Another approach is to make sure that all your investment eggs are not in one basket. Jim Kelly, a founder of HedgeServ and a 30-year veteran of the hedge fund industry, said one of the easiest things investors could do was insist that a hedge fund use different firms for the three main services it needs: a clearinghouse to buy and sell securities, a custodian to hold the money and an administrator to ensure that the value of the assets is correct. Having one firm do all three is a recipe for disaster.

“I’ve seen that Chinese walls don’t work,” he said. “The way to make it work is to have independent service providers.”

WHAT IF YOU’RE A VICTIM? If you have been caught up in a Ponzi scheme, most of the time there are not a lot of great options.

The people who have the best chance of getting any money back are usually the biggest losers. John V. Donnelly III, a lawyer with Cozen O’Connor in Philadelphia, said he helped a client keep $1.3 million he had withdrawn from supposedly high-yielding certificates of deposit he had bought from a former Texas financier, R. Allen Stanford, accused of masterminding a $7 billion Ponzi scheme. The problem was that Mr. Donnelly’s client had invested $3 million.

As for the so-called net winners — people who withdrew more than they put in — Mr. Donnelly said they would have to return the money unless they could prove they were destitute.

Often, the person who loses millions does not suffer as much as the small investor who loses $50,000. That small investor may not be able to afford the legal fees to recover anything, however devastating the losses are.

The reality is that most people will never get their money back. And that is why it is so important to do the research first.

“It’s like if you don’t hold your child’s hand and he darts out into the middle of the road and gets hit,” Mr. Ajamie said. “What are you going to do? Hire a lawyer and sue the guy?”


http://www.nytimes.com/2010/12/11/your-money/11wealth.html?ref=business&pagewanted=print