(This is a picture of the original Charles Ponzi).
If you were like me you were amazed by the Madoff case. Not because of the amount of money as much as the individuals and entities involved that were deceived by this man. Celebrities, nonprofits, and some of the country's most successful businessmen fell for his ploys.
I wanted to take a few moments to jot down a few "sniff tests" that I use when screening investment vehicles when aggressive sponsors or wholesalers come my way stating their investment is the best investment tool for my 1031 exchange clients. While I am a tax attorney by training, law school does nothing better than cause you to be cynical and jaded. While there are pros and cons to this mindset, the state of mind proves helpful in this arena.
The standard problem is, just like snowflakes and Italian immigrants, no two Ponzis are alike. The classic Ponzi scheme is where an investor take your principal (say $1,000,000) and promises you an above average return (say 12%). However, the "Sponsor" pays you with your money or other investor's money and never "invests" anything. As you can imagine, the concept is very general, so you can twist and adopt the concept as little or as much as you would like.Here are some tell-tale signs:
1. The documents don't match up. If you invested $880,000 and were promised 8% and you had an understanding how your principal was being invested, make sure that is what your paperwork says. Afterall, these crooked individuals tend to fall a little short on work ethic (as a general rule).
2. If you can't verify the investments with public data. If I have Google stock. I can check daily online and see where my account should be trading at...however, if I own 1/20th of an underground gold mine...there is no real way to verify how my account should be behaving...so, I am forced to take the "Sponsor's word for it".
3. Are the financials of the investment scheme audited? One tell tale sign is the local accounting firm and the local law firm signing off on $500 million in investments. While a traditional CPA and attorney provide prudent counsel for you and me, when you are dealing with investments and securities the legitimate sponsors get public accounting firms to audit their books and investment pools.
4. No transparency. In Madoff's case the hedge fund business allegedly was located on a separate floor from the market-making one. Such a lack of transparency should have been a red flag for anyone willing to look. In the proposed investment being analyzed does it seem as if only one individual has control and his or her underlings are only in charge of one duty (e.g. bringing in new money, sending wires, etc.). If you are dealing with an above-board shop most, if not all, of the principals should have knowledge of exactly what is going on (for the most part).
5. Unverified education or experience. With services like Brokercheck you can see anybody who has registered with Finra or the SEC that has been securities licensed. Many of these frauds have taken place under the guise of investment advice and most of these creatures grew out of some aspect of the financial industry to get a foot hold of what "normal investments look like". However, many are taken by greed and power away from the world of traditional investments.
6. Education and Language. I have taken a few Toastmasters classes and I often say "uhhh" one too many times. However, those of you with $100,000 or more on the sidelines, should recognize if someone sounds a little rough around the edges to be involved in "Capital Markets", "Foreign Currency Trading", or "Mezzanine Financing". If you owned a company and wouldn't let the person work the register, odds are you shouldn't be investing in their vehicle. This often applies in the low-level ponzi schemes focused on the unsophisticated (see an "alternative to Grandma's certificates of deposits").
7. The word "Never". I have seen three big investment scams locally. Each one of the promoters consistently said the following "we have never in our X number of years missed a dividend or interest payment". This is pretty easy to do if you are never investing in anything and constantly bringing in new money...however, if the investment thesis stinks, but the promise sounds good, run away. You can't buy your grandchildren ice cream with promises.
8. The word "guarantee". No such thing. With investments increased returns mean increased risks. If it was guaranteed it would have less risk and less return than treasury bills.
9. No references. If you can't get a human being to drive to that seems credible that invested with this sponsor, get out of town. This person is so fly by night his spouse probably makes him sleep in the basement.
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