From Hawaii to Maine to California, investment fraud is alive and well. Type "Ponzi scheme" into your search engine and you will quickly find dozens of rip-offs this year alone following a familiar and avoidable pattern, despite the publicity attached to Bernard Madoff and his ilk. So while it may seem repetitive, it cannot be stressed too much that investors must remain vigilant and take precautions to protect their life savings from predators.
Investment fraud is as old as commerce, with examples from antiquity. Unscrupulous merchants in Greece, for example, were known to have taken out loans against a cargo and then scuttling the ship. The arrangement, known as bottomry, provided that the loan not be repaid in the event that the ship was lost. Even in 300 B.C., scammers plied their trade.
The man who set the bar in the 20th century and lent his name to the eponymous scheme was Charles Ponzi. Practicing an enhanced version of the classic pyramid scheme, Ponzi promised returns of 100 percent to his investors for a three-month commitment. Repaying early investors with the tsunami of new cash pouring in, Ponzi enjoyed a sumptuous lifestyle until the demands for repayment exceeded the inflows, the game collapsed, and the remaining victims lost their entire investments.
So it would seem that it should be virtually impossible to pull off another pyramid scheme in an age of unlimited information and educated investors. But Madoff succeeded in eclipsing Ponzi by an order of magnitude, cheating his investors out of at least $17 billion. The scale of his swindle exceeded the size of the next three biggest scams in history combined. Meanwhile, new cons continue to victimize investors every day. So, a few reminders regarding how to avoid becoming a victim are always in order.
First and foremost, be certain that your investments are held by an independent custodian, and not the same firm that is making the investment decisions for you. Firms that serve as custodians include broker dealers like Schwab, TD Ameritrade and Fidelity, as well as the large banks and brokerage firms with known presence and reputation. In general, the person or firm making the investments should not be in physical possession of your assets. This is how the Ponzi scheme proliferates, usually involving falsified statements and limited access to information. Madoff, for example, literally made up phony client reports to reassure investors. By the time they became aware it was too late.
It is important to thoroughly check out the adviser or salesperson promoting the investment you are considering. FINRA is a self-regulatory agency that maintains a database that you can search to verify the credentials of your broker or adviser as well as the firm for which they work. You can find the database, called BrokerCheck, at FINRA.org.
A big red flag is a compelling story that seems a bit too good to be true, or urgent call for immediate action. A heavy dose of skepticism and patient investigation before investing is always appropriate, and undue pressure should serve as a warning to walk away.
Another key is ensuring reasonable liquidity. Certainly some legitimate investments limit the buyer's ability to redeem the funds until some specified window or redemption period and may be appropriate for sophisticated and knowledgeable investors. Most of us, however, should avoid committing funds that cannot be retrieved on demand. Even if the investment is legit, the lack of liquidity should probably take it off the table.
Ask questions, be skeptical and do your homework and take your time. Fraudsters will always be with us.
Christopher A. Hopkins, CFA, is vice president and portfolio manager for Barnett & Co.