American Greed and How to Prevent the Next Bernie Madoff

Ponzi Schemes have been around since man first exchanged money for services. There are hundreds of Ponzi Schemes going on as we speak. There are over 50 that are exposed each year, with over 150 exposed in the wake of the Great Recession. Some are pure scams, while others are somewhat market dependent. Some start out in legitimate fashion, but because of bad bets, bad markets turn into Ponzi Schemes to hide bad decisions. By the way, it is never theft according to the perpetrator, it is just “borrowing the money”. They “always intended to put it back”. To them, this nuance make it OK. Others are just crooks. In my personal experience with Merrill Lynch, those Financial Advisors that were caught “borrowing” money from client accounts were always going to put it back. The FA’s were always fired immediately and the clients made whole. It was usually involved a relatively small amount of money. I had one FA borrow money from a client’s account to buy a computer. It ended up being other things and a total of $25,000. He was fired. Another made up false statements after hours after

having asked the client to make checks payable directly to his name. We got him when the FA went on vacation and the client called about his account. He was fired. A cashier once borrowed some money by making up false deposit slips in a lesser amount than the one given back to the office. When these small discrepancies appeared, she claimed she knew nothing about it. She was fired and went to jail. I had former banker who colluded with his buddy at the bank to borrow money from clients of the bank, trade in fictitious accounts at ML. When the trading was successful they put the original money back and split the profits. When it was unsuccessful, they simply left us with an unsecured debit balance and put the original money back in the bank. This was my first office as manager, so it was a shock to me that someone would be so brazen and risk their careers for so little money. They were convinced that they had a perfect scheme and wouldn’t get caught. We quickly put a stop to this, brought in the FBI and they went to jail for five years.

On a much larger scale there is fraud and deception going on all the time. In my home town of Indianapolis, there have been two famous cases involving Ponzi schemes. One where the Financial Advisor borrowed money from his clients, lived the high life, and when confronted faked his own suicide by jumping out of his airplane over North Carolina.

On an even larger scale, we had a individual buy a financial institution, turn it into his personal piggy bank, live the highest of high lives and eventually go to jail. They both made the highlight reel on “American Greed”.

So how do we protect ourselves, our loved ones and our institutions from these schemers? Understand that if these guys weren’t good, they wouldn’t get away with as much as they do. They tend to pray on our weaknesses. When we are in financial trouble they are there to take advantage of us. When we are greedy or envious, they are right there to help us out. They pray on the elderly in particular. These are the saddest cases where a trusting unsuspecting person turns over their life savings to a relative stranger. These people are masters of instilling trust, confidence in them.

So why don’t we see the problem sooner. Why do these scams last for years? We all have a very strong need to be right. The bigger our ego, the greater the need to be right. Even after they take away these schemers in handcuffs, clients are still defending them. We also hate to be embarrassed. This publicly admitting that we are wrong. This is why people would rather lose $100,000 rather than turning in a crook. Knowing this, how would you start a Ponzi scheme?

Twelve Steps to Starting a Ponzi Scheme

  1. Set up an Independent Investment Firm that required no supervision
  2. Invest substantial capital in the office, and your lifestyle
  3. Impact the local community by giving large pledges to their favorite causes
  4. Buy a large home, lease an expensive car, boat airplane. Join the right Club, church, and civic organizations
  5. When people ask you what you do, be vague. Talk about coffee futures, derivatives, options and other exotic products. Explain that you have figured out the system and are making money hand over fist. Explain that you are sharing the idea with a few close friends and family members.
  6. Take their money. Give them a promissory note and a regular stream of income above the market ie 12-25%. Give statements monthly showing compounding effect of money. Never return any money after initial returns. When absolutely necessary pay old investors with new money.
  7. Only take money reluctantly and only through referral from trusted sources.
  8. Spend client’s money lavishly on more new cars, boats, airplanes, hookers and drugs.
  9. Eventually run out of new money to pay old, skip town, fake suicide, get caught, and go to jail.
  10. Plan new scam while in jail
  11. Get out of jail
  12. Do it all over again

How to Avoid Ponzi Schemes

  1. Only do business with brand names that you can sue successfully
  2. Avoid complicated schemes that sound too good to be true. They always are.
  3. Avoid anything guaranteed except government bonds
  4. Be wary of smooth talking confidence men in $3000 suites, with fast cars, boats, airplanes and even faster women who befriend you and make you feel that you deserve everything that they have. All you have to do is turn over your money to them.
  5. Be wary of “credibility by association” who use religion, ethnic origin, club status, or other affiliations to establish credibility
  6. Be wary of the “credibility by referral” when accepting. “If he is good enough for Tom Smith, he is good enough for me”.
  7. Be wary of previously credible people whose lifestyle suddenly changes due to an amazing new investment strategy. Opportunity is different from schemes.
  8. Be wary of friends in the investment business that fall prey to the temptations of alcohol, drugs, women or gambling. I monitored very closely my FA’s that had a reputation for trips to Las Vegas. Pump and Dump stories are very common in Las Vegas.
  9. Never invest more than 5% of your assets in an illiquid investment where you could lose it all. We are all tempted by Private Equity deals. Even the most legitimate people fail more than succeed in these ventures. If you buy them through a name brand, at least you can get your money back if the GP runs off with your money.
  10. Report suspected Fraud immediately to your State Securities Commissioner.


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