The Madoff Era : Ponzi Schemes

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The Madoff Era Ponzi Schemes The New Wave
of Fraud
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• The Madoff Case
• An old scheme that still works.
• The New Wave of Fraud
• New fraud trends.
• Technology as an enabler.

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The Madoff Case

• Bernard Madoff Professional Career
• Financial Services, Investment Management
• Former Chairman of NASDAQ Stock Exchange
• Founded Wall Street Firm Bernard L. Madoff
  Investment Securities (BMIS)
• Philanthropist

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The Madoff Case

• Red Flags
• Expert warnings by other market analysts (e.g.
  The Worlds Largest Hedge Fund is a Fraud by
  Harry Markopolos)
• "Bernie Madoff is running the world's largest
  unregistered hedge fund... Harry Markopolos
• Unusual business practices
• Reputation of the auditor

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The Madoff Case

• Lessons learned
• Be skeptical about investments
• Be skeptical about reputations
• Diversification of investments
• Due diligence

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Behind the Madoff FraudPonzi Schemes
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Ponzi Schemes

• Definition
• A Ponzi scheme is an investment fraud wherein the
  operator promises high financial returns or
  dividends that are not available through
  traditional investments. Instead of investing
  victims' funds, the operator pays "dividends" to
  initial investors using the principle amounts
  "invested" by subsequent investors.
• Source fbi.gov

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Ponzi Schemes

• History
• Ponzi schemes are named for Charles Ponzi, who
  deceived thousands of New England residents into
  investing in postage stamps back in the 1920s.
  Ponzi thought he could take advantage of
  differences between U.S. and foreign currencies
  used to buy and sell international mail coupons.
  Ponzi told investors that he could provide a
  40-50 return in just 90 days compared to the
  interest rates for bank savings accounts, stocks
  and bonds.

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Ponzi Schemes

• How to protect against a Ponzi Scheme
• Be skeptical about investments
• Be skeptical about reputations
• Diversification of investments
• Due diligence
• Avoid deferred payment plans

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Ponzi Schemes on the Internet

• Proliferation of advertisement videos for
  business opportunities structured as Ponzi
  schemes (i.e. YouTube.com).
• The Better Business Bureau identified nearly
  23,000 videos.
• promoting "cash gifting" or "gifting club"
  programs
• nearly 60 million views
• fees ranging from 150 to 5,000

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Lessons Learned (or Not)from the Madoff Case

• What happened
• Scheme based on trust, reputation, fueled by lack
  of diligence and regulatory failure
• What failed
• - Common sense, individual diligence and
  skepticism, regulatory and investigative body
  oversight and follow-up
• What can we learn
• - Fraud wont go away, diligence and attention to
  red-flags is key

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Other CommonFraud Schemes
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Common Fraud Schemes

• Pyramid Schemes
• Advance Fee Scheme
• Real Estate Fraud
• Subprime Mortgage Fraud
• Securities Fraud Schemes by Registered Persons or
  Entities
• Churning
• Unsuitable Recommendations
• Failure to Report Client Complaints
• Parking
• Front Running (Dual Trading)
• Market Manipulations

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Technology and FraudThe New Wave

• Many fraud schemes have been the same for
  centuries but new technology has provided those
  seeking to commit fraud with more tools and
  options
• Greater reach to go after more victims
• Email hoaxes that go out to millions of people
• Websites that collect data from unsuspecting
  victims
• Greater anonymity
• Email and the web can provide a cloak of
  anonymity for those that commit fraud
• Increased complexity (or at least apparent
  complexity)
• Many people arent technologically savvy, and
  those that commit fraud prey upon this fact

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Recent Cases
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Recent Cases Securities Fraud

• Robert Allen Stanford Stanford Financial Group
  
• Well-known businessman involved in charitable
  organizations, professional sports and real
  estate.
• Chairman of the privately held, wholly owned
  Stanford Financial Group.
• The Stanford Financial Group is a privately held
  international group of financial services
  companies controlled by Allen Stanford.
• The Stanford Financial Group has 50 offices in
  several countries, mainly in the Americas, and
  claimed to manage 8.5 billion of assets for more
  than 30,000 clients in 136 countries on six
  continents.

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Recent Cases Securities Fraud

• Robert Allen Stanford Stanford Financial Group
  
• Scheme For years Stanford International Bank
  managed to consistently make higher than market
  returns for its clients.
• Portraying hypothetical investment results as
  actual historical data in sales pitches to
  clients.
• Stanford claimed his CDs were as safe as, or
  safer than, U.S. government-insured accounts.
• Stanford induced clients to invest in the
  Stanford Allocation Strategies (SAS) program by
  using non-realistic performance results.
• Company analysts werent privy to almost 80 of
  the banks investment portfolio. The portfolio
  was divided three parts cash and a mixture of
  stocks, bonds and alternative investments.

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Recent Cases Securities Fraud

• Robert Allen Stanford Stanford Financial Group
  
• Legal Issues
• On February 17, 2009 Federal agents raided the
  offices of Stanford Financial and the Securities
  and Exchange Commission charged Allen Stanford
  with "massive ongoing fraud" centered on an eight
  billion dollar investment scheme.
• Stanford's assets along with those of his
  companies were frozen and placed into
  receivership.
• Following the fraud allegations various
  governments have taken over Stanford's business
  operations.

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Recent Cases Ponzi Scheme / Real Estate Fraud

• Ezri Namvar and Namco Financial Exchange
  Corporation
• Scheme
• Namco Financial is a qualified intermediary that
  facilitates the tax deferred exchange of
  properties in a type of real estate transaction
  called a 1031 exchange. This transaction allows
  a property seller to defer paying taxes on gains
  from a sale by reinvesting the proceeds in
  another property of equal or greater value within
  180 days.
• Real estate investors are required to park the
  proceeds from their initial sales in
  intermediaries such as Namco Financial until
  replacement properties can be purchased. These
  intermediaries typically place money in
  nationally insured banks or savings institutions.
• Allegedly money was taken from the 1031 exchange
  accounts and used to pay off the debts of Namvar
  and his various entities.

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Recent Cases Ponzi Scheme / Real Estate Fraud

• Ezri Namvar and Namco Financial Exchange
  Corporation
• Legal Issues
• Namvar and Namco Financial Exchange Corporation
  are facing at least five Los Angeles Superior
  Court lawsuits and one bankruptcy lawsuit.
• Based on allegations in the complaints related to
  the handling of funds in escrow accounts, Namvar
  may face charges related to criminal activity as
  well.

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Recent Cases Subprime Mortgage Fraud

• Creative Financial Solutions, Inc. (CFS)
• CFS was in the business of sending loan
  application packages and other documents to
  lenders for review and funding.
• CFS did not fund loans but received commissions
  from the lenders when the loans closed.

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Recent Cases Subprime Mortgage Fraud

• Creative Financial Solutions, Inc. (CFS)
• Scheme
• Individuals that used to work for the company
  admitted that CFS obtained mortgage loans for
  unqualified borrowers by, among other things,
  submitting false loan applications, false bank
  statements, and false income documentation.
• Devised a plan to defraud and obtain money and
  property by false and fraudulent means.
• The five individuals charged in the case worked
  as loan officers and in addition to the
  commissions, they often received kickback
  payments when loans closed.
• In total, the victim lenders funded more than 16
  million in loans on properties that have been
  foreclosed or are in the foreclosure process.

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Recent Cases Subprime Mortgage Fraud

• Creative Financial Solutions, Inc. (CFS)
• Legal Issues
• These fraudulent loans resulted in actual losses
  to the victim lenders including the following
  unrecovered loan proceeds, unpaid mortgage
  payments, the costs of recovering the properties
  through foreclosure, the costs of maintaining the
  recovered properties, and the costs of selling
  the properties after they had been foreclosed.
• Defendants pled guilty in federal court in San
  Diego to conspiring to commit wire fraud.

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Recent Cases Subprime Mortgage Fraud

• AGA Capital NY, Inc
• Operators of the mortgage brokerage firm Garri
  Zhigun, Galina Zhigun, Maryann Furman.
• Operated in various locations in Brooklyn, NY and
  Manhattan, NY from 2004.
• Brokered over one thousand home mortgages and
  home equity loans, with a total face value of at
  least 200 million dollars, with various banks
  and lending institutions.
• AGA Capital earned a total of at least 4 million
  in commissions and fees on these loans.

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Recent Cases Subprime Mortgage Fraud

• AGA Capital NY, Inc
• Scheme
• AGA Capital participated with others, including a
  lawyer, loan account officers, real estate
  appraisers, and straw buyers, in a scheme to
  defraud various subprime banks and lending
  institutions.
• Paid individuals who fit a certain financial
  profile to act as phony purchasers or straw
  buyers of the target properties.
• Prepared and submitted false and misleading
  information concerning the straw buyers current
  residence, employment, income, assets, and
  existing debt.
• Created false documentation (e.g. bank
  statements, proof of income, etc)

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Recent Cases Subprime Mortgage Fraud

• AGA Capital NY, Inc
• Scheme
• Sought mortgages and home equity loans for the
  target properties at values that were in excess
  of the properties actual sale prices.
• Procured artificially inflated appraisals of the
  market value of the target properties.
• Received mortgages and other loans in excess of
  the actual sale price of the properties securing
  the loans.
• Difference between the appraised value of the
  property and the propertys actual sale price
  represented the profits form the scheme.

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Recent Cases Subprime Mortgage Fraud

• AGA Capital NY, Inc
• Legal Issues
• Total of 23 individuals were arrested.
• Mr. and Mrs. Zhugins assets were frozen until
  further notice.
• Each person involved in the scheme faces a
  maximum on each count of the Indictment in which
  he/she is charged of thirty years in jail and a
  fine of the greater 250,000 or twice the gross
  gain or loss resulting from the crime.

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Current Economic Environment Psychology of
Investment Scams
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Current Economic Environment

• According to the ACFE Report to the Nation on
  Occupational Fraud and Abuse for 2008, US
  businesses will lose an estimated 994 billion in
  fraud losses (7 of their annual revenues)
• Instances of fraud will likely increase during
  this period of duress
• Companies are facing issues concerning valuation
  of assets such as asset-backed securities held as
  investments or cash equivalents

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Current Economic Environment

• The Fraud Triangle
• Increase in the pressures and incentives during
  current economic crisis

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Current Economic Environment
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Psychology of Investment Scams

• 2006 Consumer Fraud Research Group study funded
  by the FINRA Investor Education Foundation
  revealed the following common tactics used by
  fraudsters as part of their approach
• The "Phantom Riches" Tactic - dangling the
  prospect of wealth, enticing you with something
  you want but can't have. These gas wells are
  guaranteed to produce 6,800 a month in income.
• The "Source Credibility" Tactic - trying to build
  credibility by claiming to be with a reputable
  firm or to have a special credential or
  experience. Believe me, as a senior vice
  president of XYZ Firm, I would never sell an
  investment that doesn't produce.
• Source http//www.finra.org/Investors/ProtectYou
  rself/

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Psychology of Investment Scams

• The "Social Consensus" Tacticleading you to
  believe that other savvy investors have already
  invested. "This is how ___ got his start. I know
  it's a lot of money, but I'm inand so is my mom
  and half her churchand it's worth every dime.
• The "Reciprocity" Tacticoffering to do a small
  favor for you in return for a big favor. "I'll
  give you a break on my commission if you buy
  nowhalf off.
• The "Scarcity" Tacticcreating a false sense of
  urgency by claiming limited supply. "There are
  only two units left, so I'd sign today if I were
  you.
• Source http//www.finra.org/Investors/ProtectYour
  self/

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Fraud Regulation, Prevention, and Detection
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Existing Securities Industry Regulations

• Securities Regulation
• Federal Regulation
• Securities Act of 1933
• Securities Act of 1934
• Rule 10b Anti-fraud provisions
• Investment Advisor Act of 1940
• Investment Company Act of 1940

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Existing Securities Industry Regulations

• Sarbanes-Oxley Act of 2002
• Certification obligations for CEOs and CFOs
• New standards for audit committee independence
• Enhanced financial disclosure requirements
• New protections for corporate whistleblowers
• Other criminal penalties
• Document destruction
• Freezing of assets
• Bankruptcy loopholes

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Fraud Prevention and Detection

• Be cautious of "opportunities" to invest your
  money in franchises or investments that require
  you to bring in subsequent investors to increase
  your profit or get back your initial investment.
• If the offer of an "opportunity" appears too good
  to be true, it probably is. Follow common
  business practice. For example, legitimate
  business is rarely conducted in cash on a street
  corner.
• Know who is the promoter behind the transaction.
  If you have not heard of a person or company that
  you intend to do business with, learn more about
  them. Depending on the amount of money that you
  intend to spend, you may want to visit the
  business location, check with the Better Business
  Bureau, or consult with your bank, an attorney,
  or the police.

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Fraud Prevention and Detection

• Be cautious of business deals that require you to
  sign nondisclosure or non- circumvention
  agreements designed to prevent the investor from
  independently verifying the background and
  credentials of people with whom you intend to do
  business.
• Do not invest in anything unless you understand
  the deal. Con artists rely on complex
  transactions and faulty logic to "explain"
  fraudulent investment schemes.
• As with any investment perform due diligence.
  Independently verify the identity of the people
  involved, the authenticity of the deal, and the
  existence of the security in which you plan to
  invest.

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Fraud Prevention and Detection

• General Red Flags
• Opportunity
• Pressure
• Rationalization
• Poor internal controls
• Management override of controls
• Collusion between employees (and/or third
  parties)
• Unrealistic performance expectations
• Unusual business practices

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Fraud Prevention and Detection

• Employee Red Flags
• Employee lifestyle changes, e.g. expensive cars,
  homes, etc.
• Significant personal debt and credit problems
• Behavioral changes
• High employee turnover
• Refusal to take vacation or sick leave
• Lack of segregation of duties

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Fraud Prevention and Detection

• Management Red Flags
• Reluctance to provide information (to
  auditors/others)
• Decisions are dominated by an individual or small
  group
• Disrespect of regulatory bodies and frequent
  disputes with auditors
• Excessive number of checking accounts, frequent
  changes in bank accounts
• Frequent changes in external auditors
• Continuous rollover of loans
• Downsizing in healthy market

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Fraud Prevention and Detection

• Management Red Flags (continued)
• Company assets sold under market value
• Excessive number of year end transactions
• Service contracts result in no product
• Photocopied or missing documents
• Unexpected overdrafts or declines in cash
  balances
• Refusal to use serial numbered documents

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Fraud Prevention and Detection
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Concluding Remarks

• Current economic conditions increase pressures
  and cause fraud to rise
• Red flags are important warnings
• A little fraud soon becomes larger if left to
  grow
• Please contact local authorities and regulatory
  agencies to report any fraudulent activities

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• Questions
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