Financial Fraud

• Ponzi Schemes• High Yield Investment Programs• Pyramid Schemes• Inventory Loading Schemes• Oil Field Fraud• Protecting Investors

Carlo Ponzi

• Went from anonymity tomillionaire in six months.

• He promised to “double your money” in 90 days by buying and selling

“international postal reply coupons.”• In 1920, bout 40,000 people invested about $15

million (roughly $150 million in 2007 dollars).• Only a third of that money was returned

How it worked!

• Early investors were given double their money back but not from profits.

• The returns came from funds paid in by later investors.

• Word spread and more people invested…• …and REINVESTED!!!

Do the Math!

• 160 million postal reply coupons would have been needed to cover the investments.

• But only 27,000 were actually circulating.• Ponzi insisted that the investments were real

but…• The judge who convicted him called him a

“financial idiot.”

Hi-YIP

• High Yield Investment Programs• Often offered on the Internet• Offer profits up to 1% per Day• Investment sounds good but is vague…

“global currency arbitrage”“hedge fund trading.”

Recent Hi-YIP’s:• Diamond Mortgage Company stole $50 million in

Michigan in the 1980s. • From ‘93 until ‘97, Greater Ministries International in

Florida, cheated 18,000 people out of $500 million.• In 1995, the Foundation for New Era Philanthropy in

Pennsylvania took $500 million from 1,100 investors, mostly charities including the Red Cross.

• In 2000, a Scientology minister took $600 million from 500+ investors, mostly Hollywood Celebrities.

More Hi-YIPS• MMM in Russia bilked at least two million people out of

$1.5 billion in the 1990s.• In 1994, the European Kings Club collapsed after taking in

about $1.1 billion. In the Swiss cantons of Uri and Glarus 1 in 10 adults invested in EKC.

• In 1997, the Government of Albania endorsed investment funds that caused the Albanian people to lose $1.2 billion. They protested and toppled the government.

• In 2007, a man known as “Double Shah" was accused of taking in about $1 Billion across the Middle East.

The Reality

• The "return" is paid from new investment money, not out of profits.

• When investor D puts in money, that money becomes available to pay out "profits" to investors A, B, and C.

• Early investors quite commonly reinvest and keep their money in the scheme.

• Thus, the operator actually pays out very little. • He just send statements to investors that claim to

show how much they earned.

At Some Point:

• The scheme will collapse of its own weight, as investment slows; or,

• The authorities will examine the enterprise and find that the "assets" that should exist, do not; or – more often than not –

• The promoters vanish, taking the money with them.

Do the Math!

• If the promoter claims a return of 1% per day,

• Remember that Warren Buffet, one of the best investors ever, only earns

1% per month!(on average over 20 years.)

Pyramid Schemes

• A Pyramid Scheme requires participants pay to play.

• They give money for the right to get money.• To get money back, they must recruit others,

usually without delivering any product or service.

Geometric ProgressionLevel Participants1 62 363 2164 1,2965 7,7766 46,6567 279,9368 1,679,6169 10,077,69610 60,466,17611 362,797,05612 2,176,782,33613 13,060,694,016

Greater than World Population

Greater than Population of China

A Pyramid Scheme is mathematically unsustainable!

Inventory Loading• Selling product that cannot be resold.• Often happens at Christmas in the States,

when someone wanting to earn a few extra dollars buys toys to sell…

• Only to find that they can be purchased for less in a discount store.

• Not a “big dollar” scheme but a problem.

The Producers• The heroes set out to bilk investors out of money to produce a bad play.

• With too many investors, they win only if the play fails.

• But the play succeeds, wildly.

• Listed as one of the funniest movies ever made.

Oil Field Fraud“How Texans get rich drilling dry holes.”• “Quarter pays a Third.”• Four investors each pay one-third of the

cost of a new oil well in a proven field.• The promoter gets a carried interest.• And is paid to drill the well.

Oil Field Fraud

• However, when promoter sells more than four “quarter” interests in a new oil well…

• He wins if the well is dry…• But if he hits oil, he has a problem.“An oil well is nothing but a hole in the

ground with a liar on top of it.”

Identifying Fraud

• Too good to be true?• Unrealistic returns on Investment?• Inventory “easy” sell?• Asked to invest in a venture you don’t fully

understand?

Direct Selling

Direct Selling Companies Protect Investors.• Low cost to enter the business.• Cooling off period on contract.• Inventory can be returned for a full refund.• Earning potential consistent with amount of

investment and level of effort.• Underlying enterprise provides a quality

product or service.