By and large, in today’s regulatory environment, it’s virtually impossible to violate rules … and this is something that the public really doesn’t understand … it’s impossible for a violation to go undetected.
—Bernie Madoff
Every day someone makes a big mistake by giving money to a fraudster. Many times, these swindlers remain off the radar for months or even years because investors don’t discover that they’ve been scammed. But one day they discover that their money is gone. Investment fraud refers to a wide range of deceptive practices including untrue information or fictitious opportunities. Many think that rational investors wouldn’t invest in these “too good to be true” cases but they’re wrong. Of course, nobody intentionally puts money into a rip-off, but fraudsters are good at their craft. Regular, hard-working people often invest large sums of money into “only-for-you” schemes and lose their life savings. Some even unwittingly bring their family members and friends into the scam.
Con artists often target older and financially less educated people. Although estimates of how frequently investment fraud occurs are rare, one conservative estimate is that about 10% of older investors are victimized by investment fraud at some point in their lives. But even highly successful, financially intelligent people fall prey to skillfully tailored investment frauds. For example, Bernie Madoff’s $50 billion Ponzi scheme fooled thousands of individuals, including celebrities such as Steven Spielberg, Larry King, John Malkovich, and Zsa Zsa Gabor as well as New York University, banks in numerous countries, and the International Olympic Committee.
To convince victims to hand over their money, financial fraudsters often attempt to get them into a heightened emotional state whereby they suspend rational thinking. They use psychological tricks while trying to influence you. Those tricks may include:
Creating an aura of credibility. Fraudsters often build their reputation by claiming association with a respectable firm, such as a bank or a government body.
Planting the seed of “phantom riches.” The con artist’s job is to make you believe that high returns are achievable with little risk. Who wouldn’t get excited about an opportunity to get a 100% return with a maximum but unlikely loss of say 2%? You want those returns so badly it hinders your ability to critically examine the offer. These tricksters often promise “guaranteed returns” but these riches don’t really exist.
Emphasizing societal consensus. Swindlers try to convince you to invest by telling you that other savvy investors have already invested in the scheme.
Presenting a convincing appearance. Fraudsters build impressive websites, seals, and letterhead, which are easy to do using modern technology. Sometimes they even use the US Securities and Exchange Commission (SEC) logo without approval.
Creating a halo effect. Con artists try to project such positive personal traits as being professional, reliable, friendly, successful, and charismatic in hopes of having these traits carry over to the financial opportunity as positive investment traits.
Creating a false sense of urgency. These crooks try to entice you by claiming that the offering is in short supply. Act today! You’ll miss out if you don’t act quickly! The fear of missing out can influence you to go ahead with the investment, despite possible reservations.
Using flattery. Charlatans make you feel good by praising you for being a knowledgeable investor. The offering is only available to a small group of investors and you’re being asked to keep it secret and “join the club.”
Getting an initial commitment. These crooks try to trick you by getting you to agree to do something small with a reasonable request or suggestion. Once you feel committed to the relationship, you’re more likely to comply with the next larger, less reasonable request.
A Ponzi scheme is an investment fraud that usually promises high returns at low or no risk. The scheme is named after Charles Ponzi, an Italian immigrant to the United States during the early 1900s. He collected more than $15 million, which is more than $200 million in today’s dollars. By promising to double their investment in 90 days, Ponzi defrauded some 40,000 eager people, mostly new immigrants. The scheme purported to buy discounted postal reply coupons in other countries and redeem them at face value in the United States. However, Ponzi was actually just taking the money from new investors to pay earlier investors. His scheme ran for more than a year before collapsing.
Consider how the Ponzi scheme is perpetrated. You meet a supposedly knowledgeable investor at a party who seems to like you. The investor purportedly has a solid track record. According to his story, he left a big investment bank when he got fed up making money only for the company. He only shares his investment strategy with his closest friends, but he may make an exception for you. It’s a unique strategy that produces great returns in both market upswings and downswings. You feel flattered and excited. You’ve just met a fraudster who wants to bilk you out of your money.
In Ponzi schemes, fraudsters don’t invest the money. Instead, they use it to pay those who invested earlier and keep some for themselves. The early investors provide testimonials of their returns, which helps convince new investors to hand over their money. Meanwhile, this con artist is funding a posh lifestyle of country clubs, expensive cars and housing, private schools, and tropical vacations. But don’t be fooled, the lavish lifestyle is paid with your money! Ponzi schemes require a constant flow of new money to survive. When recruiting new investors becomes difficult or when large numbers of existing investors cash out, the scheme collapses. By definition, Ponzi schemes are doomed to fail sooner or later. Remember those early investors? They usually reinvest their profits in the scheme and thus also lose their money.
Fraudulent schemes thrive on investor greed, a basic aspect of human nature. Many Ponzi schemes share the following common characteristics.
High alleged returns with little or no risk. Remember that every true investment carries some degree of risk. The higher the expected return, the higher is the risk.
Overly consistent returns. Be skeptical if you’re told that the strategy provides consistent returns regardless of market conditions.
“Halo” effect. Fraudsters behind the scheme portray credibility to convince investors. Believability can be faked by referring to an employment history in a reputable financial or governmental institution or claiming degrees and professional certifications. You should check out actual qualifications before making an investment.
Unlicensed sellers. Investment professionals are required to be licensed or registered. Don’t trust a service provider who’s unlicensed.
Secretive, complex strategies. You should avoid strategies if you don’t understand them.
Foreign investment products. One reason for promoting foreign investment products is that conducting due diligence on these products can be difficult. But you should think twice. Aren’t local investors able to see the easy profit opportunity?
Pay early investors quickly. An effective way to increase a scheme’s credibility is to pay the profits for the early investors because they spread the word of their success to others. Those early investors usually reinvest their profits, so the scheme isn’t really risking a cash shortage.
Bernard L. “Bernie” Madoff was a highly respected financial expert who had been a founder of the Nasdaq Stock Market in the early 1970s and had served as its chairman. Nasdaq was initially an acronym for the National Association of Securities Dealers Automated Quotations. Many admired and respected his market expertise. He was a generous political donor to both Democrats and Republicans and he lobbied for stock market restructuring. Madoff was also a well-known figure at the SEC, whose staff he had helped in the 1970s and 1980s to implement more market competition.
Madoff built his market reputation based on his career as a broker-dealer. Founded in the 1960s, Bernie L. Madoff Investment Securities grew into one of the largest brokerage companies on Wall Street. The company occupied the 17th through 19th floors in the Lipstick Building in midtown Manhattan, New York. Madoff worked on the 19th floor with his brother and two sons. While running a successful brokerage business, he began investing the money as a favor to family and friends. Madoff claimed that he could generate large, steady returns through an investing strategy called “split-strike conversion,” which is an actual trading strategy, also known as a “collar.” Done legally, it’s an options strategy that tries to generate consistent returns with no extreme swings. But instead of following the strategy, Madoff simply deposited client funds into a single bank account that he used to pay existing clients who wanted to cash out. This fraud mushroomed into a $50 billion “mother of all Ponzi schemes.”
Madoff portrayed himself as cautious and discreet. He had a penthouse apartment in Manhattan, luxury apartments in the Hamptons, Palm Beach, and the Cap d’Antibes in southern France. He owned shares in two private jets and an 88-foot superyacht, aptly named “Bull.” Madoff was living a dream. As his reputation as a highly skilled portfolio manager grew, so did his presence in the Jewish community. For example, Madoff was the treasurer of Yeshiva University. He met Jewish investors in the wealthy social circles of Manhattan and the elite Jewish Palm Beach Country Club.
Madoff protected his fabricated investment strategy as a proprietary secret. He didn’t charge a management fee as he claimed that the fees charged for the trading deals through his brokers’ activities were sufficient. In reality, he made no trades. Madoff told his clients that he was a conservative investor:
I’m not hitting the ball out of the park every year. Not me, I’m not a hotshot. If you invest with me, you’ll get consistent, less-than-average returns – but you’ll get them every year.
The consistent – not flashy – returns of 10–12% a year made investors think they were making a safe, conservative choice. His clients had to sign a confidentiality agreement committing to not talking about his fund. Madoff rejected certain clients, reinforcing his appeal and increasing the demand for his fund. Many wealthy investors begged to be accepted as Madoff’s client.
Then, the once-in-a-generation 2008 financial crisis occurred, which as the worst economic disaster since the Great Depression of 1929. During this period, investors couldn’t find buyers for their investments that were falling in price. In a crisis, investors sell what the can – their good investments, not what they want to sell. So, people needing cash came to Madoff and asked for their money back. He didn’t have the money and the scheme fell apart. In 2008, he was purportedly managing $65 billion. Then in December, he revealed that the asset management unit of the firm was “just one big lie.” At least 10,000 investors lost their investments, including charities, banks, endowments, universities, and even the “smart money” professionals on Wall Street. In March 2009, after pleading guilty to the charges against him, authorities sentenced Madoff to 150 years in prison. The scheme’s collapse forced some charities to close and many people lost both their retirement savings and children’s college funds.
The process of confiscating Madoff’s assets and redistributing them to victims took a long time. Since Madoff’s arrest, many clients have died while waiting for restitution. A few have killed themselves, including one of his sons. After a decade of hard work, the court-appointed trustee had recovered 75 cents on the dollar of the stolen money.
Ezubao, a peer-to-peer (P2P) lending scheme based in the eastern Chinese Anhui province, was the largest Ponzi scheme in China. It was set up as an online scheme in July 2014, attracted funds of about 50 billion yuan ($7.6 billion) from 900,000 investors, and ceased to trade in December 2015. Ezubao consistently promised a return on investment between 9% and 14.6% to mainly small investors from rural areas. Ezubao claimed that the company’s platform was simply matching borrowers and lenders online in a regular P2P lending fashion.
In December 2015, the Chinese Government uncovered Ezubao’s fraud. Company executives confirmed that 95% of Ezubao’s investment projects were fake, as project files contained fabricated information bought from other companies. The management had created fictional borrowers who would pay outrageous rates on loans. Investigations revealed that of the 207 companies that allegedly received investments from Ezubao, only one actually received a loan.
Ezubao’s founders were extremely skilled in forming relationships with the government. By doing so, Ezubao succeeded in coming across as a reputable, trustworthy platform “approved” by the authorities. Ezubao’s practices included:
Placing ads on the state-run China Central Television just before the main evening news.
Sponsoring the online broadcast of the National People’s Congress.
Participating in the 12th China-Association of Southeast Asian Nations expo:
A gathering focused on President Xi Jinping’s “one road, one belt” initiative and an effort by Beijing to build strong economic and political ties with its Asian neighbors.
State media wrote headlines praising Ezubao’s parent company after the event.
Receiving an award from China Newsweek, a state media outlet, for being one of the most responsible internet finance companies.
Honoring themselves with phony certifications from phony companies.
Making Ezubao secretaries appear successful and by outfitting them in clothes from Louis Vuitton, Chanel, and Gucci.
To hide the fraud, Ezubao’s management literally buried the evidence. Chinese officials unearthed roughly 1,200 documents buried 20-feet underground in a neighboring province. Company documents revealed that management spent much of the fraudulent money to fund an extravagant lifestyle. Chairman Ding Ning, for instance, spent between $150 and $230 million for his personal use. Altogether, the government arrested 26 people for running the Ponzi scheme. Chairman Ding Ning and his brother both received life prison sentences, while others faced sentences ranging from 3 to 15 years. The authorities recovered only $1.5 billion.
Pyramid and Ponzi schemes share similar characteristics. For example, they both require a consistent flow of money from new investors to continue. These schemes eventually collapse when recruiting new investors becomes difficult or when many investors want to cash out. Some people use the two terms interchangeably or classify a Ponzi scheme as a type of pyramid scheme. Despite their similarities, there’s one clear difference. In a Ponzi scheme, participants believe they’re earning returns from their investments. But in a pyramid scheme, investors are aware that they’re also getting money by finding new participants.
Multi-level marketing (MLM) programs offer an opportunity to become involved in a system for distributing products to consumers. As an MLM consultant, you make money by selling products to your customers. You also earn a percentage of the income generated by the distributors you bring into the system. In most cases, the MLM is a legitimate business. You may be aware of such brands as Oriflame, Herbalife, and Mary Kay that use MLM for most of their sales.
Unfortunately, some scams disguise themselves as an MLM opportunity. Like MLM, pyramid schemes depend on your ability to recruit other people to become distributors. But the objective of an investment pyramid scheme is to get your money and then use you to get money from other people. Instead of supplying any tangible good, the scheme relies on promises of profits for enrolling other members into the system. The profitable investment opportunities don’t exist and eventually, the number of recruits dwindles. The process continues until an insufficient number of recruits are available to finance the scheme. Hence, all pyramid schemes are destined to fail.
WinCapita was an extraordinary pyramid investment scheme perpetrated in Finland. It presented itself as an invitation-only foreign exchange investment club between 2003 and 2008. WinCapita promised annual profits between 260% and 400% through an investment trading software program called the FxTrader signals system. The ploy first operated under the name “WinClub” but the name eventually changed to “WinCapita” when Finnish television reported in 2007 that the police was investigating a pyramid scheme.
The invitation-only investment club required an initial purchase of €3,000 to obtain a software license. The club operated as a classic MLM scheme: existing members who had purchased the FxTrader software license could endorse the club in their social networks and become sponsors. To “prove” the trading concept, WinCapita offered an automatic but fictitious “signal clock” software program providing “buy” and “sell” signals for a currency. Although WinCapita described the currency market as a place where only institutional investors had access, it lured new members by promising to give anyone the opportunity to participate in this allegedly hyper-profitable business.
To give an air of selectivity, admission into this private club required a recommendation from a sponsor. The sponsors soliciting investments were often well known locally, family members, or business associates. A sponsor attracting five new members would receive 20% of all their profits in perpetuity. Using aggressive and persuasive marketing techniques, sponsors presented potential investors with marketing materials that promised unrealistic returns. This word-of-mouth marketing approach was the club’s only way of acquiring new members because WinCapita prohibited existing members from disclosing any information to the public without the club’s written permission. The first sponsors received big “investment profits” that they promoted to new members. They even flashed bank statements to show that the software system was “not too good to be true.”
All operations took place on the internet. Members could only access the website with a personal user name and password. Promoters described the details of the club’s operations as business secrets. Under a complicated scheme, the members gained access to the club’s trading “profits.” WinCapita reported these profits as returns from trading in accordance with the software’s signal, when in fact, they were just redistributions of other members’ payments.
When investors withdrew money from the scheme, they received funds from the same account where they paid their invested funds. The actual trading or operations generated no new funds at any point during the scheme’s existence. The virtual profits shown on the WinCapita website were completely artificial and had no link to any real-world investment assets.
Between 2005 and 2008, WinCapita collected about €100 million from more than 10,000 victims. With estimated damages at more than €41 million, WinCapita is the largest fraud in Finnish history. Besides the financial losses, the collapse of the club also destroyed personal relationships between sponsors and their sponsored investors. Police documents contain several mentions of suicides, divorces, and mental problems resulting from the club’s collapse. Only about a quarter of the 10,000 investors signed up with the authorities in a class-action lawsuit. Many didn’t want to contact police fearing the publicity of being duped by these fraudsters. Even more surprising was that some members sincerely hoped that the club’s operations would be restarted because they still believed in the system. The group’s spokesperson suggested that the police investigation was “a conspiracy with the Ministry of the Interior, which directed the police investigations.” Some club members genuinely believed that authorities had ruined the profitable business through intervention.
WinCapita didn’t have any bookkeeping or actual legal form. The scheme was run primarily by one person, Hannu Kailajärvi, who had experience in computer programing but not in investing. The operations continued until March 7, 2008, when the company’s website stopped working and Kailajärvi disappeared. In early December 2008, authorities found him hiding in a small cottage in Nässjö, Sweden. In December 2011, the District Court found Kailajärvi guilty of aggravated fraud and sentenced him to the maximum prison sentence of four years. Later, the Court of Appeal of Helsinki found him guilty of aggravated fraud and a money collection offense and sentenced him to five years in prison. His female associate received a 15-month suspended sentence for assistance in the investigation.
An affinity fraud exploits the trust that exists in religious communities, professional and ethnic groups, as well as other groups. These fraudsters are “wolves in sheep’s clothing.” They may be members or pretend to be a part of the community. Sometimes these con artists convince the group’s leader to spread the word about the scheme. After recruiting the group leader, these tricksters use the leader as a pawn to encourage other members to invest. Once these charlatans take money from new investors, they pay early investors to keep the scheme rolling. Thus, an affinity fraud often takes the form of a Ponzi scheme. A unique feature of affinity frauds is that while the scheme is collapsing, victims may try to work things out within the group rather than notify authorities.
George Louis Theodule owned and operated several companies, about 100 investment clubs, and other entities that he used to falsely portray himself as a financial expert. He claimed to excel in trading, having more than 17 years of experience in trading stocks and options. Theodule told people they could double their money in 90 days by letting him invest their funds in stock options. He targeted the US Haitian community by telling potential investors that he used part of his trading profits for various humanitarian purposes including the funding of start-up businesses in the Haitian community as well as contributing to business projects in Haiti and Sierra Leone.
Theodule attracted investors through word-of-mouth and face-to-face meetings professing high returns. He encouraged investors to begin investing as soon as possible. Theodule typically depicted his investment plan and incredible profits trading stocks and options on dry erase boards or flip charts. The presentations emphasized the safety and security of investing by guaranteeing investors a 100% return with no risk. The fictional trading scheme claimed to be safe because it invested in the stocks and options of well-known companies such as Google, John Deere, Monsanto, Best Buy, and Gamestop.
Theodule used company names like Creative Capital Consortium and Creative Capital Concepts to perpetrate his scam. To add to investors’ sense of security, he directed prospective investors to form “investment clubs” that purported to have a self-regulatory agency, Smart Investment Management Services, LLC (SIMS), which helped the investors form. This entity also supposedly protected investors through independent verification of their deposits. SIMS was really a private company run by a former Creative Capital employee, not a regulatory entity.
Theodule raised more than $30 million from nearly 2,500 investors from July 2007 to December 2008. He placed only a small portion of the money into trading accounts and most people lost all their money. Theodule’s claims of trading success were completely false because he really just operated a massive Ponzi scheme. His trading records reveal trading losses of at least $18 million. He diverted the remainder of investor funds to support his lavish lifestyle that included exotic cars, motorcycles, jewelry, and trips to Las Vegas.
The scheme collapsed when the SEC filed an emergency enforcement action in December 2008. According to US Attorney Wifredo Ferrer, “Theodule took advantage of people who trusted him because of their cultural affinity. Such tactics are intolerable, especially given that some of his victims lost their entire life savings.” In 2014, Theodule received a federal prison sentence of 12½ years.
A pump-and-dump scheme is a plan that boosts a stock’s price with false or exaggerated statements about the underlying company. Fraudsters buy large amounts of a firm’s stock and sell their positions after the hype has led the stock price to skyrocket.
Pump-and-dump schemes typically target small, thinly traded stocks whose price can be easily manipulated. With the advent of the internet, this illegal practice has become even more prevalent. These swindlers post false information online with claims to have insider information, which is non-public information about a publicly traded company that could provide a financial advantage when used to buy or sell shares of that company’s securities. In some countries, such as the United States, some kinds of trading based on insider information are illegal. The fraudsters’ initial stock purchases increase the stock price. That increase becomes part of the story about the firm being on the rise. The aim is to artificially boost the stock price even further by urging investors to buy the “hot” stock quickly before the price takes off even more. After pumping up the stock price even more, fraudsters sell their shares, or dump them, at the high price and then move to their next stock. Without them pumping up the stock, its price plummets leading most investors to lose money.
Stratton Oakmont, a firm founded by Jordan Belfort, executed one of the most widely known pump-and-dump schemes of all times. During the 1990s, Stratton Oakmont grew to be the largest over-the-counter (OTC) firm in the United States. OTC refers to the process where small company stocks are traded via a trader network, not at a formal stock exchange. Stratton Oakmont participated in numerous pump-and-dump schemes causing massive losses to investors. Authorities indicted Belfort for securities fraud and money laundering in 1999, and then in 2003, sentenced him to four years in prison and a personal fine of $110 million. He only served 22 months of his sentence. As of 2019, the government reports Belfort still owes about $97 million.
The tale of Belfort and Stratton Oakmont became well known to the public in the movie The Wolf of Wall Street, which premiered in December 2013. Belfort also captured his tale in his own memoirs, The Wolf of Wall Street and Catching the Wolf of Wall Street. He now operates his own company, which provides sales training and markets Straight Line training programs aimed at building wealth.
Abraxas J. Discala, also known as AJ Discala, and his network of company insiders, brokers, and others executed a sophisticated scheme to trick investors out of millions of dollars. The group manipulated the securities of three different publicly traded companies in 2013 and 2014.
His first large scale stock price manipulation scheme involved a private company called CodeSmart. Discala and his co-conspirators engineered a reverse merger of CodeSmart with a public shell company. In a reverse merger, a private company merges with an already exchange-listed company. Unlike in an initial public offering (IPO), no capital is raised and no regulatory approval is needed for a reverse merger. After gaining the control of CodeSmart’s shares, Discala and his co-conspirators artificially inflated the company’s stock price twice and sold its shares at a profit.
One of the group’s members served as CodeSmart’s chief executive officer and issued materially misleading statements to increase the stock’s price and volume. CodeSmart issued false press releases about once every three days between May 13 and August 21, 2013. Such action led to inflating the stock’s price from $1.77 to $6.94. At the highest closing price, CodeSmart’s market capitalization exceeded $100 million while its assets stood at $6,000, revenue at $7,600, and income at a net loss at $103,000. The firm’s true value had no relation to its market valuation. Two of the group’s members brought CodeSmart’s stock for their clients’ accounts. The clients didn’t know that the price had been inflated due to actions by Discala and his co-conspirators. After Discala and his group reduced their trading, CodeSmart’s stock price crashed. Discala made more than $2.8 million in trading profits from pump-and-dumps involving CodeSmart. In July 2014, CodeSmart’s stock traded at $0.01 per share.
Their second large-scale stock price manipulation scheme involved a company called Cubed. In early 2014, Discala and his network of crooks inflated Cubed’s stock price to make it appear like a legitimate company with genuine demand for the security. On June 23, 2014, when Cubed reached its highest price of $6.75 per share, its market capitalization was about $200 million. At the same time, Cubed reported zero revenue, negative stockholders equity, and a net loss of $15,000. Between October 2013 and July 2014, Discala also manipulated the stock price of StarStream Entertainment Inc. and The Staffing Group, Ltd.
In May 2018, authorities convicted Discala of conspiracy to commit securities fraud, mail and wire fraud, and two securities fraud counts related to the three publicly traded companies. William Sweeney of the Federal Bureau of Investigation stated in a press release:
Investors know they’re taking a chance when purchasing stock and other securities, but they don’t anticipate the odds being stacked against them from the start. In so many cases, we see criminals in the white collar world autonomously controlling other people’s money and diverting it for their own benefit. Stealing is stealing, in whatever form or fashion, and today’s conviction proves just that.
Microcap fraud is a form of investment fraud that involves microcap companies which are companies with very small market capitalization and a low stock price, often called penny stocks. The term penny stock generally refers to a security that trades at less than $5 per share. Publicly available information about these companies is scarce and thus price manipulation is relatively easy. Microcap stocks are typically traded in the OTC market, which is a decentralized market that doesn’t require companies to undergo a formal application process or meet any minimum financial standards. Market participants trade with each other through various communication modes including telephone, email, and proprietary electronic trading systems. Two participants can execute a trade in an OTC market without others being aware that the transaction occurred. More than 10,000 companies have their shares traded on the US OTC markets. As these markets lack transparency and have lax financial standards, microcap stocks are highly vulnerable to pump-and-dump because of the ease of manipulating stock prices.
Between 2009 and 2015, an ex-convict named Edward Durante and his co-conspirators planned and executed a fraudulent penny stock scheme. Authorities had previously convicted Durante of conspiracy to commit securities fraud, wire fraud, money laundering, and a market manipulation scheme. In 2003, he received a 121-month prison sentence. Durante didn’t inform investors about his prior conviction and authorities prohibited him from any association with selling securities.
In 2011, Durante used the fictitious name Anthony Walsh when acquiring VGTel Inc. as a shell company. As a result of the purchase, he controlled almost all of VGTel’s issued shares, which represents an unlisted penny stock. Durante told one investor that VGTel had done several major deals and would be expanding quickly and thus the stock price would increase substantially. He also told the investor that although he wasn’t a VGTel officer or board member, he nonetheless controlled the company. Based on these conversations, the investor introduced Durante to at least 30 friends and/or family members who eventually became VGTel investors.
As licensed brokers, the co-conspirators sold VGTel stock to investors in New England, Ohio, and California. During the sales of VGTel’s private stock, Durante claimed that VGTel would use the funds raised for its operations and growth in connection with potential reverse mergers. In reality, no reverse mergers occurred and he used $9 million for his personal use. Durante and his co-conspirators told investors that they would receive an 8% dividend until their private shares could be sold at a promised premium in the public market. In fact, investors never received any dividend or interest payments and many investors didn’t receive VGTel stock certificates or the ability to sell their shares.
Durante also manipulated VGTel’s stock price by setting up other shell companies that bought controlling interests in VGTel and by recruiting brokers as co-conspirators. Because Durante and his co-conspirators could take both sides of a single transaction, they artificially controlled VGTel’s stock price.
Between April and October 2013, the group inflated the stock price from $0.25 to $1.90 a share. Durante bribed investment advisors to sell the stock to their clients, sometimes without the clients’ knowledge or permission. He used the trading profits for his personal use. In 2016, Durante pled guilty to conspiracy to commit securities fraud, money laundering, and perjury. In 2018, authorities sentenced him to 216 months in prison for defrauding at least 100 investors of more than $15 million.
High yield investment programs (HYIPs) are unregistered investments usually operated by unlicensed promoters. These programs are generally run online through flashy websites. The most common signs that an HYIP is a fraud are:
Promoting incredible returns, often within a short time frame.
Telling investors that there’s little or no risk.
Making unsolicited offers online or by telephone.
HYIPs may involve various forms of investments such as stocks, commodities, real estate, precious metals, or even paintings. Fraudsters may suggest that the scheme is supported by or operates under the auspices of a major international body such as the International Monetary Fund, United Nations, or Federal Reserve. A clear warning sign is if an obscure or offshore bank that’s difficult to contact issues the security. Another red flag is the need for speed and confidentiality to secure the deal.
Paul Burks was the owner of Rex Venture Group, LLC, through which he owned and operated Zeekler, a sham internet-based penny auction company, and its purported advertising division, ZeekRewards (collectively “Zeek”). Between January 2010 and August 2012, Burks operated a massive Ponzi scheme that bilked $900 million from a million victims across the United States and abroad.
Burks and his co-conspirators purported that Zeekler was generating massive retail profits from its penny auctions and the public could share in such profits by investing in ZeekRewards. This classic example of an HYIP Ponzi scheme guaranteed investors a 125% return on their investment. ZeekRewards kept promising that “everybody wins.” These fraudsters told ZeekRewards investors to participate in the complicated Retail Profit Pool, which supposedly allowed victims collectively to share 50% of Zeek’s daily net profits. The daily “award” was usually 1.5% of the investment. Although the cap on investments was $10,000, people could invest on behalf of their spouses or other relatives. Some victims even mortgaged their homes to increase the amount of their investment.
Burks fabricated the daily “profit” numbers. About 98% of all incoming funds came from victim investors, whose money Burks used to make Ponzi-style payments to earlier investors. The scheme could only stay afloat so long as new investor contributions were sufficient to satisfy the outflows. The company kept no books or records other than retaining the deposit and withdraw the information in a simple transactional database. Besides promising excessive returns, Burks and his co-fraudsters used other ways to actively promote Zeek to current and potential investors. They made false representations of Zeek’s success in weekly conference calls and leadership calls referred to as Red Carpet Events. They also used various media sources such as print media, websites, emails, and journals to make false and misleading statements about Zeek’s success to recruit their victims.
In August 2012, the SEC announced an emergency asset freeze to halt the operations of ZeekRewards, which was on the verge of collapse. At that time, the Burks and his fellow con artists fraudulently represented to its victims that their investments were collectively worth $2.8 billion due to the compounding nature of the paper profits. In reality, they had only $320 million available to pay investors. Over the course of the scheme, Burks diverted about $10 million to himself.
In July 2016, a federal jury convicted Burks of wire, mail, and tax fraud. In February 2017, authorities sentenced Burks to nearly 15 years in prison and ordered him to repay $244 million to his victims. At sentencing, the judge stated that for the scheme to work, it would have required a miracle on the order of the “loaves and fishes.” The judge was referring to the miracle in the Gospel of John called The Feeding of the 5,000, which reports that Jesus used five barley loaves and two small fish supplied by a boy to feed a multitude.
An IPO is the first time that a private company offers stock to the public. Thus, an IPO only happens once for each company. Through this process, a previously privately held company is transformed into a public company. Historically, many IPOs have been underpriced, meaning that a stock is selling at a price below its intrinsic or true value. Investors who buy the shares of a hot IPO issue may sell their shares on the stock exchange at a large gain during the first days of trading. With only a limited number of shares available in a “hot issue,” market excessive optimism on the part of investors may result in strong and positive initial returns.
Jaswant “Jason” Gill and Javier Rios established a fake hedge fund called JSG Capital Investments. Through this fund, they swindled 200 investors out of $10 million by falsely claiming to buy shares of various technology companies such as Uber, Airbnb, and Alibaba before their IPOs. JSG purported to be a San Francisco-headquartered boutique investment firm with $25 million in assets under management. JSG’s website featured the firm’s investment philosophy beside a picture of the New York Stock Exchange trading floor. It set forth a supposed four-step “investment process” that purported to rely “on concentrated research to identify great businesses that are trading at highly discounted valuations because investors overreacted to negative macro or company-specific events.”
JSG represented itself in marketing materials as “an independent and privately-owned Investment Advisory firm” that provides “personal portfolio management attention to every client.” These representations were false. Gill also touted his falsified background as a former Managing Director at Morgan Stanley with close ties to well-known Silicon Valley venture capital firms, which gave him access to shares in popular pre-IPO companies. Gill falsely claimed he had received an undergraduate degree and an MBA from the University of California Berkley. Gill, Rios, and JSG Capital Investments were not registered with the SEC or any state regulator. According to the SEC, Rios’s background was in foodservice.
The scheme started in September 2013. The victims were mainly middle-class investors without prior investment knowledge or experience. JSG promised “access to alternative investment strategies that were previously only available to the 1-percenters” or rich people. JSG also promised guaranteed fixed returns up to 60% annually. JSG’s investor contracts represented that assets held at established brokerage firms offered security for the investments. An insurance policy supposedly offered investors additional security against losses. These representations were also false.
Instead of buying any shares, JSG used the money mainly for vacations, Las Vegas casino trips, gentlemen’s club access, and other personal use. These swindlers transferred only $100,000 of the $11.2 million received, or less than 1%, to JSG’s brokerage account. Altogether, Gill and Rios spent more than $5.5 million personally or otherwise inappropriately diverted it, while making $4.2 million worth of Ponzi-like payments to JSG investors to perpetuate the scheme. In May 2016, authorities arrested and charged them with wire fraud and conspiracy to commit wire fraud, which carries a maximum penalty of 20 years in prison.
Unfortunately, many investors still haven’t learned the lessons that highly publicized pyramid and Ponzi schemes should have taught. Such scams are more prevalent than most realize. In fact, many investors simply abide by the notion that “it won’t happen to me.” Yet, these age-old scams still work to cheat victims of their hard-earned money. Even sophisticated investors are sometimes unable to recognize that a seemingly appealing investment opportunity is really a fraud. Today, investors face an array of increasingly complex and confusing frauds. The fight against fraud continues because creative shysters are constantly developing new ways to fleece the public. Your best line of defense against investment fraud is education and awareness. By understanding why people fall for these ploys and how to avoid them, you can reduce the risk of becoming a victim.
All is not lost. Being aware of the following lessons might help you avoid becoming prey to investment fraud:
Understand that people fall for investment frauds due to gullibility, irrationality, greed, and being overly optimistic or overconfident, among other reasons.
Avoid investment fraud by asking questions, conducting research, knowing the salesperson, being watchful of unsolicited offers, remaining vigilant, understanding the investment, and controlling your emotions.
Request access to all information about an investment and those offering it. Legitimate investment professionals have no problem in providing such information.
Recognize the signs or red flags of investment fraud, such as investments guaranteeing high returns with little risk, once-in-a-lifetime deals, pressure to buy quickly, and overly consistent returns.
Follow the old saying that “If it sounds too good to be true, it probably is.”