Ponzis Pyramids and Bubbles
An introduction to financial fraud
Professor Russell James Dept. of Personal Financial Plann...
The core of any Ponzi Scheme is the HIDDEN reality that payments come from new investors, not actual profits
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Core
•“Plausible” story
•Abo...
Charles Ponzi
https://www.youtube.com/watch? v=vFEMzCMyMXc
•HIDDEN reality that payments come from new investors, not ac...
Arbitrage in post office international reply coupons valued at $.06 in U.S., sold for $.01 in Spain.
•HIDDEN reality that...
50% return in 45 days or 100% return in 90 days
•HIDDEN reality that payments come from new investors, not actual profits...
Investors were recent immigrants, often of his ethnicity
•HIDDEN reality that payments come from new investors, not actua...
“Truly, for an immigrant, I did not look the part. There was nothing in my appearance to suggest the bread winner; nothing...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
“Broke right from ...
Early investors were paid as promised (from new investors’ money) leading to an enormous demand from new and repeat invest...
Lasted 8 months. Took in a total of $15 million before collapse.
•HIDDEN reality that payments come from new investors, n...
New Era Philanthropy
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Co...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
Bernie Madoff
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“P...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
http://s.wsj.net/public/resources/documents/st_madoff_victims_20081215.html
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
•HIDDEN reality that payments come from new investors, not actual profits
Common Features
Ponzi Core
•“Plausible” story...
How is a pyramid scheme different from a Ponzi scheme?
Each passenger pays $5,000 to the captain to join the pyramid. Once a 8 passengers have paid ($40,000), the captain is ret...
Pyramid Scheme
•REVEALED reality that payments come from new investors, not actual profits
•True story
•Unknown returns...
How is a market “bubble” different from a Ponzi scheme?
Housing price-to-rent (price-to-income) ratios
Andre, C., Gil-Alana, L., Gupta, R. (2014). Testing for persistence in hou...
S&P 500 historical price-to-earnings ratio To December, 2014
From http://www.multpl.com/
Bubble
•REVEALED reality that growth comes from new investors, not actual profits
•Yes
•Yes
•High variance
•No
•No
...
Protecting yourself from Ponzi schemes
Why me? Why do they need MY money? If this investment is so great, wouldn’t it be easier to get more money in larger chunk...
Beware of investments that look “too good”
High return, low variance investment results are a statistical red flag for fr...
Question it Get outside advice. Verify with outsiders (not affinity group members) such as state securities regulators, SE...
Year of Discovery
Name/Alleged Investment
Amount
2014
Nationwide Automated Systems; ATMs
$123MM
2014
KGTA Petroleum...
Ponzis, Pyramids, and Bubbles: An introduction to financial fraud
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Ponzis, Pyramids, and Bubbles: An introduction to financial fraud

A review of the elements and examples of ponzi schemes, pyramids, and market bubbles and how to avoid them.
Published on: Mar 4, 2016
Published in: Economy & Finance      
Source: www.slideshare.net


Transcripts - Ponzis, Pyramids, and Bubbles: An introduction to financial fraud

  • 1. Ponzis Pyramids and Bubbles An introduction to financial fraud Professor Russell James Dept. of Personal Financial Planning Texas Tech University
  • 2. The core of any Ponzi Scheme is the HIDDEN reality that payments come from new investors, not actual profits
  • 3. •HIDDEN reality that payments come from new investors, not actual profits Common Features Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops What is a Ponzi Scheme?
  • 4. Charles Ponzi https://www.youtube.com/watch? v=vFEMzCMyMXc •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops
  • 5. Arbitrage in post office international reply coupons valued at $.06 in U.S., sold for $.01 in Spain. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Charles Ponzi
  • 6. 50% return in 45 days or 100% return in 90 days •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Charles Ponzi
  • 7. Investors were recent immigrants, often of his ethnicity •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Charles Ponzi
  • 8. “Truly, for an immigrant, I did not look the part. There was nothing in my appearance to suggest the bread winner; nothing that could even be remotely associated with the thought of manual labor, of work of any kind; of economic penury. From tie to spats, I looked like a million dollars just out of the mint; like a young gentleman of leisure, perhaps like the scion of wealthy parents on a pleasure tour. And that goes to show that appearances don't mean a thing. In fact, I was in a jam right then… Broke right from the start, my entire resources in cash amounting to $2.50.” From his autobiography (pnzi.com) Charles Ponzi
  • 9. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core “Broke right from the start, my entire resources in cash amounting to $2.50.” •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Charles Ponzi
  • 10. Early investors were paid as promised (from new investors’ money) leading to an enormous demand from new and repeat investors. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Charles Ponzi
  • 11. Lasted 8 months. Took in a total of $15 million before collapse. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Charles Ponzi
  • 12. New Era Philanthropy •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops https://www.youtube.com/watch? v=dfIz9_Pw_tk
  • 13. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Gave donors a chance to double their gifts to charity allegedly from a group of wealthy “anonymous donors.” Later, non-profits were told that their funds would be matched by the anonymous donors and returned after a three-to- nine month holding period in a “semi-escrow” Prudential Securities account New Era Philanthropy
  • 14. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Claimed to have six anonymous donors providing matching funds. The founder was friends with John M. Templeton, Jr., son of John Templeton, Sr., the famous investor and philanthropist. Used Prudential Securities account. New Era Philanthropy
  • 15. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Gift or deposit was doubled after 6 months, later 9 months. New Era Philanthropy
  • 16. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Founder was Philadelphia Christian businessman, started with his philanthropic Christian friends and expanded to Philadelphia area churches & non-profits (before mushrooming to national nonprofits in the last year) New Era Philanthropy
  • 17. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors? •Social credibility v. audited credibility •Collapses when growth slows/stops Although beginning with friends and then local Philadelphia nonprofits, eventually expanded to including Philadelphia Public Library, University of Pennsylvania, Philadelphia Orchestra. Then mushroomed before collapse including many national charities and universities. New Era Philanthropy
  • 18. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Original credibility from relationships with other Philadelphia Christian businessmen. Later, credibility came from others who had invested and the plan’s longer duration 1989- 1995. New Era Philanthropy
  • 19. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Grew exponentially. Started with personal acquaintances in 1989 with $5,000 minimum donations, then $25,000 minimum donations. In 1994 opened to non- profit deposits. At collapse had raised $345 million. New Era Philanthropy
  • 20. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops https://www.youtube.com/watch?v=s68FR1MXT8Q http://video.pbs.org/video/1122731028/ http://www.hulu.com/watch/59463 Bernie Madoff
  • 21. Bernie Madoff •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops “The essence of his scheme was to deposit client money into a Chase account, rather than invest it and generate steady returns as clients had believed. When clients wanted their money, "I used the money in the Chase Manhattan bank account that belonged to them or other clients to pay the requested funds," he told the court.” http://www.reuters.com/article/2010/12/02/us-madoff- jpmorgan-idUSTRE6B153220101202
  • 22. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Fake trades were “recorded” after the fact to match indicated returns. Because he operated a trading company and was former chairman of NASDAQ, some assumed he had insider trading ability. [E.g., “front running” where stockbroker buys ahead of customer’s large buy orders then sells immediately afterwards] Bernie Madoff
  • 23. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Provided above market returns with essentially no variance in a hedge fund for many years. Offered only about 10.5% annual returns, but returns were always up. Harry Markopolis notes, “Only 4% of the months were down months.” Bernie Madoff
  • 24. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops No mandatory delay. Targeted private foundations as they need only pay 5% of assets per year, thus few redemptions. Because the investment opportunity was “exclusive,” investors were wary of removing their money from his fund, in case they could not get back in later. Bernie Madoff
  • 25. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Started and grew with wealthy Jewish investors and nonprofits. New York Post reported that Madoff "worked the so-called 'Jewish circuit' of well- heeled Jews he met at country clubs on Long Island and in Palm Beach.“ “The major firms on wall street had no money with Madoff.” – Harry Markopolis Bernie Madoff
  • 26. http://s.wsj.net/public/resources/documents/st_madoff_victims_20081215.html
  • 27. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops •Started firm in 1960 •Former chairman of NASDAQ •Financial inquiry foregone by some investors perhaps because presumption of insider trading (front running) to create profits Bernie Madoff
  • 28. •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi Core •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops Because of his low return rates (app. 10.5%) the collapse could have come more slowly (after his death). But, the financial crisis caused a massive run of redemptions. Bernie Madoff
  • 29. How is a pyramid scheme different from a Ponzi scheme?
  • 30. Each passenger pays $5,000 to the captain to join the pyramid. Once a 8 passengers have paid ($40,000), the captain is retired, the co-pilots become captains, etc. The goal is to become a captain. The pyramid can become a scam when the promoter fills in the top three levels with phony names (all paying him). Example Pyramid Scheme (not “Ponzi”)
  • 31. Pyramid Scheme •REVEALED reality that payments come from new investors, not actual profits •True story •Unknown returns •Much variance •Unknown delay •Maybe •Yes •Maybe •Slows/stops instead of collapse •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops
  • 32. How is a market “bubble” different from a Ponzi scheme?
  • 33. Housing price-to-rent (price-to-income) ratios Andre, C., Gil-Alana, L., Gupta, R. (2014). Testing for persistence in housing price-to-income and price-to-rent ratios in 16 OECD countries. Applied Economics, 46 (18), 2127-2138
  • 34. S&P 500 historical price-to-earnings ratio To December, 2014 From http://www.multpl.com/
  • 35. Bubble •REVEALED reality that growth comes from new investors, not actual profits •Yes •Yes •High variance •No •No •No •No •Must collapse IF supply is unlimited •HIDDEN reality that payments come from new investors, not actual profits Common Features Ponzi •“Plausible” story •Above market returns •No returns variance •Mandatory delay for investment return •Targets affinity group •Less sophisticated investors •Social credibility v. audited credibility •Collapses when growth slows/stops
  • 36. Protecting yourself from Ponzi schemes
  • 37. Why me? Why do they need MY money? If this investment is so great, wouldn’t it be easier to get more money in larger chunks from sophisticated institutional investors? If the investment is so great, why does it require paying this promoter to sell it to me? Great investments don’t come looking for you.
  • 38. Beware of investments that look “too good” High return, low variance investment results are a statistical red flag for fraud. Bollen, N. & Pool, V. (2012) Suspicious patterns in hedge fund returns and the risk of fraud. Review of Financial Studies, 25 (9), 2673-2702
  • 39. Question it Get outside advice. Verify with outsiders (not affinity group members) such as state securities regulators, SEC, technical professionals in the field. Pay for quality advice. Start by Googling it. Don’t be rushed. Show me the audit. Review CPA audited financial statements. Is this a large CPA firm? Why not? Can the assets actually be sold for their stated value? Remember, profit is opinion – cash is reality. Watch the reaction to hard questions. Defensiveness? Socially inappropriate? Threatened with being left out?
  • 40. Year of Discovery Name/Alleged Investment Amount 2014 Nationwide Automated Systems; ATMs $123MM 2014 KGTA Petroleum; Reselling crude and other oil products $20MM 2013 Yost Development - Tunisia $40MM 2012 Zeekler penny auction website $600MM 2012 Contract emu farming $28MM 2012 Gold - Genneva Malaysia Sdn Bhd $330MM 2012 Bitcoin Savings and Trust (BTCST) $250MM 2011 Risher “private equity funds” $21MM 2010 Justin Laurin Prather – Lubbock, TX; bridge loans for golf carts $12.5MM 2010 Sale of promissory notes – World Financial Group $14.8MM 2010 Oxford Group - Minnesota $194MM 2009 Benny Judah– Lubbock, TX $59MM 2009 Green energy investments (Mantria Corp) $30MM Not So Rare: Example Reported Ponzi Schemes

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