Ponzi schemes and other investment scams SAIFM Investment Summit Presenter: Ingrid Goodspeed Chief Director: Financial Sector Development, National Treasury 21 June 2016
Investment fraud impacts thousands of people in South Africa and is responsible for millions of losses Masterbond collapse in 1991 impacted 22000 investors. A 13- year curatorship recovered at least 46% of funds invested. Fidentia Asset Management (J Arthur Brown) involved losses estimated at R1.4 billion with very little recovered. Fidentia was an asset manager, at the centre of a highly regulated and supervised savings and investment industry, with conventional, recognisable products Leaderguard Securities (Leaderguard Spot Forex) saw 1600 investors many pensioners lose more than R300million. Leaderguard Spot Forex was licensed as an asset management company
Investment fraud impacts thousands of people in South Africa and is responsible for millions of losses Herman Pretorius (Relative Value Arbitrage Fund) promised annual returns of 20% to 30% and attracted over 3000 investors had losses approaching USD250million Tannenbaum s scheme is reported to have cost a select group of investors an estimated R15 billion Travel Ventures International was a pyramid scheme shut down by the SA Reserve Bank in 2011 after it attracted over one million investors who invested over R265million. Property syndications such as Sharemax are estimated to have lost some 40000 investors in excess of R5billion
Little is known about the decision-making, experiences and behaviours of the victims of such financial crimes People impacted by investment fraud are not simply passive victims the ways that they seek to verify the authenticity of the investment opportunity include talking to family, friends and colleagues, challenging the fraudster, conducting independent research, contacting the regulators and other professionals Fraudsters do not simply mislead victims they build a relationship to the point where the victims become emotionally attached to the fraudster and even defend the fraudster and the investment against criticism. Specific background to the decision to invest: Financial: change in circumstances, optimistic or pessimistic beliefs Family circumstances: a strong desire to provide for family members Psychological: personality traits that enable the fraud. Stress at time of contact. Greed, ego and ignorance
Yet the outcomes of investment fraud are clear Retirement postponed sometimes indefinitely Students forced to give up their studies Suicides Undue stress, divorce and illness
Investment fraud red flags Cold calling where the caller is aware of specific personal details, contextual factors in their lives at the time. Caller is perceived not to be pushy but interested in being helpful Financial advisors often because they too have fallen prey to the fraudster and have been offered good commissions to sell the investment Asset managers are unlicensed or unknown Financial service / product providers with no brand name / reputation Investments that are Illiquid (e.g., property, private equity), unlisted, unregistered Investments have consistent positive returns
Investment fraud red flags Investments are low risk with high returns, which are often guaranteed There is pressure to make quick decision i.e., high-pressure sales tactics Investment offer through individuals in communities such as churches or clubs i.e., affinity fraud Insider tips sellers insinuates that they have access to inside information that the general public does not have Success of the investment is ascribed to a highly complex investing technique, groundbreaking new technology or special super-secret methods or assets Attractive rollover opportunities are offered at when attempting to cash out
Types of investment fraud Pyramid versus pozi schemes Similarity Sustainability of schemes depends on influx of new investors Money from new investors is used to provide returns for older investors Differences Ponzi scheme investors think their money is in a bona fide investment that they plan to hold for some time. They believe their risk is market fluctuations Pyramid scheme: contributors know that if there is no new money the scheme will collapse and they will lose their money. They must remain motivated to recruit new contributors to the pyramid or they will not get paid.
Types of investment fraud Pyramid versus pozi schemes 1 Ponzi 2008 Bernard Madoff Bernard L Madoff Investment 65bn securities LLC (US) 2 Pyramid 1990 Sergey Mavrodi MMM (Russia) 10bn 3 Ponzi 2009 Allen Stanford Stanford International Bank 7bn (Antigua) 4 Pyramid 2008 Tom Peters Peters group worldwide(us) 4bn 5 Ponzi 2009 Scott Rothstein Structured settlements (US) 1bn 6 Ponzi 1994 Damara Bertges European Kings club (Germany 1bn Switzerland) 7 Ponzi 1994 Loan Stoica Caritas company (Romania) 1bn 8 Pyramid 2009 Nevin Shapiro Grocery diverting (US) 1bn 9 Ponzi 2008 Marc Dreier Dreier LLP (US) (promissory notes 1bn forged) 10 Ponzi 2012 Paul Burks Zeek rewards (US) 1bn
Other types of investment fraud Off the book deals: This is a deal a broker or financial advisor offers that is not supervised by their employers and is, more often than not, illegal. N0 record of the deal is kept Pump and dump schemes: A small group of in-theknow investors buy a share before they recommend it to other investors. This results in a sharp spike in the share price. At this stage, the in-the-know investors dump their shares at the higher price, creating a sharp dip in the share price Share fraud: A fraudster sells worthless or unsaleable shares from call centres known as boiler rooms, typically using highpressure sales techniques Crowdfunding and crowdfarming 419 scam/advance fee fraud
The negative consequences of investment fraud at a national level Undermines confidence in financial markets Divert savings from productive to unproductive uses Cost to the fiscus if bailouts occur Swings in consumption (possibly funded by credit) driven by paper profits or early withdrawals Socio-economic strife when a large number of households are exposed to losses or the closure of their pyramid scheme Undermine the reputation of authorities, regulators and law enforcement
Gaps in the financial sector regulatory framework that allow investment relationships to exclude regulator s powers A partnership where individuals invest their monies in a partnership and utilise the capital to produce positive returns An investment club where persons with a commonality of interest pool their monies to make an investment A company formed for investment purposes in which investors obtain equity A trust in which beneficiaries monies would be pooled, but which would fall outside the ambit of the Collective Investment Schemes Control Act, due to the nature of the underlying investments or because it is a private arrangement between persons involved in a private business arrangement Deliberate regulatory arbitrage use of investment structures that do not require authorisation - for example each investor is established as a credit provider to invest in bad debt 12
Gaps in the financial sector regulatory framework that allow investment relationships to exclude regulator s powers Unless a financial product is involved, the Financial Advisory and Intermediary Services Act does not apply. For example becoming a member of a investment club or beneficiary of a trust is not the acquisition of a financial product While product suppliers may be required to be authorised under the FAIS Act when giving advice relating to their products, the selling of such products by a product supplier directly to the public may not amount to an intermediary service, such as a company doing a private placement of equity 13
South Africa is implementing a structural reform of its financial sector regulatory framework The Financial Sector Regulation Bill to implement the twin peaks (prudential and market conduct) system for regulating the financial sector is currently being considered by the Standing Committee on Finance. regulatory and supervisory framework that promotes financial stability; the safety and soundness of financial institutions; the fair treatment and protection of financial customers; the efficiency and integrity of the financial system; the prevention of financial crime; financial inclusion; and confidence in the financial system. The Minister of Finance may designate a facility, arrangement or system a financial product or a service a financial service 14
Consumer protection objective requires a proactive approach to confronting investment fraud Improved victim profiling to help FSCA and other regulators understand which sectors of society are particularly at risk for each type of investment crime More advanced techniques to intervene in investment frauds earlier and more often Enhance awareness among investors so they have the knowledge and tools to protect themselves against fraudsters Train and develop the investment fraud investigators of regulators and prosecuting authorities 15
Ponzi schemes and other investment scams SAIFM Investment Summit Presenter: Ingrid Goodspeed Chief Director: Financial Sector Development, National Treasury 21 June 2016