by Jim Marasco , CPA,CIA, CFE

Fraud Matters, Spring 2009

As the economy continues to falter, Ponzi schemes nationwide have become exposed and revealed billions of dollars of losses for investors. Individuals, not-for-profit organizations and company pension funds have lost massive amounts of money. Most people had never heard of Ponzi schemes prior to the current recession. What is a Ponzi scheme? Ponzi schemes, also known as pyramid schemes, are attractive to investors because of above-market investment returns advertised. Investment funds are pooled with others and investors receive returns that are paid from the deposits of new investors. Rarely is the money invested in real investment vehicles, much less ones that actually can return what is being offered. Italian immigrant Charles Ponzi popularized the scheme in the early 1900s. His name has been synonymous with this type of fraud since that time.

Protect yourself from falling victim

The latest schemes uncovered have exposed victims from all walks of life. Money managers, Hollywood elite, faith organizations, etc., have all watched their fortunes disappear as these schemes collapsed. As new money stops flowing into the pyramid, old investors can’t cash out, causing a cash crunch and the eventual demise of the scheme. Staying clear of these frauds is the best way to protect yourself and your organization from falling victim.

Use Common Sense

If it sounds too good to be true, it probably is. An investment opportunity can look like a sure thing, but investors must always think rationally rather than emotionally. companies, most investments will not offer a guaranteed return. Guarantees of 8 to 12 percent annually are unrealistic because markets fluctuate. If an investment manager suggests you’ll realize these returns, you should be skeptical.

Choose Wisely

Choose an investment manager just as you would an attorney or accountant. Experience and skill should be considered, rather than personality or charisma. Most Ponzi schemes are orchestrated by outstanding salesmen with an impressive personal resume but, apparently, a lack of professional ethics. Inquire about professional accreditations and whether any complaints have been lodged against the firm or individuals involved.

Ask Questions

Don’t be afraid to ask your investment manager tough questions, such as “What exactly am I investing in?” and “Who is your auditor?” Honest investment firms generally use well-established, reputable auditing firms. Dishonest ones intentionally choose small, obscure firms that can easily be influenced. You’re within your rights to ask to see audited financial statements.

Demand Detailed Reports

Most perpetrators of Ponzi schemes send periodic reports to investors with limited information included. This is a major red flag. Honest investment firms provide very detailed, professionally prepared reports on a regular basis, generally monthly, quarterly, annually or all three. Reports should include clear details about any changes in your assets – whether you’ve made or lost money – and most will tell you where your assets were invested. Ponzi schemes perpetuate and temporarily thrive because victims trust the central principals enough to ignore the lack of documentation.

Be Patient

The promise of significant wealth via one successful investment is appealing, but investing should be an intellectual, rather than an emotional, exercise. Be skeptical. Think more about what can go wrong than what can go right. Deal with established investment managers. Ask tough questions about where your money is going. Demand regular, detailed reporting. Before making any significant investment, consult your accountant or attorney. If you suspect you are a victim of a Ponzi or pyramid-type scheme, call us. We can offer the best course of action to help you seek recovery of your investment and determine the legitimacy of your investment manager. Once the scheme collapses, the chances of a full recovery are severely diminished. – James Marasco, CPA, CIA, CPE James I. Marasco, CPA/CFF, CFE, CIA Jim is a partner at EFPR Group. He brings more than 18 years of public accounting and auditing experience. He is a full-time management consultant and travels extensively throughout the country while leading StoneBridge Business Partners (an EFPR Group affiliate company). Article republished with the permission of CPAmerica.