If it sounds too good to be true, it usually is...
Each year thousands of South Africans fall victim to bogus investment schemes. The common thread running through these intensely marketed opportunities is the promise of “fast cash”. It seems Joe Average cannot resist the “get rich quick” tagline. Earlier
Ponzi and pyramid schemes are illegal deposit-taking schemes that promise new investors returns well in excess of official bank rates. Website wikipedia.org defines a Ponzi scheme as “a fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from profit earned by the individual or organization running the operation.” (It is named after Charles Ponzi, who used the technique in an international reply coupon scam in the 1920s). To ensure consistent cash flows the Ponzi scheme mastermind lures new investors with promises of significantly higher returns than comparable investments. But the scheme collapses when it fails to attract enough new capital to pay out existing investors. In most cases Ponzi schemes are shut down by authorities before they melt down, with the result scheme masterminds often blame the authorities for their victims’ losses.
Examples of giant Ponzi schemes
The masterminds of Ponzi schemes spare no expense in creating an illusion of wealth and usually claim their investment edge lies in some extremely technical or obscure trading activity. “The promoter [of a Ponzi scheme] sells shares to investors by taking advantage of a lack of investor knowledge or competence, or using claims of a proprietary investment strategy which must be kept secret to ensure a competitive edge,” observes the website. The better known schemes have soaked up billions in “investor” funding before collapsing.
Two giant Ponzi schemes have been exposed in recent years. Bernard Madoff is the admitted operator of a Ponzi scheme today acknowledged as the largest financial fraud in US history. He started the scheme under the guise of a wealth management firm in the early 1990s and it is estimated he lost $18 billion of investor funding. The total grows to $65 billion if one includes the fabricated gains he reported on accountholders’ investments. Madoff was sentenced to 150 years in prison in June 2009.
Also in 2009 a story broke about South African investors losing billions to a Ponzi scheme created by businessman Barry Tannenbaum, now domiciled in Australia. He was accused of defrauding hundreds of wealthy investors of more than R10 billion, though it remains difficult to determine the exact quantum of the fraud. The Mail & Guardian reported at the time: “Tannenbaum lured investors with the promise of 200% annual returns linked to pharmaceutical imports and was accused of forging HIV/Aids drug orders to give reassurance when money started to dry up.”
The trouble with complex frauds
The trouble with complex frauds such as those masterminded by Tannenbaum is that prosecutors have a hard time bringing the perpetrators to book. In the latest update (around March 2012) local prosecutors were still trying to extradite Tannenbaum (from Australia) and one of his alleged accomplices, Dean Rees, from Switzerland. There is also an investigation underway to determine how the scam operated within the restrictions imposed by the Financial Intelligence Centre Act (FICA). Writing in the Business Day, November 2011, David Gleason observed that a single local bank allegedly handled 130 000 transactions for Tannenbaum, while another allegedly processed transactions through as many as 160 accounts for Rees. The question: why were no warning signals generated by the banks’ internal processes?
South Africa has also suffered its fair share of pyramid schemes, which operate slightly differently to those just described. The difference is succinctly put by wikipedia.org: “In a Ponzi scheme, the mastermind acts as a ‘hub’ for the victims, interacting with all of them directly. In a pyramid scheme, those who recruit additional participants benefit directly – and failure to recruit new members typically means no investment return.” You are rewarded for participation in a pyramid scheme through a commission on every new member you introduce. Pyramid schemes collapse much faster because they require exponential increases in participants to sustain them.
There is no doubt local investors will continue being suckered into “get rich quick” schemes. You need only page through the Sunday papers to find any number of lucrative investment opportunities promising 20%-plus per annum. We would give most of these so-called opportunities a wide berth – but if you have to get involved – be sure to check them out thoroughly.
Editor’s thoughts: Ponzi and pyramid schemes are dime a dozen in South Africa. We would love to hear from you if you have encountered an investment opportunity that seems to good to be true… Send an email to gareth@fanews.co.za
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