Protect yourself against Ponzi schemes

New Zealand courts have dealt with several Ponzi schemes in the past few years, where investors are fleeced by some guru who had promised high returns in return for not asking too many questions.

The root cause of people losing everything to their investment advisors is a lack of transparency, starting with the question: Who actually owns my investments?

The safest and simplest way to own assets is by having it in your own name, registered on a recognised register of ownership. The alternative is where it is held by a custodian on your behalf. Both offer security of ownership.

Yet that is not what happens in these Ponzi schemes, where the investor basically hands their money over to a guru advisor of some sort who invests in his/her own pool of investments, and then allocates the pool to the investors. There is no oversight and no one can prove that the assets actually exist. All you have is what comes off the advisor/manager’s printer. You can print anything, it’s just a piece of paper.

The template for a Ponzi scheme works as follows.

  • You are advised to invest with a family member/ religious group, friend of a friend or some other trusted person who is a financial wiz. The close relationship is important because you are going to be too embarrassed to ask for evidence of what exactly is happening to your money. This opens the way to “Affinity Fraud”, one of the biggest areas of fraud worldwide, involving people you know and respect or who are family and friends and who take you to the cleaners.
  • You are provided with proof of superior returns by others investing with this investment manager. Superior returns are possible over short periods but always are achieved by taking higher risks, which only later come home to roost.
  • The returns are very stable year on year, with little sign of volatility that usually accompanies high returns. This is the giveaway. It is technically impossible to produce better than market returns with lower than market fluctuations in those returns. The chart below shows how superior returns were achieved over more than a decade with no fluctuations by a brilliant fund manager, called Bernie Madoff. It was the low volatility rather than the high returns that raised red flags among some analysts who warned that Bernie must be running a Ponzi Scheme. From the fraudster’s point of view, it is imperative that there is never a fall in value of investments as that would trigger a rush of investors taking their money out of the fund. In a Ponzi scheme late cash pays early investors and if there is a rush of funds taken out, the Scheme unravels because there is not enough cash to go around.
  • Your assets are not registered in your name or held in custody on your behalf. In a Ponzi scheme the investment manager holds the assets in his name in a pool of similar assets where the results can be manipulated and fictional ownership created.

You should only invest in a manager who can display substantial protection for client’s money, through independent custodians, regular audits and independent reporting of assets held in custody sent directly to the client.

Madoff: High returns plus low variation equals trouble

This article does not constitute advice but is presented for debate. Any advice provided in relation to financial products is general in nature and is not personalised. This type of service is defined in the Financial Advisers Act 2008 as a ‘class service’. It does not take into account a client’s personal financial position, their goals or objectives or their risk preferences, and so should not be followed without consulting a Financial Advisor. A disclosure document for Neville Glaser can be obtained if requested at neville@glaserindicators.co.nz

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