How Charles Ponzi Can Inform Your Compliance Program

Yesterday, I used some of the wisdom from current CIA Director General David Petraeus to suggest how senior management might move forward with a compliance program. Today I will use a very different individual to help inform your third party due diligence, Charles Ponzi.

My colleague Tracy Coenen writes an invaluable blog entitled The Fraud Files Blog. She consistently writes about detecting fraud in all its forms. In a recent post,entitled “Ponzi Scheme and Investment Fraud Red Flags”, Tracy identified many Red Flags which might come up if you performed some due diligence on a Ponzi scheme or persons promoting it. In her blog post, she listed “some red flags about the “investment” you’re considering that might indicate it is a Ponzi scheme” and they are as follows:

• Promoters are not registered to sell investments (Consider doing a background check through Financial Industry Regulatory Authority (FINRA) if the promoter is U.S. based.);
• Promoters have a history of being investigated and/or disciplined for actions related to investments (Google is your best friend for this one.);
• Promoters and/or founders of the business/investment have criminal, bankruptcy, or civil court histories that are troubling (Use PACER to search all federal court records for a nominal fee. State courts generally have their own online systems, and access to them is growing daily.);
• Difficulty in verifying whether there is a legitimate business behind the investment (Again, Google is your friend!);
• Groundbreaking “new technology” or other special (but super-secret) methods or assets, which are going to take the world by storm and be the greatest thing since sliced bread;
• Complicated alleged business model that prevents an experienced investor from understanding how money is really made;
• The alleged performance of the company is suspiciously higher than competitors or companies in related industries;
• No objective third-party information can be found about the company;
• Elaborate explanations for why the business cannot be verified;
• Unusually high rates of return offered on the investments (Note that this one is the most common across all Ponzi schemes.);
• Returns on investment are guaranteed (Not to be confused with an annuity from a reputable company with a guarantee in the contract.);
• Promoter downplays the amount of risk investors will be exposed to, often  using phrases such as “a sure thing”;
• Reluctance to provide documentation supporting claims being made about the investment and the business behind it;
• Address of the “business” is a mail drop location, virtual office, or small private office that couldn’t possibly hold a business the size that is being claimed (Google Maps is very helpful for this one.);
• Few (if any) employees in the operation other than the founder and/or promoter;
• Background of the principals of the business is mismatched with what the business does (Use Google to find out what kinds of jobs they held previously, and compare it to what they’re supposedly doing now.); and
• Company’s alleged success is related to a recent announcement of some sort, rather than historical financial results (This one is even worse if the information in the announcement can’t be verified, and it appears to just be a PR stunt for the benefit of potential investors.).

One of the things that struck me in reading Tracy’s list of Ponzi scheme Red Flags is how closely they mirror those which may appear in a Foreign Corrupt Practices Act (FCPA) or UK Bribery Act due diligence investigation. Additionally the Red Flags would seem to organize themselves into four general areas:

1. Something seems out of the ordinary.
2. Reluctance of party to supply information/difficulty of verifying information.
3. The scheme is not verifiable by data, only anecdotally.
4. Mismatch in business experience with the product or services offered.

In due diligence training, I always tell people to listen to their guts, or if the hair on the back of their neck stands up, pay attention. Not listening to your internal warning system can lead your company down a path that it may well not desire to travel. Red Flags are so called for a reason and if they are raised they must be sufficiently clear. Tracy Coenen’s list of Red Flags for Ponzi schemes is one which any corporate compliance officer should take to heart.

Tracy Coenen, CPA, CFF  has also written a useful book for helping companies and individuals detect fraud and Ponzi schemes and investment frauds entitled, “Expert Fraud Investigation: A Step-by-Step Guide.” She can be reached via email at tracy@sequenceinc.com.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2012