Point of no return
A Ponzi scheme is a fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from actual profit earned by the individual or organisation running the operation. The scheme usually entices investors by offering higher returns than other investments, in the form of short-term returns that are either abnormally high or unusually consistent.
Continuing the high returns requires an ever-increasing flow of money from new investors, but the system is destined to collapse eventually because the earnings, if any, are less than the payments to investors. Charles Ponzi, from whom the scheme takes its name, became notorious for using the technique in 1920. His original scheme was based on the arbitrage of international reply coupons for postage stamps. However, he soon diverted investors’ money to make payments to earlier investors and himself.
If there is only one lesson we can take from the real case described below, it is that every commercial transaction must have a rational purpose. If you are administering a company and see large amounts of money being paid into the account (or indeed many small amounts) you need to know what they represent. I have been a finance director and know that if a company receives money it has to be for one of the following reasons:
- Share capital. Understand why it is required, who is acquiring the shares, and the basis of the share price (if above par).
- Loans. This is a favourite of the laundering fraternity. If a company receives a loan, ascertain what it is for and the identity of the lender. If it is unsecured, interest free and with no fixed date for repayment – unless of course it is from a trust overlying the company or directly from the beneficial owner – be suspicious. In business, companies are never fortunate enough to borrow money from third parties on such advantageous terms.
- Income. Discover what goods or services are being sold. For goods, a corresponding purchase price must have been paid. For services, ask whether your client has the skills and experience to be, for example, earning consulting fees of USD500,000 per month from a foreign government department. Ask to see the invoice and the contract if applicable.
‘If Ponzi schemes teach us one lesson, it is that every commercial transaction must have a purpose’
Now to the real case about a massive Ponzi scheme. It was orchestrated and executed by Mr X, who encouraged his investors to invest into his high-yielding investment scheme. In September 2007, the Financial Intelligence Unit (FIU) received information that a company owned by Mr X was operating a high-value investment scheme out of the Turks and Caicos Islands (TCI). A proactive investigation was initiated with no complainants at the time, as every one of Mr X’s investors believed in the scheme.
Details from overseas agencies revealed that Mr X, instead of trading the investors’ funds, was simply investing minimum amounts and moving the remaining funds from one account to another for no apparent business purpose. On one occasion USD53 million was transferred to a Swiss bank in London over the course of a couple of days and back to the US, incurring bank charges but realising no profit.
The FIU established the lack of trading activity by Mr X. They also found that the little trading done by Mr X actually led to losses. Despite this, Mr X was consistently paying his investors an average 10 per cent return per month. Based on Mr X’s own admission, the total turnover of his scheme was in the region of USD1.2 billion, of which approximately USD300 million passed through the TCI.
In June 2008, the FIU received suspicious transaction reports from local banks in relation to Mr X’s company. Two years of investigations followed, with the assistance of a number of foreign jurisdictions and agencies, to prove a case against Mr X. On 23 September 2010, following a plea agreement, Mr X was convicted of deception and money-laundering offences and sentenced to a substantial term of imprisonment in the TCI. The search for the outstanding victims’ funds goes on.
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