Ponzi Schemes
Contemporary Commentary
By: Bill E. Branscum
Copyright 2009

These are surely troubling, tremulous, economic times, and we can expect to see the system to continue to be overwhelmed with cases involving Ponzi schemes, and their multi-level marketed brethren, Pyramid schemes, but let us not be too quick to rush to judgment.

I say that for a number of reasons.

First, as investigators pursuing financial cases, we must all keep in mind that economic down-turns do not foster new schemes - they expose existing schemes. The reasoning for this should be intuitively obvious. For those who do not investigate these schemes for a living, the explanation lies in the essential elements common to them all. Specifically, these schemes need two things in order to remain viable; the influx of new investor capital, and previously invested capital left on deposit to continue to "grow."

When the economy begins circling the bowl, two things happen. New investors become harder to find, and existing investors who were previously content to "let it ride," begin making demands upon their accounts. Without in-flowing funds, the promoters are unable to meet their obligations, investors become unhappy, they get suspicious, and they begin filing complaints. Think about the cases that are dominating the news these days. Bernard Madoff and R. Allen Stanford did not launch into new undertakings in an effort to cope with a crumbling economy; whatever they are ultimately proved to have done, Madoff and Stanford had each been doing it for a very long time.

Second, let us all be very clear in our minds that the "robbing Peter to pay Paul" concept does not define a fraudulent scheme. Just because a business develops cash flow issues, does not make it a criminal enterprise. Remember, Ponzi/Pyramid schemes are, by definition, insolvent from their inception. That is not to say that an otherwise legitimate enterprise could not transmogrify into an investment scheme, but proof that an enterprise was struggling to stay afloat by using today's income to pay yesterday's obligation does not make that case - if it did, the government could indict nearly everyone out there these days.

Consider your situation, whomever you happen to be. Let's say you are like most of us - house payment, car payments, and maybe a boat payment, as well as the ubiquitous bills for groceries, utilities, insurance, alimony, child support . . . and the list goes on. Things have slowed down for you, it isn't raining money for you the way it was, and money is tight -- but the phone rings, you have a new Client, and they send you a $5,000 retainer. You knew it was coming, you knew things had to turn around, and there it is. My question to you is, "Are you going to leave that money in your trust account against future billing, or are you going to make that overdue house payment?"

I know we are talking apples and oranges here, but I hope to help you visualize my point. Remember, the people out there behind the various investment related enterprises depend upon those undertakings for the income necessary to pay their bills. The larger the investment related enterprise, the larger the bills. When you see an Indictment that reads, "Investigation reveals that Joe Schmoe used the proceeds of this undertaking to finance an affluent lifestyle . . ." you should say to yourself, "So what? Of course he did."

As a high profile investment advisor, or whatever he portrayed himself to be, his undertakings were the source of his income, and he had to use that income to finance an affluent lifestyle if he wanted to play in the game. What billionaire is going to entrust his investment capital to a guy wearing a suit from JC Penny's, who drives a Kia, and lives in a mobile home? I suspect that Warren Buffett drives a nice car - assuming he actually drives himself anywhere these days.

"So what?"

Third, losers howl, no matter how they come to lose. Just as, "Everybody loves a winner," "Everybody hates a loser," and that is especially true of their investors. The guy who loses other people's money can expect to be dealing with an angry crowd. When a loud enough mob demands crucifixion, things become political, and anybody can be nailed to a cross.

Considering the way these cases typically develop, a misguided prosecution would be profoundly disturbing; a good argument could be made that the entrepreneur running an investment related undertaking would be better off accused of murder, than running a Ponzi scheme.

Suppose, for example, that your Client was running an apparently legitimate investment related undertaking that was genuinely realizing double-digit returns . . . say 10-12%, and had been for years - one of the legitimate feeder funds that invested with Madoff might be a good example. Further suppose that when things went bad, the government misinterpreted the facts and erroneously concluded that your Client was running a Ponzi scheme, as opposed to being the victim of one. You could expect the government to open their attack with a stiff left in the form of an SEC Complaint, followed immediately by a wicked right in the form of a Temporary Restraining Order, and the Appointment of a Receiver, divesting your Client of the ability to manage his business, control over his assets, and the resources necessary to defend himself.

You've seen motions, responsive pleadings, memoranda of law, etc., and based upon your experience, you might expect that your Client could be divested of his assets, and control of his investment related undertaking in a matter of months . . . but it doesn't work that way in these cases. This "one-two" punch is generally an instant knock-out.

For example, look what happened in the Madoff case. On December 11, 2008, the SEC filed their Complaint and requested that assets be frozen, and a Receiver be appointed. The following day, on December 12, 2008, the Court ruled accordingly. Overnight, Bernard Madoff was divested of enormous wealth, and control of a financial empire. Shortly thereafter, the Office of the United States Attorney filed criminal charges.

The case of Robert Allen Stanford is another good example. On February 17, 2009, the SEC filed a Complaint, accompanied by a Motion for the Appointment of a Receiver and a Motion for a Temporary Restraining Order. The responsive Orders were filed later that same day. Shortly thereafter, the Office of the United States Attorney filed criminal charges.

These are not isolated incidents; this is the way you can expect this to work in these cases. Your Client is likely to see his entire world come to a screeching halt - and if that is the worst of it, he's lucky. Once criminal charges are filed, you can expect the government to fight for pretrial detention. I have attached the dockets for both previously referenced cases, so you can see the battle that was waged on this issue.

It is hard to effectively defend yourself, while locked in a cell, separated from your financial resources. Even if the Client can marshal the funds necessary to finance an effective defense, the attorneys involved need to be cautious lest they be forced to disgorge the funds thus received. Receivers, Bankruptcy Trustees, and government forfeiture potential serve to make defense funding in these cases problematic.

To be clear, I am not suggesting that there is anything wrong with this system. In my view, based upon my experience working with fraud victims, the way the SEC works with the DOJ in shutting down massive investment schemes is almost as brutal, aggressive and effective as it needs to be. The people who promote investment scams destroy people; they destroy entire families. They get no sympathy from me.

If anyone is holding out any hope that Madoff was misunderstood, or the unfortunate victim of the economy, I have included Madoff's own statement, in the form of his Plea Allocution, and the Sentencing Order that followed, as exhibits.

On the other hand, when I read allegations leveling Ponzi accusations at someone, I am invariably reminded of the RICO Act prosecution of Arnold Strom by the Florida Office of the Statewide Prosecutor. This was back in 1997, one of my first cases as a Private Investigator, and it was immediately apparent that Strom was the devil incarnate, a real low-life degenerate, who preyed upon the hapless, hopeless masses . . . if you could believe the daily drivel in the government's press releases.

The government press crusade was relentless; they blathered on, and on, and on.

I was retained by Naples Attorneys Michael McDonnell, and Charles Murray, to investigate the matter for the defense, and provide expert testimony as to what a Ponzi scheme actually was. The fact is, this was the most egregious prosecution I have ever been involved in, and the government had no clue - as evidenced by the ultimate Directed Judgment of Acquittal. The government spent more than a week presenting their "case," the defense destroyed it as they presented it, and the Court ruled that the prosecution did not present evidence upon which a guilty verdict could stand.

For me, it was an outstanding introduction to the world of criminal defense, as presented by a couple of attorneys who were exceptionally good at it.

That sort of government witch hunt, "Ponzi Scheme" prosecution, was a scenario that I hope to never see again.

In the vast majority of these cases, the government deserves a lot of credit for the work they do, and have done, in protecting the public from those who promote investment fraud. The enormous power that the government can bring to bear notwithstanding, these cases are not easy to make. The major Ponzi/Pyramid Scheme cases are potentially winnable by either side, if for no other reason than their inherent complexity. It has been my experience, working for the government and without, that any case of sufficient complexity is up for grabs - the Wesley Snipes Tax Case is a perfect example.

Widely touted as the "unwinnable case, in the unwinnable place," it fell to a defense team that mastered the evidence, and gifted attorneys who very effectively put the Internal Revenue Service on trial. To participate in a masterfully orchestrated winning defense is a rewarding thing.

Related Reading:

Regarding the Strom case:

Oracle International
Bill E. Branscum, Investigator
(239) 304-1639




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