It is no secret that people like to engage in not just earning money, but watching it grow as well. Every year more than 50% of Americans invest billions of dollars in various assets including stocks, bonds, real estate, and other assets with high hopes of watching those assets gradually increase in value. With most reputable stock market indices only increasing an average of 8% a year, many people with a higher risk tolerance find themselves actively looking for investments with more promising returns. Unfortunately, while legitimate investments do exist that can potentially yield higher returns, many people find themselves out of hundreds of thousands of dollars after investing into fraudulent companies that take advantage of people looking for a good return on their money.
Woodbridge Group of Companies: The Biggest Ponzi Scheme Since Bernie Madoff
Perhaps one of the most notorious cases of 2017 was an alleged Ponzi scheme coordinated by real estate developer Robert H. Shapiro. In December, the Woodbridge Group of Companies, a conglomerate of more than 275 limited liability companies, was charged with operating a $1.2 billion dollar Ponzi scheme. The operation began during the summer of 2012 when Shapiro’s companies started raising what accumulated to more than one billion dollars from over 8,400 unsuspecting investors, many of them senior citizens. As with any financial scheme, Shapiro promised his investors immense returns, which he claimed would be acquired from the high rates of interest that his companies were earning on loans they made to third-party borrowers. As the Securities and Exchange Commision (SEC) discovered, however, nearly all the “third-party borrowers” were limited liability companies with no revenue, no bank accounts, no history of paying any interest under these loans, and most notably, were owned and controlled by Shapiro. Despite raking in over $1 billion in investor funds, Shapiro’s companies generated a mere $13.7 million in interest accrued from truly unaffiliated borrowers, while paying out in excess of $60 million to a salesforce who pitched the investments as “low risk” and “conservative.” Without any actual revenue to pay back his investors, Shapiro resorted to the hallmark of Ponzi frauds: using new investor funds to pay back the returns owed to older investors. Meanwhile, as stated by the SEC, Shapiro utilized some of the funds to support the lavish lifestyle of him and his family, spending up to $21 million of investor money on fashion, luxury vehicles, jewelry, club memberships, expensive wines, and chartering private planes. In December of last year, Shapiro and his vast list of fraudulent companies became unable to pay the dividends and interest payments that they owed to investors. As a result, additional funding from investors was halted, and most of the companies involved in the scheme were made to file for Chapter 11 bankruptcy. The repercussions of Shapiro’s scheme will leave investors with losses upward of $900 million, including over 2,600 investors who’d put up their entire retirement savings.
Bayou Hedge Fund Group: Losses, Fake Returns, and Phony Audits
Aside from operating an active Ponzi scheme, famous fraudsters have historically adopted other methods of scamming investors of millions of dollars. In 1996, Sam Israel III and James Marquez launched their first private hedge fund known as “Bayou Hedge Fund Group.” Initially, and arguably with good intentions, they were able to solicit investments of over $300 million from a number of wealthy individuals, guaranteeing the value of the investment to break $7.1 billion within the decade. Several months after the launch, however, the hedge fund started sustaining trading losses and began lying to their investors by fabricating the fund’s performance summaries. By 1998, when the hedge fund had accumulated millions of dollars in losses, it became clear that Bayou’s investment strategy was not producing the kind of returns that the fund had promised its investors. Throughout the year, Israel, along with Bayou’s Chief Financial Officer (CFO) and Public Certified Accountant (CPA) Daniel Marino, began falsifying the investment returns that they reported to their clients and used the phony returns when documenting the fund’s stability in the year-end financial statements. Rather than dissolving the company, Israel saw promising gains in an alternate path. After realizing that the fund’s losses would not withstand an independent audit, Marino agreed to fabricate the company’s audit so as to not recognize any losses the fund has undergone. Toward the end of 1998, Marino founded “Richmond Fairfield Associates,” a phony accounting firm with one actual client: Bayou Hedge Fund Group. Working under the “firm,” Marino drafted a phony audit consisting of falsified and highly inflated financial data to maintain the facade that the company was turning a profit.
Unnoticed by the SEC, the guys behind Bayou kept the facade going for years to come while falsifying the reports and conveying an image of profitability to investors, which in turn brought in tens of millions of dollars in investor funds. In January of 2003, Israel decided to liquidate Bayou and restructure it into four separate funds: Bayou Accredited, Bayou Affiliates, Bayou No Leverage, and Bayou Superfund. After restructuring, although investor funds peaked at over $125 million, the fund itself had not become more profitable, and even more money was lost through trading. In 2003, investor deposits into Bayou Superfund totaled more than $90 million, though the fund had lost approximately $35 million through unprofitable trading. Regardless, the fund’s 2003 statement reported a profit of more than $25 million.
Despite taking massive losses year after year, the SEC reported that the men behind Bayou, particularly Israel and Marino, generously enriched themselves at the expense of their investors. In addition to owning the four divisions of the Bayou group, Israel also owned Bayou Securities LLC, a brokerage company that was used to execute the trades from each fund. Being that Israel’s trading strategy required the funds to buy and sell millions of dollars of securities on a daily basis (similar to a day-trading strategy), Israel and Marino raked in millions of dollars in trading commissions from which they paid themselves annual salaries and “profit” distributions. In 2003, while $49 million of investor funds was lost through bad trades, Bayou Securities “earned” nearly $29 million in commissions.
In 2004, after having sustained consistent losses since Bayou’s inception, Israel and Marino started to panic and became desperate to recover the funds that they owed to investors through short-term, high-yield investments. In April of 2004, Israel and Marino halted all trading activity and liquidated the assets of the Bayou funds before wiring nearly $150 million of investor funds to a Citibank account in an attempt to recuperate some of their losses through a series of “prime bank instrument trading programs.” As the SEC details, such “investments” are a historical staple among fraudulent investment scams and require that vast sums of money be transferred to various bank accounts, both foreign and domestic. After wiring over $100 million to numerous banks, including $120 million to Deutsche Postbank, then to another German bank followed by a transfer to a British Bank and finally, a domestic bank in New Jersey, the Arizona Attorney General’s Office concluded that the funds were likely the proceeds of a fraudulent prime bank instrument scheme (they were right), and initiated a forfeiture action against the funds. In 2006, the hedge fund filed for Chapter 11 bankruptcy-court protection, and in 2008, Israel was sentenced to 20 years in prison and ordered to forfeit $300 million after pleading guilty to defrauding his investors.
Stratton Oakmont: The Famous Pump-And-Dump
As previously mentioned, while Ponzi and pyramid schemes tend to comprise the majority of prominent financial schemes, certain individuals do find novel ways to get their “share” of illegal profits. Besides being the subject of The Wolf of Wall Street, one of the biggest movies of the decade, Jordan Belfort’s now-bankrupt investment firm “Stratton Oakmont” is a prominent example of a financial scheme that didn’t take the Ponzi path.
Stratton Oakmont, by any measurable metric, was the largest over-the-counter (OTC) brokerage in the country throughout the late 1900s. Before founding the firm with stockbroker Danny Porush, Jordan Belfort had opened a franchise of Stratton Securities, a minor league broker-dealer, and acquired the company when he discovered that the firm’s business model could potentially bring in millions under his leadership. During its operation, Stratton Oakmont was actively involved in the underwriting of 35 company initial public offerings (IPOs), among which the most prominent was fashion accessory giant Steve Madden.
Stratton Oakmont’s business model was nothing short of a pump-and-dump scheme, a form of microcap stock fraud that involves the artificial inflation of a penny stock through false and often positive advertising, followed by a massive selloff of the stock when it breaks a certain price target above its initial cost. Once the shares are sold, the stock usually plummets and leaves shareholders incurring massive losses while the executives, in this case, Belfort and Porush, collected massive profits. According to an SEC report, Stratton was used as a “boiler room,” or a room used for intensive telephone selling, and the firm’s stock manipulations followed a specific formula. Before an IPO, Stratton gained control over the “float,” or available shares outstanding of a certain stock, and doled out portions of the inventory to “nominees” with whom Stratton had entered into secret agreements with beforehand. Stratton would then manipulate the stock price and sell the artificially inflated shares to their own customers through high-pressure sales tactics while earning millions in profits. After being subject to a number of disciplinary actions by the National Association of Securities Dealers (NASD), the firm was finally shut down in 1996. In 1998, Belfort and Jordan were indicted for securities fraud and money laundering.
Though the cases outlined above are inherently related in that they are all financial scams that have left victims out of millions of dollars, there is something to be said about the amount of time it took government agencies like the SEC to notice, and meticulously examine these fraudulent firms for financial malpractice. In the case of Robert Shapiro’s Woodbridge Group of Companies, the entire business strategy was a Ponzi scheme from the get-go. Shapiro recorded fraudulent loans that he made to companies that were under his name, and relied on new investors to repay old ones. The result was relatively straightforward since most of his companies filed for bankruptcy, within a few years of beginning operations, after the loans that he actually made brought in negligible amounts of interest compared to the assets the company once held.
On the other hand, though Israel was also in the long term investment “business,” under his leadership, Bayou Hedge Fund Group saw nearly a decade of continued deposits from investors. As opposed to Shapiro’s case, Bayou’s premise guaranteed that the assets invested (in the millions) into the firm would see colossal gains in the course of ten years when the fund would be worth several billion dollars. In addition, since investors as well as the SEC couldn’t see that the fund was actually losing millions of dollars a year through bad trading practices, and instead, through false reports, were certain the firm was making record profits, Bayou saw continued investor deposits from optimistic investors. With regard to its downfall, authorities took issue with the firm only when Arizona officials noted that hundreds of millions of dollars were frequently being transferred from one bank to another, oftentimes from one country to another. In the firm’s aftermath, we can assume that had Israel continued trading (and losing money), rather than looking for foreign short term investments, it could’ve been several years before the firm’s fraudulent practices were discovered by the SEC.
The case of Stratton Oakmont undoubtedly has fundamental differences from the other two schemes. For one, rather than deceiving their clients regarding the future value of their investment, Stratton focused on the short term manipulation of a stock, and therefore, their clients who purchased the stock under false pretenses. Additionally, unlike the first two cases where the firm made money from the sale of direct “investments” as well as commission fees, Stratton made money by selling artificially inflated shares of penny stocks to foolish investors who’d been pitched the company’s bullish outlook. Furthermore, unlike the downfall of Woodbridge and Bayou, Stratton did not engage in the forging of financial documents but was rather caught in the act of selling shares of a new company at a rate significantly above its market price. Though Stratton has had a history of regulatory problems with the NASD dating back to 1989, it was only successfully caught in the act of “pumping-and-dumping” a stock in 1993.
Do Your Research, It Can Save You Your Retirement Fund
While a quick google search will only bring up the most prominent investment and financial scams, the fact is that millions of Americans are cheated out of billions of dollars every year. If you’re looking to invest a considerable amount of money, make sure that the institution of your choice isn’t guaranteeing massive returns in a relatively short period of time. In the world of finance, if it sounds too good to be true, it most likely is and will cost you a fortune. In addition, make sure in doing research on the firm that the financial statements are delivered by a respected third party and that the institution has been audited by a big-name auditor, preferably one of top four including KPMG and Ernst & Young or the like. Before investing, make sure you understand and trust the business model of the institution holding your money, so you can avoid losing your money and becoming a statistic.