Is there a new wave of Ponzi schemes coming? There’s a possibility

One impact of the last economic downturn (like others before it) was to expose the many Ponzi schemes that were being perpetrated. The largest of them was Bernie Madoff’s multi-year, multibillion dollar scheme. Sitting in Madoff’s shadow were still well-known, but lesser lights of Allen Stanford and Stanford Financial Group and Scott Rothstein and Rothstein Rosenfeldt Adler P.A.

Each of these criminal enterprises caused potential losses in the billions of dollars, and caused millions of dollars in damage to the South Florida community. They affected hundreds, if not thousands, of people — both in terms of investors who lost their investments and the innocent employees who lost their jobs.

In a Ponzi scheme, no investment actually takes place. Instead the perpetrator simply repays earlier investors with the funds from new investors. The perpetrator does not create any wealth through industry or investment. Such a scheme will eventually collapse.

Since the Great Recession, the number of Ponzi schemes uncovered and their size has diminished markedly. In 2015, according to www.ponzitracker.com , there were 61 uncovered Ponzi schemes with collective potential losses of approximately $800 million. This represents a decrease of 10 percent in the number of Ponzi schemes uncovered in 2013 and 2014. The potency of the schemes also appears to be decreasing as the estimated losses for the 2015 uncovered schemes is 25 percent less than in 2014. Moreover, only one scheme in 2015 appears to have losses of more than $100 million.

The data supports two possible theories: Ponzi schemes are less prevalent and less potent today than they were a decade ago; or, the relatively buoyant financial recovery has allowed these schemes to remain hidden for longer. It is our view, based upon decades of collective experience in the industry, that the second explanation is more likely.

Since Charles Ponzi originally developed his creative (and fraudulent) financing of postal reply coupons it appears that the size, breadth and scope of Ponzi schemes has been accelerating not decelerating. A simple review of the Wikipedia list of Ponzi schemes demonstrates the magnitude and speed at which these types of schemes have increased.

It is doubtful that any one factor beyond greed is responsible for the increase in scope and complexity of financial frauds. Indeed, we believe that at this very moment there are myriad Ponzi schemes (and similar financial frauds) in operation and that just a simple economic change will expose them. It is very possible that material change in interest rates will induce investors to bring their investment dollars back into traditional safe investments and lead to Ponzi operators’ collapse.

No justice system on the planet has developed a coherent and guaranteed way to make the victims of a Ponzi scheme whole again. Indeed, since one of the hallmarks of a Ponzi scheme is the payment of older investors with the funds from new investors, it naturally pits the early investors against the newer investors. Moreover, the perpetrators of the fraud are often ostentatious high-living individuals who siphon off tens (or hundreds) of millions of dollars for their own benefit.

Rothstein is a prime example of this. He prominently flaunted his millionaire lifestyle replete with mansions, exotic cars, private jets and rich friends, which was part of the criminal enterprise that allowed him to gain the trust of otherwise smart people. This was integral to his fraud. Of course, his fancy dinners, lavish vacations and other discretionary spending could not be fully recouped in order to make investors and victims whole.

The best way for investors to protect themselves is to follow these simple steps:

▪ Understand the deal, which means understand where the risk is and why the investor is entitled to a return.

▪ The risk should match the return; “risk-free with high returns” is a red flag.

▪ Hire professionals to analyze the deal. Any business lawyer with experience will spot issues and problems with most deals quickly.

▪ Trust your instincts, not the paper. This means if something is “too good to be true” or “doesn’t quite feel right,” then trust your instinct and do not place all of your trust in legal documents that may be shown to you.

The human capacity for greed is rarely curbed. However, any combination of capital flight or economic weakening will lay bare these frauds. In the current political climate, South Florida may be particularly susceptible if the Latin money invested here begins to flee to other more accepting or welcoming jurisdictions.

It is almost a certainty that right now there are people being victimized by fraudsters who are running Ponzi schemes. Upon their discovery, millions of dollars will have been lost and millions more will be spent in legal wrangling as these schemes wind through the justice system. Now, during the upswing in the economy, is the time one must be most vigilant. Our experience in the Rothstein, Madoff and other cases tells us that another wave of Ponzi scheme cases is likely just around the corner.

James Gassenheimer is a partner at Berger Singerman and member of the firm’s Business Reorganization and Dispute Resolution practice groups. Isaac Marcushamer is also a partner at Berger Singerman and member of the firm’s Business Reorganization practice group. www.bergersingerman.com

This story was originally published March 19, 2017 at 5:00 PM with the headline "Is there a new wave of Ponzi schemes coming? There’s a possibility."