Ponzi Scheme in China: $7.6 Billion Lost

A recent article in The Economist elaborates on a massive Ponzi scheme that recently collapsed in China and caused 900,000 investors to lose about $7.6 billion.

Ponzi schemes are not new in China. In fact, China’s current lack of regulation in the peer-to-peer lending industry has created an environment ripe for fraud. This article points out how the lack of government regulation can lead to an economic environment where investors find it nearly impossible to distinguish between fraud schemes and legitimate businesses. We can also learn a few additional things from this Ponzi scheme that might help investors identify when something really is too good to be true.

The SEC's Record with Large Ponzi Schemes: Not So Hot

I've been listening to Harry Markopolos's book, "No One Would Listen: A True Financial Thriller" (I recommend it by the way) and have been surprised at how much of the book is devoted to criticizing the SEC. From Harry's account, the SEC totally dropped the ball and was incompetent, corrupt or both in how it handled the Madoff case. I personally think he has a pretty good argument and that the SEC has managed to avoid serious consequences even though the Madoff case was a tragedy that they could have prevented.

Well, now that the Stanford Ponzi scheme is being tried, we are learning that the SEC also dropped the ball with Sir Charles. It may be that the SEC really doesn't understand Ponzi schemes or that they are underfunded, undereducated, understaffed and under-incentivized. All we know for sure is that they appear to be underperforming. Reuters has an article that talks about how Sir Charles was able to keep the SEC at bay for so many years while he built his Ponzi empire, complete with retail offices in the U.S. I recommend it for further insight.

One claim by Markopolos is that the SEC staff are all basically looking for a job in industry to make more money. As such, when they go to investigate a firm, they also ask for a job application. The Reuters article seems to add a second witness to this claim as it describes a former SEC investigator by the name of Barasch and his role in helping Stanford stay out of the SEC's crosshairs:

Barasch was told at the time by an SEC ethics officer that he was legally precluded from representing Stanford. Barasch went to work for Stanford anyway. In a later investigation of the failure to catch Stanford earlier, the SEC Inspector General asked Barasch why he did so. His reply, according to the Inspector General's report: "Every lawyer in Texas and beyond is going to get rich over this case. Okay? And I hated being on the sidelines." 

FBI agents and prosecutors also uncovered evidence that on at least two occasions Barasch sought confidential information regarding the SEC's probe of Stanford during his brief representation of the banker, Justice Department officials said in court records and a press release. 

In agreeing to pay the fine, Barasch denied any misconduct, settling the matter "to avoid the expense and uncertainty of protracted litigation," his attorney, Paul Coggins said.

Another claim by Markopolos is that the SEC seemed to avoid taking on the Madoff case because it was too large and complex. Instead, they went after cases that Harry describes as fleas while the elephant (Madoff) was running free. This Reuters article also seems to bear this out in the following quote:

In 1997, 1998, 2002, 2004, and 2005, according to internal agency records seen by Reuters, examiners for the SEC recommended that the agency investigate Stanford. In three of those instances, Barasch, at the time an SEC official in Ft. Worth, personally overruled the examiners' recommendations, according to those records. Those decisions helped the Ponzi scheme to continue unabated for several additional years, costing investors additional billions of dollars, according to a report by the SEC's Inspector General. 

Barasch told the SEC Inspector General that he made those decisions because he was not sure the SEC had the statutory authority or jurisdiction to investigate. He blamed his superiors and a broader culture within the SEC for pressuring the staff not to pursue complex and difficult cases, according to the Inspector General report. 

Apparently, Barasch was able to help Stanford both while he worked for the SEC and after he went to work for Sir Allen (i.e. Stanford) himself. Sounds like a bad case of a corrupted fraud investigator. I have a feeling I will be reading another book in the future about how the SEC dropped the ball in the Stanford Ponzi scheme too, costing thousands of people billions of dollars.

Stanford Trial: Two Friends Become Enemies

The NY Times discusses how the trial regarding the alleged Ponzi scheme run by R. Allen Stanford will pit Stanford against his long-time friend and CFO of Stanford Financial Group before it collapsed, James M. Davis. It's a classic example of the Prisoner's Dilemma. Here are some excerpts:

How to Avoid Becoming a Fraud Victim

Since Bernie Madoff's massive Ponzi scheme hit the news two years ago, there have been countless other Ponzi or pyramid schemes that have quietly failed under the radar. For example, have you heard of Sir Allen Stanford's Ponzi scheme? If you read this blog, you probably have but others I talk to haven't heard of Stanford's $7 billion Ponzi scheme. This is a new phenomenon brought about by the shear size of Madoff's scheme. Anything else seems insignificant. Prior to Madoff, a $10 million Ponzi scheme that came to light in a community would be big news and a $50 million scheme would make national news. Nowdays, a $200 million local Ponzi scheme gets mentioned by a small blurb in conjunction with the weather forecast: "Rain in the forecast tomorrow and investors lost $200 million in local Ponzi scheme. More on the forecast at 10pm." That's it--not even a complete sentence about the scheme!

So many Ponzi schemes have come to light in the past two years or so that I hope people are becoming wiser to the con artists who were thriving before the great recession. I'm also hopeful that the silver lining in the great recession is that these economic parasites will be cleansed from our colon and the economy can be more productive as a result. Unfortunately, unless we learn some basic lessons, my hopes may be unfounded. Here are my top five tips to keep the scammers away from your bank account.

Madoff's Anniversary: Oldest Son Commits Suicide

Saturday, December 11, 2010 was the two-year anniversary of the day when Bernie Madoff's sons, Mark and Andrew, contacted law enforcement officials to notify them that their father was running the largest Ponzi scheme in history. On this same day, Bernie and Ruth's oldest son, Mark, decided he could no longer take the emotional trauma and he took his life. Unfortunately, this is the second suicide linked to Bernie Madoff's scam. Just a few weeks after the Madoff scam came to light in 2008, one of his investors who managed others' money in the scame Rene-Thierry Magon de la Villehuchet, was found dead after he slashed both of his wrists. Here are the gory details of Mark's suicide and some thoughts on this tragic disaster that Bernie left for others to clean up.

Charlie Chaplin's Time Traveller

A friend pointed me to an article on Boston.com that discusses a YouTube video that has gone viral on the web. In the video, a guy named George Clark analyzes a Charlie Chaplin film scene where a person that appears to be a woman walks by while talking into something that Clark concludes must have been a cell phone. Since cell phones were non-existent in Chaplin's day, Clark concludes that the woman must be a time traveller.

Well, let's think about this for a minute. How would a time traveller be able to talk into a cell phone back in Charlie Chaplin's day? I may not understand time travel well enough--even though I have watched Napoleon Dynamite several times---but I don't think this woman could use her iPhone from 2050 when she was back in the 1920s. Are we asserting that her cell coverage also travelled forward in time? If not how did this phone work.

One possibility is that two people travelled back to 1920 with their cell phones. This sounds good if we think our cell phones just work between themselves like walkie-talkies. However, unless the technology changes dramatically between today and when time travel is perfected, these two time travellers would have needed to bring at least one cell tower, a satellite and the equipment to communicate to the satellite and a rocket to launch the satellite into space. They also would need computers and people to keep all that running.

Well, I'm wondering why this video is going viral on the web. Is it because people are that gullible and don't think enough about the implications that they think this guy might have discovered evidence of time travel? If so, there is little hope that the Ponzi schemers of the world will be out of business any time soon...In fact, as soon as a fraud perpetrator watches that video, he will probably set up a Ponzi scheme that guarantees 25% per month returns on a company that has discovered time travel!