Banks and Ponzi Schemes

I’ve said it so many times it’s almost becoming a mantra: It’s virtually impossible to carry out a major Ponzi scheme without the complicity of a large bank.  The receiver that was court-appointed to recover what’s left of Danny Pang’s billion-dollar investment fraud has provided the latest proof.

According to the receiver, HSBC Bank gave Pang the patina of legitimacy by allowing his firm to issue so-called net-asset-value reports on HSBC letterhead that were false.  Some of these statements were even signed by an HSBC official.  The receiver is seeking to recover from HSBC nearly $2 million in fees and unspecified damages.

Bank of America figures prominently in Ponzi schemes in Florida and Long Island and allegations have emerged that JP Morgan Chase may have abetted Bernard Madoff’s Ponzi scheme. Unfortunately, a 2007 Supreme Court decision known as Stoneridge makes it considerably more difficult to hold third-parties legally culpable for fraudulent schemes.

Senator Arlen Specter (D-PA) last July sought to pass legislation to remedy the Supreme Court decision, but the bill died a near instant death.  The Financial Reform Bill provides no legal avenue to offset the Stoneridge decision. Sadly, Specter last week lost the Democratic primary. Such is the fate of one of the few politicos willing to stand up to Wall Street.

Suit Says Schwab Misled Investors

FINRA’s Arbitration Statistics a Bad Omen for Brokers

Earlier this month FINRA issued securities arbitration statistics for 2008 and, in my estimation, Wall Street should prepare for a wave of claims the likes of which we’ve never seen before.  This year marks the beginning of a ‘claim boom,’ resulting from the credit and housing crisis.  It is analogous to the spike in claims after the tech bubble rocked investors in 2000.  There are similarities between these two eras and there are also some stark differences; but the end result is the same: Wall Street’s incompetence, deceit, and outright greed manifested itself in the form of painful losses for investors.

Let me be clear, losses that investors have suffered as a result of the credit and housing crisis are dramatically worse than during tech bubble fallout.  And the number of investors who suffered losses is likely to be much higher too because the contraction occurred across nearly every asset class.

Therefore, based on how last year’s statistics relate to 2000, I fully expect that in 2009, the amount of claims filed will approximate 8,000. Not only that, the numbers will increase from there in subsequent years.

To wit, in 2007, 3,238 claims were filed.  Last year however, 4,982 investors filed claims, an increase of 35 percent.  Now, consider these statistics compared to the tech bubble era:

• 2000 (tech market begins to fracture): 5,559 claims filed
• 2001 (tech bubble collapses): 6,915 claims filed
• 2002 (investors begin to realize their losses and understand their rights): 7,704 claims filed
• 2003 (investor anger is at its apex): 8,945 claims filed
• 2004 (investors continue to lick their wounds): 8,201 claims filed

There is a six-year “eligibility” period during which investors can file arbitration claims against brokers.  This will give investors who currently don’t understand their full legal rights time to file claims.  In fact, we received calls from investors with losses in tech stocks as late as 2006.  Indeed, investors may still be filing arbitration claims related to the current crisis as late as 2014.

The Signs Were There

For me, the hardest aspect of the current era is that investment losses were easily foreseeable.  Brokers either turned a blind eye knowingly or were incredibly negligent. Either way, they failed their customers miserably. The list below reflects some huge red flags leading up to the credit crisis and throughout the past year. Any one of these events alone should have prompted brokers to adjust portfolios to minimize the destruction:

• Early 2007: Collapse of the sub-prime mortgage market surfaces with New Century and Countrywide facing bankruptcy
• June 2007: Two Bear Stearns hedge funds collapse - a seismic shock to the mortgage backed securities market
• September-December 2007: Financial services firms, including the nation’s largest brokerage and mortgage firms, begin writing down billions of losses due to exposure to failing mortgages
• March-June 2007: Wall Street firms tap sovereign wealth funds to shore up their battered balance sheets
• February 2008: The $330 billion auction rate securities market collapses, sending credit markets into turmoil
• March 2008: Bear Stearns collapses
• June 2008: Short seller David Einhorn publicly accuses Lehman Brothers of potentially fraudulent valuations of toxic debt
• August 2008: Fannie May and Freddie Mac enter into conservatership
• September 2008: Lehman Brothers collapses
• October 2008: The worst month in banking industry history

The point is, we were warned. Over this period the markets dropped an astounding 40-50 percent.

To be quite honest, I think my estimate of 8,000 arbitration claims is inaccurate.  The real number is likely to be much, much larger.

Tips to Avoid a Ponzi Scheme

1. Be wary of recommendations from brokers or financial advisors based solely on the fact that they are a member of an organization or religious or ethnic group to which you belong.
2. Investigate the investment thoroughly and check the truth of every statement you were told about the investment.  You can research on the Internet any stocks or other investments that are being pitched.
3. Be very cautious and avoid promises of “guaranteed” returns or spectacular profits.  In the last year or so, the market has declined over 40%.  Anyone promising to make money such as 10 or 15% on an annual basis when the market is going down is likely to be a phony.
4. Be skeptical of any investment opportunity that is not in writing.  If someone has something real to offer they will put it in writing, otherwise it is not real if simply said orally.
5. Don’t be pressured or rushed into investing in a “once in a lifetime” or “can’t miss” opportunity.  Legitimate investment opportunities are not rushed to investors and investors must be given time to carefully think about and investigate the proposed opportunity.
6. Check out your brokers on FINRA.org.  Check out your broker’s customer complaint, regulatory history and employment history .
7. Check out investment advisors on the SEC’s database.
8. Do not do business with unregistered investment advisors.
9. Avoid anyone who has prior customer complaints or regulatory problems and avoid brokers or advisors who have switched firms repeatedly (at least three changes in a five year period).
10. Make sure that any investment is held at a known reputable financial institution (Citibank, Bank of America, etc.) and that there is a specific account with your name on it and an account number.  Verify that the money is in fact being held by the bank.
11. Never make a check out personally to an investment advisor or a small unknown company.  It is possible or even likely that your money will be stolen.
12. Check to see if the investment advisor has a website.  If there is no website, this is a big red flag that your broker or advisor is not legitimate.
13. Make sure you understand the investment advisor’s strategy and what he or she will put your funds in.  If you don’t understand it after speaking with the advisor and doing your own independent research, avoid the investment.
14. If it‘s too good to be true, it probably is.

Joseph Forte: Bernie’s got Company

Just as Bernie Madoff proved, and others before him, the Ponzi scheme did not end with Charles Ponzi and it appears it won’t end with Bernie Madoff either. The Pennsylvania fund manager, Joseph Forte, seems to be the latest alleged fraudster.

According to the SEC, Forte began Joseph Forte LP in 1995 and obtained $50 million from roughly 80 investors. He lured his investors by giving them a limited partnership in his firm and employed an investment strategy that traded S&P. 500 stock futures in addition to foreign currency futures and other futures contracts. He promised unbelievably generous returns between 19% and 38% annually, according to the SEC. Amazingly, these returns would make Forte’s fund, however fraudulent, appear to be an even better investment than Madoff Securities.

Ironically, it may have been Madoff’s downfall that led Forte’s investors to reveal his alleged fraud. As an aside, the SEC might try to take credit for bringing down Forte but I’m skeptical. According to the Philadelphia Inquirer, an investor sent Forte an email asking that he confirm assets in the supposedly inflated $150 million fund. It’s suspected that many investors filed suit and Forte realized then his alleged fraud would become exposed. According to the Commodities Futures Trading Commission (C.F.T.C), Forte then promptly turned himself in.

As I’ve said before, fraudsters usually get exposed eventually. But the trick is not to get caught up in one of these schemes in the first place. The most important take away for any investor is that they should take exceptional care when choosing where to invest their money. They should understand their money manager’s investment strategy and should expect realistic returns on their investment. This may all seem very obvious to some but too often smart investors are taken advantage of by a seemingly safe investment or are blinded by lavish returns. One lesson I hope will last is that investors should not allow someone who they consider to be a friend, manage their money. This can only lead to clouded judgment. .

Like Madoff and Forte or before them, Peter Dawson in Long Island, NY and Joseph Shereshevsky of WexTrust, perpetrators of financial fraud don’t only strike the ultra-high net worth individuals or institutional investors. They also hit mom and pop investors, religious communities, public institutions and non-profit organizations. I’ve been an investor advocate for a long time and while I’ve seen it all, I still cringe when I hear about these cases.

Hopefully, a small silver lining will be that the people who deceive investors’ confidence for their own benefit will be slowly exposed and eliminated. And while I’m certain that is of no solace to investors who lost their money with Forte, there still might be options on the table for investors to recoup some of their lost funds.

Fund of Funds Pass the Buck and Lose It For Their Clients

“If it sounds too good to be true…It probably is.”

We’re hearing this phrase repeatedly with regard to Bernie Madoff’s alleged Ponzi scheme.   Under a cloak of secrecy, Madoff’s funds reportedly delivered handsome returns year after year regardless of market volatility.  To the best of my knowledge, only the Treasury Department can print money, but apparently that fact was lost on a great many of so-called “sophisticated” investors.

Retirees and smaller investors deserve a pass (and their money back) for falling victim to Madoff’s reported schemes.  Even if the returns were unbelievable, they didn’t have a frame of reference to make a complete judgment.  After all, Mr. Madoff was a respected member of several wealthy communities and donated large amounts of money to various charities. On the surface he appeared to be a Wall Street legend.  By the same token, if any reasonable amount of due diligence had been performed, the red flags were out in the open.  From his secret formula, to outsized returns and even a one-room auditing firm, there were plenty of reasons to be suspicious of Mr. Madoff.  And indeed, many were and chose to invest elsewhere.

Which is why, as we all shake our heads at the clear signs of fraud, we should be shaking our fingers at the managers of the feeder funds who ignorantly - perhaps even fraudulently - invested huge percentages of their assets under management with Bernie Madoff.  It is the fund of funds manager whose job it is to be on the look out for warning signs of potential fraud risks.  They have a fiduciary responsibility, and are paid handsomely, to make suitable investment decisions for their clients.  They were paid to have the frame of reference individual investors cannot possibly have.

Fund-of-funds exist to seek out and vet the very best - and safest - money managers.  They are also expected to diversify so that in case of a large collapse, the damage is mitigated.  They are usually paid 1 to 1.5 percent of total assets under management as well as a hefty chunk of the returns.  One of the fund-of-funds that had significant exposure to Madoff Securities is Ascot Partners, managed by J. Ezra Merkin.  He has reportedly lost $1.8 billion of his client’s money. According the New York Times, Mr. Merkin took just three paragraphs to explain his losses to clients; this compared to a fifty-four page offering memo.

Ascot, as well as other feeder funds such as Fairfield Greenwich, Tremont and Maxam Capital Management could have significant liability for their losses if in fact their firms did not perform a reasonable amount of due diligence for which they were paid. Through this negligence, they may have empowered Mr. Madoff to pull of what many are saying is the scam of the century.

In addition to negligence, it’s likely that there are disclosure issues at stake. Fund-of-fund investors likely had no idea such a huge percentage of their money was under Mr. Madoff’s control - or any single money manager for that matter.  Huge concentrations like this are indicative of “style drift,” which occurs when a manager diverges from the original strategy promised to investors…usually because of large losses.

For these reasons and the impending litigation, the fund-of-funds industry has been dealt a huge blow.   It was redemption requests that led to Bernie Madoff’s undoing.  I certainly hope he’s an exception to the norm, but I have my doubts.

Madoff Securities Alleged Ponzi Scheme Exposed: What’s an investor left to do?

In a bull market, investors are happy and tend not ask many questions. But when times get tough, they start wanting answers and Ponzi schemes are inevitably discovered.

The latest, of course, involves Bernard Madoff, a fixture on Wall Street for decades and one of the creators of the NASDAQ exchange. Mr. Madoff is the founder of Bernard L. Madoff Investment Securities. He was arrested by Federal Bureau of Investigation agents and charged with criminal securities fraud by federal prosecutors in Manhattan. The SEC has shown up late to the party once again and filed a civil suit, years after they were alerted of suspicious activity at Madoff Securities’ investment arm. All told, the alleged Ponzi scheme totaled $50 billion, possibly half of which was investor funds.

Naturally, Bernard Madoff’s clients are wondering if there’s anything left, and if so, how they can get their money back. Some investors will have an up-hill road to travel but for others there are legal options they can immediately pursue.

Firstly, to the extent that there are any funds left, claims can be filed against Madoff Securities directly. But it’s unlikely that there will be any money left. “It’s all a lie,” Mr. Madoff told investigators who were there to arrest him.

And it is doubtful there will be any recourse through the Securities Investor Protection Corporation (SIPC) because the money management function at Madoff Securities was held outside of the brokerage unit.

But investors that were placed into the Madoff Funds through other “fund-of-funds” or by another hedge fund manager could have more maneuverability. Indeed, managers of fund-of-funds could have liability for failing to perform a reasonable amount of due diligence on Bernard Madoff’s dealings. They had an obligation to research Mr. Madoff, his firm, and his returns. Managers of fund-of-funds were compensated to do this and likely marketed their due diligence capabilities to their clients.

The red flags were very clear in this case. Perhaps the most compelling was the fact that Mr. Madoff was generating such high returns using a strategy tied to the S&P 500. And this was all happening while the overall market sank in 2008!

The magnitude of Mr. Madoff’s deception is astounding. And the destruction of wealth that has apparently occurred here is shockingly awful. But if there is a silver lining to this at all, it’s that during this economic crisis the unnecessary middle men, fraudsters, hucksters and Wall Street’s ugly underbelly are being exposed and eliminated.

While that is likely of no consolation to Madoff Securities clients and investors, rest assured, they will also have their day in court.

The Perils Of Peddling Faulty Microwave Ovens

Retail investors historically have had very short memories. I’d crash your computer if I recounted all the scams and cons I’ve seen in the three decades I’ve represented individual investors, yet somehow Wall Street’s systemic fraud and dishonesty never seems to lead to a shortage of customers. Even the dot.com fraudulent research scam didn’t lead to a massive client exodus.

But Wall Street might have exploited its customers one time too many. According to a survey by Prince & Associates, a whopping 81% of investors with $1 million or more of investible assets plan to change investment advisers. An even larger number, 86%, plan to tell other investors to avoid their adviser. A mere 2% of investors plan to recommend their broker to other investors. So much for those client referrals…

Admittedly, not all “investment advisers” are brokers at the big Wall Street firms, but “wealth management” has been one of their major focus areas these past few years. And $1 million in investible assets wouldn’t even get you a meeting with the receptionist at the top-tier multifamily offices.

I suspect one of the tipping points might have been the marketing of auction rate securities, which Wall Street sold as cash equivalents but were in fact quite risky. Amazingly, these securities were aggressively sold to Wall Street’s most wealthy - and profitable — customers. Brokers were under considerable pressure to move those microwave ovens.

One of the few growth businesses in the months ahead will be conflict free multifamily offices with established and unblemished track records serving the interests of their clients. Indeed, marketing tools multifamily offices might want to consider are the state attorney general ARS complaints against the big brokerage firms, such as Massachusetts’ARS lawsuit against Merrill Lynch. These easy-to-understand complaints unquestionably offer some of the most impressive insight into the conflicted workings of Wall Street ever written.