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Get-rich-quick Schemes

With battered investors left to choose between low-return safe investments and slumping stocks, Oklahoma fraud experts are expecting an outburst of get-rich-quick schemes in the coming months. "So far, I don’t think our complaint numbers have risen,” said Irving Faught, administrator of the Oklahoma Securities Department. "I expect them to when we get out of the denial stage and into the reality stage.”

Elaine Dodd, Oklahoma Bankers Association fraud authority, said she’s also anticipating an increase in crimes preying on consumers, particularly those who have seen their nest eggs shrink dramatically. "I think when the economy is unbalanced, we’re all just a little more willing to suspend belief and jump at something,” Dodd said. "That’s not when we make our best decisions.”

Faught said investment losses have generated more complaints to his department, although that doesn’t necessarily translate into more fraud. The Securities Department investigates each complaint, although most turn out not to be scams — just bad investments, Faught said.

The agency has seen an uptick in reports of exotic vehicles designed to attract investors looking to bounce back from recent losses, Faught said. "The con artists follow the headlines,” he said. "If we are in crisis times and losing money, they try to offer you a risk-free higher return.” Although the fraud appears to be obvious when schemes unravel, Faught said, "They’re fairly irresistible when you’re in dire circumstances.”

An official with the Securities and Exchange Commission recently said the frequency of Ponzi schemes has not increased, but the size of the frauds has. The prime example is the $50 billion Bernard Madoff investment fraud that came to light in recent weeks.

Oklahoma has had its share of Ponzi schemes in the past several years, although none have been on the scale of the Madoff event. However, the pain for investors who lost everything is just as acute, Faught said. "In the substance of the matter, our people who lost hundreds of thousands instead of millions are just as bad off,” he said.

Dodd said Oklahoma’s relatively small population makes it more difficult to run a large scam. "I think people know who they’re dealing with here in a different way,” Dodd said. "It may be a large state, but it’s a small state. It’s easier to check things out here.”

Check out any investment before signing on the dotted line, Faught advises. Make sure any person offering a security is licensed to sell such instruments, and whether the investment is registered, he said. Much of that legwork can be accomplished on the Securities Department’s Web site.

A local banker can help identify many cons, Dodd said. For instance, the "advance fee” scam that offers a sweepstakes or lottery payoff after the victim pays some fee, often involves the use of a bogus check, which many bankers can flag, Dodd said. Dodd also likes the Invest Ed program run by the Securities Department.

The Ponzi scheme is a fraudulent investment program that pays investors from the proceeds of other investors rather than actual profits. The scam is named after Charles Ponzi, who employed it in the early 1900s. Here are some recent homegrown Ponzi schemes:

• Bill Hickman Sr. pleaded guilty in 2004 to swindling hundreds of investors out of more than $8 million in a Ponzi scheme run out of his Shawnee insurance agency. He promised annual profits of 20 percent or more, but no funds were ever invested. Money from later investors was used to pay off earlier investors and the remainder funded the Hickman family’s lavish lifestyle. Hickman was sentenced to 160 years in state prison to be served after completing an eight-year federal term.
• Marsha Schubert, a former licensed investment adviser based in Crescent, is serving a 25-year prison sentence after pleading guilty to money laundering and fraud. From 2000 into 2004, scores of Schubert’s clients lost more than $9 million, most of which Schubert redistributed to other investors. When the scheme unraveled, more than $3 million had disappeared and even the winners — who earned more than $6 million in "profits” — turned into losers as they had to return their gains.
• Phillip L. Raglin, 22, of Wagoner collected more than $800,000 from investors after promising remark-able returns, although he was not registered to sell securities. Raglin pleaded guilty in 2008 to money laundering and was ordered to serve a 10-year prison sentence and pay $1 million in restitution.
• Tulsa-based Powder River Petroleum International has been accused in court documents of running a Ponzi scheme by collecting more than $40 million from thousands of Asian investors seeking to invest in oil and gas properties, court documents show. The company spent little on buying up energy assets, records show. No criminal charges have been filed against the officers of the publicly traded company, which has been in bankruptcy since December.

Pyramid schemes now come in so many forms that they may be difficult to recognize immediately. However, they all share one overriding characteristic. They promise consumers or investors large profits based primarily on recruiting others to join their program, not based on profits from any real investment or real sale of goods to the public. Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure. There are two tell-tale signs that a product is simply being used to disguise a pyramid scheme: inventory loading and a lack of retail sales. Inventory loading occurs when a company's incentive program forces recruits to buy more products than they could ever sell, often at inflated prices. If this occurs throughout the company's distribution system, the people at the top of the pyramid reap substantial profits, even though little or no product moves to market. The people at the bottom make excessive payments for inventory that simply accumulates in their basements. A lack of retail sales is also a red flag that a pyramid exists. Many pyramid schemes will claim that their product is selling like hot cakes. However, on closer examination, the sales occur only between people inside the pyramid structure or to new recruits joining the structure, not to consumers out in the general public.

A Ponzi scheme is closely related to a pyramid because it revolves around continuous recruiting, but in a Ponzi scheme the promoter generally has no product to sell and pays no commission to investors who recruit new "members." Instead, the promoter collects payments from a stream of people, promising them all the same high rate of return on a short-term investment. In the typical Ponzi scheme, there is no real investment opportunity, and the promoter just uses the money from new recruits to pay obligations owed to longer-standing members of the program. In English, there is an expression that nicely summarizes this scheme: It's called "stealing from Peter to pay Paul." In fact some law enforcement officers call Ponzi schemes "Peter-Paul" scams. Many of you may be familiar with Ponzi schemes reported in the international financial news.

Both Ponzi schemes and pyramids are quite seductive because they may be able to deliver a high rate of return to a few early investors for a short period of time. Yet, both pyramid and Ponzi schemes are illegal because they inevitably must fall apart. No program can recruit new members forever. Every pyramid or Ponzi scheme collapses because it cannot expand beyond the size of the earth's population. When the scheme collapses, most investors find themselves at the bottom, unable to recoup their losses.

Some people confuse pyramid and Ponzi schemes with legitimate multilevel marketing. Multilevel marketing programs are known as MLM's, and unlike pyramid or Ponzi schemes, MLM's have a real product to sell. More importantly, MLM's actually sell their product to members of the general public, without requiring these consumers to pay anything extra or to join the MLM system. MLM's may pay commissions to a long string of distributors, but these commission are paid for real retail sales, not for new recruits.

The legacy of Mr. Ponzi lives on as pyramid and Ponzi schemes continue to plague us and challenge the law enforcement community. Fortunately, in the U.S., the Federal Trade Commission is just one among many agencies that have the authority to file suit to stop this type of fraud. The Securities and Exchange Commission also pursues these schemes, obtaining injunctions against so-called "financial distribution networks" which in fact sell unregistered "securities." The U.S. Department of Justice, in collaboration with investigative agencies like the FBI and the U.S. Postal Inspection Service, prosecutes pyramid schemes criminally for mail fraud, securities fraud, tax fraud, and money laundering.

State officials independently file cases in state court, often under specific state laws that prohibit pyramids. California defines pyramids as "endless chains" and prohibits them under its laws against illegal lotteries. In a slightly different vein, Illinois classifies pyramid schemes as criminal acts of deception directed against property. Some states like Georgia prohibit pyramid schemes under a statutory framework that regulates business opportunities and multilevel marketing.

Don Mecoy. Conditions favorable for fraud epidemic? The Oklahoman. February 22, 2009.

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