The typical advice investors receive about financial fraud is this: If it sounds too good to be true, then it is.
But that advice too often is ignored.
An investigation by The Durango Herald into a Southwest Colorado-based Ponzi scheme shows that new methods of investor education might be needed – methods that focus more on investors' psychology than on their business savvy.
Victims of Ponzi schemes have such a will to believe they're making money that they often ignore advice, and some victims even blame authorities when the scheme falls apart and the promoter is arrested, said Fred Joseph, Colorado's securities commissioner.
Joseph once tried hard to convince a Pueblo man not to send $50,000 to Belgium for the promise of getting millions in return.
“They want so badly to believe in the tooth fairy,” Joseph said. “I don't think the guy ended up doing it, but I don't think he was too happy with me.”
But many investors are just trying to find better places to put their money in an era of ultra-low interest rates, Joseph said.
Joseph's best advice is to look for three red flags:
The investment promises a higher return than most investors can get on the regular markets.
It promises low risk or no risk.
Investors have to act immediately or lose their chance to make money.
Hurricane of fraud
That advice has been around a long time. But investment fraud continues to be a huge drain on the economy.
Computer Evidence Specialists, a private firm in Florida, estimated securities that fraud – a category that includes Ponzi schemes – cost Americans $40 billion a year. That's about the same as the damage that Hurricane Sandy did to the East Coast last year.
The victims include not just unsophisticated people, but educated and wealthy people as well.
Denver Broncos legend John Elway lost money to Colorado Ponzi schemer Sean Mueller.
Bernie Madoff, who ran the biggest Ponzi scheme in history, swindled movie director Steven Spielberg and former New York Attorney General Eliot Spitzer – who made a career out of cracking down on financial crime.
Fred Baker ran a scheme out of Durango in 2006 and 2007 that federal authorities say caused $1.2 million in losses, but in actuality might have been a lot worse.
Baker exemplifies a new trend in financial crime. He set up a Ponzi scheme to invest in other Ponzis, thinking he could beat the system and reap the initial high payouts in high-yield investment programs.
HYIPs usually bear the classic trademarks of a Ponzi scheme, promising “too good to be true” returns for minimal risk, and they do a thriving business on the Internet.
“Telling people that it is too good to be true won't do it, because the emphasis is going to be on 'good' and not the other side of it,” said Tamar Frankel, a Harvard law professor who published a book last year called The Ponzi Scheme Puzzle.
People fall for con men because they don't understand their own weaknesses well enough.
She suggests that investors always wait at least three days to invest after hearing about an “opportunity.” And they should explore the background of the person offering the investment and never invest with someone who isn't a licensed securities dealer.
American culture has ambivalent feelings about con men and their victims, Frankel said.
“Our culture suggests everyone should take care of themselves, and if you're foolish enough, I'll skin you,” she said.
Perhaps the best advice comes from Baker himself, on one of his last posts on Twitter before reporting to prison:
“Overconfidence – Before you attempt to beat the odds, be sure you could survive the odds beating you.”