Scrutiny reveals wave of apparent scams

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Scrutiny reveals wave of apparent scams
By Joanna Chung in New York
Published: January 25 2009 20:34 | Last updated: January 25 2009 20:34
What do a plane crash, a missing Florida businessman and Bernard Madoff have in common?

They are part of a wave of “Ponzi’’ schemes and other financial scams coming to light in recent weeks. The alleged $50bn “Ponzi” scheme by Mr Madoff, the New York broker, is by far the biggest and most high profile. But investigators across the US are chasing a raft of similar, albeit smaller, frauds.


In Florida, the Securities and Exchange Commission last week accused Arthur Nadel, a hedge fund manager who has gone missing, of defrauding investors and allegedly overstating the value of investments in six funds he advised by about $300m. Authorites are searching for Mr Nadel, dubbed as “mini-Madoff’’ by local media.

Meanwhile, an Indiana financial adviser, Marcus Schrenker, who was wanted on financial fraud charges, has been accused of trying to fake his own death in a plane crash. He has pleaded not guilty and was to undergo a psychiatric examination to determine whether he was able to stand trial.

The 38-year-old took off alone in his Piper aircraft on January 11 from Anderson, Indiana, heading for Destin, Florida. But over Alabama he issued a Mayday call to air traffic controllers telling them his windshield had shattered and he was bleeding profusely. Police believe he then baled out of the aircraft with his parachute.

Two F-15 jets were scrambled to intercept the aircraft and the pilots reported that the aircraft was empty and apparently flying on auto-pilot. The fighters followed it until it crashed in East Milton, Florida, not far from a populated area.

One of the latest cases came on Friday from Chicago where a suburban businessman who allegedly promised investors 10 and 15 per cent annual interest rates on promissory notes, was accused of operating a “Ponzi’’ scheme for more than 20 years – resulting in losses estimated in tens of millions of dollars.

The apparent rash of scams does not necessarily mean more are occurring, but that more are being exposed as frauds, experts say. After the alleged Madoff scheme became known, some investors have begun to question their advisers more closely about how they generate what appears to be unusually high or steady returns.

“When the market goes down and the economy is distressed, people are more watchful about their investments and where their money is going . . . especially since there is less abundance of capital to work with,’’ says Blake Coppotelli, a senior managing director at Kroll, the corporate investigations group.

It is also harder to hide “Ponzi” schemes and other scams during a down market. For instance, Ponzi or pyramid schemes, with slight variations, effectively “rob Peter to pay Paul’’. Early investors at the top of the pyramid are paid off with money from new investors at the bottom, requiring a constant search for new investors.

Mr Madoff’s alleged scheme apparently became unworkable when he was faced with $7bn of redemptions from investors and could not pay them.

Fraud cases tend to spike immediately after downturns. Following the savings and loan crisis in 1990, white-collar fraud arrests rose by more than 50 per cent over the next two years, according to the National White Collar Crime Center. Following the 2000 internet bust, arrests jumped 25 per cent in the following two years.

Over the course of the next 12 months, the Commodity Futures Trading Commission, the futures market regulator, expects a 25 per cent increase in commodity pool or hedge fund fraud case filings – above the 15 cases filed during the preceding 12 months because of Ponzi scheme activity, says Stephen Obie, acting director of enforcement.

The SEC, which is conducting one of the investigations into Mr Madoff’s alleged scheme, categorises Ponzi schemes as a securities offering frauds. There were 115 enforcement actions related to overall offering frauds in 2008, compared with 68 and 61 actions in 2007 and 2006, respectively.

Mr Coppotelli expects there will a growing number of fraud cases, in addition to “Ponzi” schemes this year. A shortage of business opportunities also means that some companies struggling to maintain revenue streams could “adopt fraud as an acceptable alternative strategy,” he adds. Such expectations have raised questions about law enforcement resources.

US Senators Charles Schumer and Richard Shelby last week introduced bipartisan legislation asking for an additional $110m annually to hire more white-collar crime investigators. “Our white-collar crime divisions are understaffed, underfunded and overwhelmed,’’ Mr Schumer says.

Copyright The Financial Times Limited 2009