A Calgary judge recently sentenced two men to 12 years in prison for one of the largest Ponzi schemes in Canadian history, the Calgary Herald reports. The pair left thousands of victims in their wake, with total losses estimated up to CA$400 million. Investors were promised an annual return of 34 percent, with low risk, that would grow their initial CA$99,000 investment to more than CA$1 million in eight years. They were told the business involved selling gold for refining. The judge said that some of the victims were left homeless, became suicidal, and suffered rejection by friends and family.
This is not a typical Ponzi scheme — it's worse. Typically, the fraudsters take money from investors and form shell companies, moving the money offshore to an account that feeds those companies before moving it again. A portion of that money will go to an actual operation or toward building something that looks real. In this case, it was all shell companies and nothing was produced. It is also not unlike another famous Canadian gold mining scandal, Bre-X Minerals, where there appeared to be a viable mining opportunity but no production. At no time did Bre-X officials say they would be producing gold.
Vigilance on the part of regulators, as well as a highly proactive whistleblower, were critical elements in detecting this fraud. A red flag was raised when one of the Alberta Security Commission's own staff members spotted a newspaper ad promising investors a fantastic rate of return from the fraudsters' company. The son of an elderly investor couple, also an accountant, detected the fraud and launched a campaign to expose the ringleaders Milowe Brost and Gary Sorenson.
Much has been written about strategies that individuals, organizations, and auditors can use to prevent Ponzi schemes. Here are a few more that come to mind, related to this case:
- Be skeptical of pitches to get financially involved in exotic, obscure, or "too good to be true" investments. If you get a pitch for an asset class you're not familiar with, make sure you understand the process by which it achieves returns. If you don't understand it or your advisor cant explain it clearly, you probably shouldn't be get involved. Also beware of unusual and/or secretive conditions for getting involved. For example, those promoting the Merendon investments encouraged people to mortgage their own homes. Another example: the two fraudsters in our story used fear to build their empire, demanding that investors sign privacy agreements that later made them nervous about talking to police. Also, be especially wary if your adviser downplays or denies risk. Don't be fooled by "salting" techniques regarding the rewards of investing. Brost and Sorenson, for example, were known for showing off enticing evidence of their success: little plastic bags containing silver and gold. Finally, a key question not asked often enough in these situations and before investing is, "How and when can I get my money out?"
- Be prepared to commit some time and effort to deeper research before you invest. Put on your gumshoes and find out how long the company has been in the business, as well as the career histories of key senior company officials. The other investors you may learn are also involved aren't necessarily a good indication of whether you should be confident. One Merendon investor was finally convinced after his accountant said he, too, had put money into the company. Check the logic of what is being claimed as the basis for good returns on an investment. In our story, Stone Mountain Resources was spending hundreds of thousands dollars putting infrastructure into a location in which no precious metals/minerals had been located. There was no indication that the area was economically viable, yet roads, a bridge, and several buildings were put in. A site visit could be very helpful (but not necessarily welcomed by fraudsters – they frequently also place sites in far-off locations). Some of those defrauded in our story were offered trips — at their cost — to see the mine and refinery in Belize, but they declined.
- Those nearing or in retirement are especially at risk and need to protect themselves. A large portion of the investors in our story were retirees. According to a recent study by the North American Securities Administrators Association, nearly half of all investor complaints submitted to state securities agencies came from seniors. It's alway tempting to seek higher returns, but seniors are likely best advised to stick to well-known investments, investment companies, and financial advisors. Wide circulation of the results of this story and others like it perhaps will help awareness.