The Madoff Era : Ponzi Schemes & The New Wave of Fraud

1. The Madoff Era :Ponzi Schemes & The New Wave of Fraud

2. The Madoff Case • An old scheme that still works. • The New Wave of Fraud • New fraud trends. • Technology as an enabler.

3. The Madoff Case • Bernard Madoff Professional Career : • Financial Services, Investment Management • Former Chairman of NASDAQ Stock Exchange • Founded Wall Street Firm Bernard L. Madoff Investment Securities (BMIS) • Philanthropist

4. The Madoff Case • Red Flags : • Expert warnings by other market analysts (e.g. The World’s Largest Hedge Fund is a Fraud by Harry Markopolos) • "Bernie Madoff is running the world's largest unregistered hedge fund...” –Harry Markopolos • Unusual business practices • Reputation of the auditor

5. The Madoff Case • Lessons learned : • Be skeptical about investments • Be skeptical about reputations • Diversification of investments • Due diligence

6. Behind the Madoff Fraud:Ponzi Schemes

7. Ponzi Schemes • Definition : • A Ponzi scheme is an investment fraud wherein the operator promises high financial returns or dividends that are not available through traditional investments. Instead of investing victims' funds, the operator pays "dividends" to initial investors using the principle amounts "invested" by subsequent investors. Source: fbi.gov

8. Ponzi Schemes • History : • Ponzi schemes are named for Charles Ponzi, who deceived thousands of New England residents into investing in postage stamps back in the 1920s. Ponzi thought he could take advantage of differences between U.S. and foreign currencies used to buy and sell international mail coupons. Ponzi told investors that he could provide a 40-50% return in just 90 days compared to the interest rates for bank savings accounts, stocks and bonds.

9. Ponzi Schemes: • How to protect against a Ponzi Scheme: • Be skeptical about investments • Be skeptical about reputations • Diversification of investments • Due diligence • Avoid “deferred” payment plans

10. Ponzi Schemes on the Internet • Proliferation of advertisement videos for business opportunities structured as Ponzi schemes (i.e. YouTube.com). • The Better Business Bureau identified nearly 23,000 videos. • promoting "cash gifting" or "gifting club" programs • nearly 60 million views • fees ranging from $150 to $5,000

11. What happened • Scheme based on trust, reputation, fueled by lack of diligence and regulatory failure • What failed • - Common sense, individual diligence and skepticism, regulatory and investigative body oversight and follow-up • What can we learn • - Fraud won’t go away, diligence and attention to red-flags is key Lessons Learned (or Not)from the Madoff Case

12. Other CommonFraud Schemes

13. Common Fraud Schemes • Pyramid Schemes • Advance Fee Scheme • Real Estate Fraud • Subprime Mortgage Fraud • Securities Fraud Schemes by Registered Persons or Entities: • Churning • Unsuitable Recommendations • Failure to Report Client Complaints • Parking • Front Running (Dual Trading) • Market Manipulations

14. Technology and Fraud:The New Wave • Many fraud schemes have been the same for centuries but new technology has provided those seeking to commit fraud with more tools and options: • Greater reach to go after more victims • Email hoaxes that go out to millions of people • Websites that collect data from unsuspecting victims • Greater anonymity • Email and the web can provide a cloak of anonymity for those that commit fraud • Increased complexity (or at least apparent complexity) • Many people aren’t technologically savvy, and those that commit fraud prey upon this fact

15. Recent Cases

16. Recent Cases : Securities Fraud • Robert Allen Stanford & Stanford Financial Group : • Well-known businessman involved in charitable organizations, professional sports and real estate. • Chairman of the privately held, wholly owned Stanford Financial Group. • The Stanford Financial Group is a privately held international group of financial services companies controlled by Allen Stanford. • The Stanford Financial Group has 50 offices in several countries, mainly in the Americas, and claimed to manage $8.5 billion of assets for more than 30,000 clients in 136 countries on six continents.

17. Recent Cases : Securities Fraud • Robert Allen Stanford & Stanford Financial Group : • Scheme – For years Stanford International Bank managed to consistently make higher than market returns for its clients. • Portraying hypothetical investment results as actual historical data in sales pitches to clients. • Stanford claimed his CDs were as safe as, or safer than, U.S. government-insured accounts. • Stanford induced clients to invest in the Stanford Allocation Strategies (SAS) program by using non-realistic performance results. • Company analysts weren’t privy to almost 80% of the bank’s investment portfolio. The portfolio was divided three parts; cash and a mixture of stocks, bonds and alternative investments.

18. Recent Cases : Securities Fraud • Robert Allen Stanford & Stanford Financial Group : • Legal Issues: • On February 17, 2009 Federal agents raided the offices of Stanford Financial and the Securities and Exchange Commission charged Allen Stanford with "massive ongoing fraud" centered on an eight billion dollar investment scheme. • Stanford's assets along with those of his companies were frozen and placed into receivership. • Following the fraud allegations various governments have taken over Stanford's business operations.

19. Recent Cases : Ponzi Scheme / Real Estate Fraud • Ezri Namvar and Namco Financial Exchange Corporation: • Scheme – • Namco Financial is a qualified intermediary that facilitates the tax deferred exchange of properties in a type of real estate transaction called a “1031 exchange.” This transaction allows a property seller to defer paying taxes on gains from a sale by reinvesting the proceeds in another property of equal or greater value within 180 days. • Real estate investors are required to park the proceeds from their initial sales in intermediaries such as Namco Financial until replacement properties can be purchased. These intermediaries typically place money in nationally insured banks or savings institutions. • Allegedly money was taken from the 1031 exchange accounts and used to pay off the debts of Namvar and his various entities.

20. Recent Cases : Ponzi Scheme / Real Estate Fraud • Ezri Namvar and Namco Financial Exchange Corporation: • Legal Issues – • Namvar and Namco Financial Exchange Corporation are facing at least five Los Angeles Superior Court lawsuits and one bankruptcy lawsuit. • Based on allegations in the complaints related to the handling of funds in escrow accounts, Namvar may face charges related to criminal activity as well.

21. Recent Cases : Subprime Mortgage Fraud • Creative Financial Solutions, Inc. (“CFS”): • CFS was in the business of sending loan application packages and other documents to lenders for review and funding. • CFS did not fund loans but received commissions from the lenders when the loans closed.

22. Recent Cases : Subprime Mortgage Fraud • Creative Financial Solutions, Inc. (“CFS”): • Scheme : • Individuals that used to work for the company admitted that CFS obtained mortgage loans for unqualified borrowers by, among other things, submitting false loan applications, false bank statements, and false income documentation. • Devised a plan to defraud and obtain money and property by false and fraudulent means. • The five individuals charged in the case; worked as loan officers and in addition to the commissions, they often received kickback payments when loans closed. • In total, the victim lenders funded more than $16 million in loans on properties that have been foreclosed or are in the foreclosure process.

23. Recent Cases : Subprime Mortgage Fraud • Creative Financial Solutions, Inc. (“CFS”): • Legal Issues : • These fraudulent loans resulted in actual losses to the victim lenders including the following: unrecovered loan proceeds, unpaid mortgage payments, the costs of recovering the properties through foreclosure, the costs of maintaining the recovered properties, and the costs of selling the properties after they had been foreclosed. • Defendants pled guilty in federal court in San Diego to conspiring to commit wire fraud.

24. Recent Cases : Subprime Mortgage Fraud • AGA Capital NY, Inc: • Operators of the mortgage brokerage firm – Garri Zhigun, Galina Zhigun, & Maryann Furman. • Operated in various locations in Brooklyn, NY and Manhattan, NY from 2004. • Brokered over one thousand home mortgages and home equity loans, with a total face value of at least $200 million dollars, with various banks and lending institutions. • AGA Capital earned a total of at least $4 million in commissions and fees on these loans.

25. Recent Cases : Subprime Mortgage Fraud • AGA Capital NY, Inc: • Scheme : • AGA Capital participated with others, including a lawyer, loan account officers, real estate appraisers, and straw buyers, in a scheme to defraud various subprime banks and lending institutions. • Paid individuals who fit a certain financial profile to act as phony purchasers or “straw buyers” of the target properties. • Prepared and submitted false and misleading information concerning the straw buyer’s current residence, employment, income, assets, and existing debt. • Created false documentation (e.g. bank statements, proof of income, etc)

26. Recent Cases : Subprime Mortgage Fraud • AGA Capital NY, Inc: • Scheme: • Sought mortgages and home equity loans for the target properties at values that were in excess of the properties’ actual sale prices. • Procured artificially inflated appraisals of the market value of the target properties. • Received mortgages and other loans in excess of the actual sale price of the properties securing the loans. • Difference between the appraised value of the property and the property’s actual sale price represented the profits form the scheme.

27. Recent Cases : Subprime Mortgage Fraud • AGA Capital NY, Inc: • Legal Issues: • Total of 23 individuals were arrested. • Mr. and Mrs. Zhugins’ assets were frozen until further notice. • Each person involved in the scheme faces a maximum on each count of the Indictment in which he/she is charged of thirty years in jail and a fine of the greater $250,000 or twice the gross gain or loss resulting from the crime.

28. Current Economic Environment – Psychology of Investment Scams

29. Current Economic Environment • According to the ACFE Report to the Nation on Occupational Fraud and Abuse for 2008, US businesses will lose an estimated $994 billion in fraud losses (7% of their annual revenues) • Instances of fraud will likely increase during this period of duress • Companies are facing issues concerning valuation of assets such as asset-backed securities held as investments or cash equivalents

30. Current Economic Environment • The Fraud Triangle • Increase in the pressures and incentives during current economic crisis Pressure / Incentive Rationalization Opportunity

31. Current Economic Environment Data obtained from the ACFE 2008 Report to the Nation on Occupational Fraud & Abuse (based on 959 cases of occupational fraud). $2,000,000 Type of Fraud Median Loans

32. 2006 Consumer Fraud Research Group study funded by the FINRA Investor Education Foundation revealed the following common tactics used by fraudsters as part of their approach: • The "Phantom Riches" Tactic - dangling the prospect of wealth, enticing you with something you want but can't have. “These gas wells are guaranteed to produce $6,800 a month in income.” • The "Source Credibility" Tactic - trying to build credibility by claiming to be with a reputable firm or to have a special credential or experience. “Believe me, as a senior vice president of XYZ Firm, I would never sell an investment that doesn't produce.” • Source: http://www.finra.org/Investors/ProtectYourself/ Psychology of Investment Scams

33. The "Social Consensus" Tactic—leading you to believe that other savvy investors have already invested. "This is how ___ got his start. I know it's a lot of money, but I'm in—and so is my mom and half her church—and it's worth every dime.” • The "Reciprocity" Tactic—offering to do a small favor for you in return for a big favor. "I'll give you a break on my commission if you buy now—half off.” • The "Scarcity" Tactic—creating a false sense of urgency by claiming limited supply. "There are only two units left, so I'd sign today if I were you.” • Source: http://www.finra.org/Investors/ProtectYourself/ Psychology of Investment Scams

34. Fraud Regulation, Prevention, and Detection

35. Existing Securities Industry Regulations • Securities Regulation • Federal Regulation: • Securities Act of 1933 • Securities Act of 1934 • Rule 10b – Anti-fraud provisions • Investment Advisor Act of 1940 • Investment Company Act of 1940

36. Existing Securities Industry Regulations • Sarbanes-Oxley Act of 2002: • Certification obligations for CEOs and CFOs • New standards for audit committee independence • Enhanced financial disclosure requirements • New protections for corporate whistleblowers • Other criminal penalties: • Document destruction • Freezing of assets • Bankruptcy loopholes

37. Fraud Prevention and Detection • Be cautious of "opportunities" to invest your money in franchises or investments that require you to bring in subsequent investors to increase your profit or get back your initial investment. • If the offer of an "opportunity" appears too good to be true, it probably is. Follow common business practice. For example, legitimate business is rarely conducted in cash on a street corner. • Know who is the promoter behind the transaction. If you have not heard of a person or company that you intend to do business with, learn more about them. Depending on the amount of money that you intend to spend, you may want to visit the business location, check with the Better Business Bureau, or consult with your bank, an attorney, or the police.

38. Fraud Prevention and Detection • Be cautious of business deals that require you to sign nondisclosure or non- circumvention agreements designed to prevent the investor from independently verifying the background and credentials of people with whom you intend to do business. • Do not invest in anything unless you understand the deal. Con artists rely on complex transactions and faulty logic to "explain" fraudulent investment schemes. • As with any investment perform due diligence. Independently verify the identity of the people involved, the authenticity of the deal, and the existence of the security in which you plan to invest.

39. Fraud Prevention and Detection • General Red Flags : • Opportunity • Pressure • Rationalization • Poor internal controls • Management override of controls • Collusion between employees (and/or third parties) • Unrealistic performance expectations • Unusual business practices

40. Fraud Prevention and Detection • Employee Red Flags : • Employee lifestyle changes, e.g. expensive cars, homes, etc. • Significant personal debt and credit problems • Behavioral changes • High employee turnover • Refusal to take vacation or sick leave • Lack of segregation of duties

41. Fraud Prevention and Detection • Management Red Flags : • Reluctance to provide information (to auditors/others) • Decisions are dominated by an individual or small group • Disrespect of regulatory bodies and frequent disputes with auditors • Excessive number of checking accounts, frequent changes in bank accounts • Frequent changes in external auditors • Continuous rollover of loans • Downsizing in healthy market

42. Fraud Prevention and Detection • Management Red Flags (continued): • Company assets sold under market value • Excessive number of year end transactions • Service contracts result in no product • Photocopied or missing documents • Unexpected overdrafts or declines in cash balances • Refusal to use serial numbered documents

43. Fraud Prevention and Detection Data obtained from the ACFE 2008 Report to the Nation on Occupational Fraud & Abuse (based on 237 cases of occupational fraud involving $1 million or more).

44. Concluding Remarks • Current economic conditions increase pressures and cause fraud to rise • Red flags are important warnings • A little fraud soon becomes larger if left to grow • Please contact local authorities and regulatory agencies to report any fraudulent activities

45. Questions ?