Thursday, January 11, 2018
Ponzi schemes recur with an astounding regularity. The latest comes from the Woodbridge group of companies. The $1.2 billion scheme ran for about five years. It took advantage of about 8,400 investors, many of them elderly.
Like many other Ponzi schemes, commission-hungry sales agents brought fresh infusions of capital to the scheme. Interestingly, the scheme allowed sales agents to pick how much they would receive in commissions:
The sales agents were paid well. According to the SEC complaint, "Woodbridge offered its [mortgage] product to its external sales agents at a 9% wholesale rate, and the agents in turn offered the [mortgage notes] to their investor clients at 5% to 8% annual interest — the external sales agent received a commission equivalent to the difference," the SEC asserted.
In total, Woodbridge may have paid out over $64 million in commissions to sales agents. Some of these sales agents had been kicked out of the securities industry. The Investment News details some of the sales claims that enabled the scheme:
For example, one insurance salesman and former broker, James H. Gilchrist, promoted the loans at dinners in Jensen Beach. The invitation encouraged potential attendees to "learn how to earn 6% fixed interest" a year, touting "monthly income checks" and "no market risk" along with an entree of chicken alfredo, salmon or shrimp scampi. "How to make your retirement savings CRASH PROOF," the invitation declared. Mr. Gilchrist did not return calls for comment.
Any registered brokerage firms that sold these investments may have a problem on their hands. Brokerage firms have an obligation to do some diligence on the product to make sure that there is some reasonable basis for believing the product to be suitable for some customers. FINRA's guidance provides that:
(a) The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. In general, what constitutes reasonable diligence will vary depending on, among other things, the complexity of and risks associated with the security or investment strategy and the member's or associated person's familiarity with the security or investment strategy. A member's or associated person's reasonable diligence must provide the member or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy. The lack of such an understanding when recommending a security or strategy violates the suitability rule.
From what I've seen, I'm not sure how these products would have passed careful scrutiny.