Thursday, January 11, 2018

Another Billion Dollar Ponzi Scheme

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.  

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Very sad, Ben. How can we effectively educate folks not to buy into these schemes? Given that I have elderly relatives and friends, I wonder . . . .

In 2012, Tamar Frankel was quoted in the New York Times ( saying the following after the release of her book, The Ponzi Scheme Puzzle: "Gullibility is the tendency to believe without reasonable evidence. Every culture draws a line between trust and gullibility. And in the financial arena, the line between trust and gullibility may have to be more tightly drawn." I hope we can figure out how to do that . . . .

Thanks for posting.

Posted by: joanheminway | Jan 11, 2018 7:35:47 PM

I'm not sure what the answer is. There is probably a fraud equilibrium. The more of these that happen, the more cautious people will become.

Posted by: Ben Edwards | Jan 12, 2018 10:53:22 AM

Another book that may be of interest: "The Confidence Game: Why We Fall for It . . . Every Time" by Maria Konnikova

Posted by: Stefan Padfield | Jan 12, 2018 12:04:02 PM

We invested with James Gilcrist with a company Fidelity about 5 years ago in Vero Beach. Promoted every sat. on radio. Any comment ?

Posted by: Ron c | Feb 1, 2018 3:14:42 AM

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