My Thoughts On Recent Ponzi Schemes
Florida woman who led a nearly $200 million Ponzi scheme sentenced to 20 years in prison
Alex Mehr and Tai Lopez accused of running $112 million Ponzi scheme
It feels like these Ponzi schemes have been popping up like mushrooms after rain. I have been coming across more of those lately. I thought I’d provide my thoughts on the topic not to add to the negative news you may be reading lately but rather to share a few key takeaways that directly apply to investing in real estate too.
Unfortunately there is no easy way to tell fraud is present as the signs are not always obvious. I previously shared a few key strategies to spot a scam as well as my own learnings from a failed investment (which was officially declared as a Ponzi scheme too last month). However, this recent news triggers a few additional observations that I want to share for your consideration.
In most cases the dominos fall during periods of market contractions and down cycles.
What this means is that we, as investors, should be on high alert during good times (or at least be prudent enough to exit during good times), if we are invested in a deal that is too good to be true. It is not uncommon for Ponzi schemes to trigger claw back provisions, however. Thus, any earnings above and beyond recovery of the principal investment could be clawed back the authorities because those profits were effectively generated with new investors’ money.
Understand the underlying business structure and cash/cash flow paper trail.
How does the business make money? How is it capitalized? Are these real people with real assets and real business?
In the Florida woman example case, where the core business activity was providing short term merchant cash advances, you would want to understand the operator’s vetting process and credit policies when extending credit, who their customers are (consumers or businesses), their bad debt and allowance for losses and how that compares to actual, their loan loss ratio, the collection and portfolio management processes, the repayment rate, the underlying client contracts, etc. That is not to say contracts cannot be falsified but if you request sufficient information along with financials (see below), discrepancies may pop up.
In the Marco Santarelli’s case, investors were promised returns generated from a variety of businesses including e-commerce, real estate, Broadway shows, and cryptocurrency (i.e., lack of focus and expertise on a single area of business). Assuming one jumped into the hodge podge portfolio, it would be important to understand how each of these underlying asset classes generates cash flow, request copies of their financials and the bank statements showing the incoming deposits, understand the operator’s background and experience in these areas.
In the case of Tai Lopez, the business plan was quite logical – buy distressed companies with physical retail locations, leverage his/his partners ecommerce expertise to boost online sales, turn them around, and exit at a healthy multiple. All investor calls were touting continuous revenue but there was no detailed discussion on profits. While financials were provided, they turned out to be fraudulent.
High returns that are too good to be true. The merchant card advance deal offered a 120% return, which is too good to be true. The promissory notes offered a 12-15% return (on the higher end of the spectrum, especially for the real estate deals). The distressed buy out deal offered 25% annual returns.
While I will not stand here and claim achieving high returns is impossible, it is (in my humble view) the outlier and not the norm…especially when the investment is being advertised as achieving such returns on a consistent basis (I painfully learned this lesson myself).
In addition, anyone in the business long enough has at some point experienced a downturn and potentially a loss. A seamless track record with zero history of losses (especially when lending!) is rare.
Ask for financials and understand the track record. Track record alone is not enough – think Bernie Madoff or the lessons learned from a past passive investment I was a part of (which subsequently turned out to be fraud). Those operators who have been in business for a while can provide long history of financials, preferably audited financials. You can start the review there and request ancillary reports, if pink flags appear or you have questions.
In the merchant card advances case the scheme ran for about a year, i.e., not long enough to establish a track record. So if you are presented with a similar deal of a lifetime, give it at least two full years (though excessive returns alone would be a red flag).
Third party oversight by a reputable CPA firm (preferably one peer reviewed by the AICPA) adds additional comfort. This alone is not a guarantee to catch the fraud (the two multi-million-dollar fraud schemes I caught and saved those losses for my now former employer had been going on for years until I stepped in and stopped their music and one of them had a reputable CPA firm).
Glamorous lifestyle. In almost all cases, the criminal usually reroutes investor proceeds to maintain a lavish lifestyle – owning multiple luxury homes (or should I say mansions), flying first class, driving multiple Ferraris and Lamborghinis. Creating and maintaining such a lifestyle is not impossible but if one was to dig into the underlying business model and size up the margins, inevitably the question will arise – how is that lifestyle maintained given the profit profile of the business.
Paused on no communication. In almost all cases, communication stalled and eventually paused before the fall out. The LP forums were blowing up months before the Marco Santarelli’s syndications with no word or response from the sponsor himself. In my case, I remember raising the red flag on this to the fund manager I invested with and on a well-known passive investor forum and in both cases my concerns were dismissed…This actually hurts more as these were the people I trusted and who were supposed to be fiduciaries, i.e., have investors’ best interest at heart…
Trust your gut. While data and logic are important, so is your intuition. This fight or flight response that originates in the gut is difficult to explain. I can recall situations from my own past where I trusted my intuition and others where I did not. Hindsight is always 20-20 but I if you catch yourself going back and forth too many times and ruminating, it is probably best to pause. Trust me – investment opportunities will be there, and it is better to miss on an outstanding one rather then enter into an outstandingly bad and painful one.
For better or worse, we learn most from our painful experiences, mistakes (which I like to call seminars) or the seminars of others. Thus, when I come across cases like this one, I like to dive in and see what new lessons I can extract and apply in my own investment journey. And I hope my reflections added value to you today as well.
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Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.