Other People's Money

Other people’s money Marcus Killick – CEO Gibrlatar FSC Gibraltar magazine February 2008 Some claim that all of literature can be distilled into seven basic plots. These are: overcoming the monster; rags to riches; the quest; voyage and return; comedy; tragedy; rebirth. The financial services frauds that the average person may fall victim to similarly fall into a few basic categories. The details may vary but these techniques have held true throughout the years. Whilst the newspapers focus on large scale frauds, many fraudsters deliberately go for small amounts from large numbers. They do this both to reduce the risk of detection and rely on the victim being too embarrassed at their own perceived stupidity to report the matter. As can be seen from some of the tricks below they may also allude to the enterprise being in some way illegal (for example a tax or exchange control evasion vehicle) so also deterring the victim from reporting the matter to the authorities for fear of getting themselves into trouble. Now to the scams 1) The pyramid scheme There are a number of types of pyramid scheme. The traditional versions all share one overriding characteristic. They promise consumers or investors large profits based primarily on recruiting others to join their program rather than being based on profits from any real investment or real sale of goods to the public. According to the US federal Trades Commission (FTC), there are two tell-tale signs that a product is simply being used to disguise a pyramid scheme: inventory loading and a lack of retail sales. Inventory loading occurs when a company's incentive program forces recruits to buy more products than they could ever sell, often at inflated prices. The people at the bottom of the pyramid make excessive payments for inventory that simply accumulates in their bedrooms or attics. In the case of legitimate multi level marketing businesses a meaningful income can be earned solely from the sales of the associated product or service to customers who are not themselves enrolled in the scheme. Key ways to identify such a pyramid scheme include: • A high pressure sales pitch • Little to no information offered about the company unless an investor purchases the products and becomes a participant 1 • Vaguely phrased promises of limitless income potential • No product or a product being sold at a price ridiculously in excess of its real market value. • An income stream that chiefly depends on the commissions earned by enrolling new members or the purchase by members of products for their own use rather than sales to customers who are not participants in the scheme. A variant of the traditional style pyramid scheme is known as the Ponzi scheme, after Charles Ponzi one of its more famous perpetrators, who, in Boston in 1919, offered 90 day promissory notes at an interest rate of 50%. He achieved this briefly by using the investment made later participants to pay the excessive interest offered to earlier investors. An even more audacious project was set up by John Law in the early eighteenth century and known as the Mississippi Scheme which at one stage promised returns of 120%. The key difference between a pyramid and Ponzi scheme is that in a Ponzi scheme the promoter generally has no product to sell and pays no commission to investors who recruit new "members." Instead, the promoter collects payments from a stream of people, promising them all the same high rate of return on a short- term investment The scheme has to collapse, the only question is when. As the scheme grows it need more and more participants to fund payments to the earlier ones. Whilst it appears attractive to some, as the early investors do make significant gains, this comes from others investors, not from the profitability of the scheme itself, and so the vast majority (over 90%) will lose their investment. The economic costs of such schemes can be huge. It is estimated that the collapse of such a scheme in Albania in 1996 cost investors $1 billion (43% of the country’s GDP). In 1994 in Russia at least two million people were duped in another scheme, losing as much as $1.5 billion A further variation of a pyramid scheme is the chain letter distributed with a list of 5– 10 names and addresses on it. The recipient is told to send a specified small sum of money (typically a few pounds) to the first person of the list. The recipient is then to remove this first person from the list, move all of the remaining names up one place, and to add his own name to the bottom of the list (and possibly others). Then he was to copy the letter with the new name list to 5-10 more people. Allegedly, if this procedure is repeated by others down the line the individual would eventually move to the top of the list and receive money from others. To show the impossibility of such a system working for the vast majority of people. Let us assume that each person mailed actually responds, pays to the person at the top of the list and sends the letter to ten others. By the time the ninth person to be put on the list starts to receive anything, one billion letters have to be in circulation 2) The share ramp Ultimately a share has only two measurements of value, what someone is willing to buy it for, or failing that, what value the assets of the underlying company are worth if they are sold, the company put into liquidation, the debts paid and what is left 2 returned to the shareholders. Under this fraud, investors are made to believe the shares they are being offered are far more valuable than they really are. Share ramping, though now generally illegal, is as old as stock exchanges themselves. Indeed during the South Sea Bubble of the early eighteenth century one company advertised itself as "a company for carrying out an undertaking of great advantage, but nobody to know what it is". In the 21sr century potential investors are rung, frequently from so called boiler room operations, using high pressure techniques, and offered shares in companies alleged to have huge potential for growth. These companies, if they exist at all, have little if any liquidity, often only being sold by the one broker. Sometimes the victim will be rung again to be told that the shares have increased in price and then encouraged to buy still more. If the investor finally decides to sell they find that the shares having been ramped by the boiler room are in fact, worthless as they are not listed on a recognised stock exchange and therefore there are no buyers. According to the UK Office of Fair Trading, investment scams, which include such boiler rooms, as well as fine wines and works of art, claim 90,000 victims in the UK each year, costing them £490m in total. As well as phone calls, email “tip sheets” may be sent as well as supposedly ”independent” websites talking the company up. 3) The advanced fee fraud Advanced fee frauds have their ancestry in one of the oldest frauds known, the “Spanish Prisoner” scam. It originated in England in the late 16th century during the reign of Elizabeth I when England was under threat of invasion by Spain. Under this fraud an individual was approached by the fraudster with a convincing story about a wealthy compatriot of his who has been imprisoned in Spain by King Philip II under a false identity. The fraudster claims that this prisoner cannot reveal his identity without serious consequences and is relying on him to raise sufficient money to secure his release. He then offers the victim an opportunity to supply some of the money, with a promise that he will be rewarded when the prisoner returns. Once the money has been paid the conman reports difficulties in securing the prisoner's release. Additional funds are therefore requested and then more and more. The commonest modern form of these are the so called Nigerian or 419 frauds under which an individual is contacted (originally by fax but now commonly by e-mail) the number "419" refers to the article of the Nigerian Criminal Code dealing with fraud. The sender purports to be an executive of an oil company, bank employee, lawyer representing a dead relative etc. The list is endless but the play is the same. One of the key features of both the Spanish Prisoner scam and its descendants is the emphasis on secrecy; the fraudster also often tells the victim that he was chosen carefully based on his reputation for honesty. 3 Victims can lose more than their money. They may not only risk criminal sanction themselves where the scam alleges to involve the theft of the money being transferred but some have been killed after travelling to the fraudster’s country having been lured by the scam. Other victims have committed suicide. Into this category also falls the regular e-mail lottery “wins”. Here the individual who tries to claim will be asked to pay upfront charges. Often these will initially be small in nature (say an administration charge) but followed by tax, legal and other costs which mount up into several thousands of pounds, until the victim eventually sees sense or is drained of all their cash. According to the Financial Times, a recent survey on behalf of Microsoft found that half of those polled had received a lottery scam e- mail. About 16% had opened the e-mail, 10% replied and about 3% said they had lost money.

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