From Lou Pearlman to Bernard Madoff, a rash of investment frauds in recent years has many people fretting about how to avoid becoming ensnared in a so-called Ponzi scheme.
Maitland financial planner Susan Spraker had just told a wealthy, prospective client how she would balance his portfolio, minimize his investment risk and meet his financial goals.
"He said, 'All of that sounds real good, but how do I know you're not a Madoff?' " she recalled. "It clearly weighs on a lot of people's minds. And, in a positive sense, it does make them more careful."
So how can you reduce your chances of falling for a financial con artist? Here's some advice offered by Spraker and other financial experts.
The 'sniff test'
A financial con almost always comes with a guarantee of endless, high returns with little or no risk. It may sound exciting and enticing, but it also doesn't pass the sniff test.
If it sounds too good to be true, it probably is. Back in the 1920s, in the original Ponzi scheme, swindler Charles Ponzi sold investors "postal coupons" that he said were guaranteed to pay spectacular returns. The coupons were worthless, and any returns that investors received were paid with money Ponzi continued to take in from new investors — the classic formula for what is now known as a Ponzi scheme.
Ponzi schemes take many forms; investors should be especially beware of "sure thing" deals that involve foreign-exchange trading, oil-and-gas investments, gold and precious metals, even "green" technology, a recent Florida Office of Financial Regulation report warns.
Other red flags include: unsolicited offers by phone or e-mail, emotional appeals, high-pressure sales tactics, guilt trips, and "exclusive" or secretive deals supposedly available only to select people in the same social or professional circles. Fraudulent pitches known as affinity scams may target specific religious, ethnic or minority groups.
In Central Florida, convicted con artist David Merrick of Apopka used church connections across the country and abroad to lure investors into his Trader's International Return Network — a Ponzi scheme that absconded with $15 million. Merrick pleaded guilty to conspiracy and wire fraud in May.
"As a general rule, people should never invest with anyone who pushes religious belief as part of their investment-marketing promotions," Spraker said. "It is just too easy to become a tactic that can manipulate people."
Do your homework
Many Ponzi schemes are peddled via special meetings, seminars or conferences that play on group manipulation. Avoid "impulse investing" at such events. Get everything in writing — prospectuses, references, professional histories of the people involved — then take it home and check it out.
In the Merrick case, for example, anyone from the start could have called regulators and found out that Merrick had no license or qualifications for selling securities. FINRA.org, website of the securities industry's self-policing agency, has a Web link called "Brokercheck" that will tell you whether an individual is a registered investment professional and whether that person has any disciplinary history or sanctions.
The vast majority of investments must also be registered with state regulators — something that also was not done in the case of Merrick's Trader International scheme. Some investments may be exempt from registration if they are being sold to "accredited investors." In Florida, that's someone with a net worth of at least $2 million. Investment brokers are required to prove the client's net worth — something that is virtually never done in a Ponzi scheme.
Too late for regrets
Ira Katz regrets that he invested more than $6,000 with former stock broker Richard Alan Pizzuti of Sanford. The money has now vanished. Pizzuti is bankrupt and the target of a securities fraud investigation by state and federal industry regulators.
Katz, an Atlanta real estate agent, thinks Pizzuti was running a Ponzi scheme — an allegation the former broker vigorously denies.
Katz says he could have avoided the whole situation by first checking out Pizzuti's broker-disciplinary history: Pizzuti had several incidents in the 1990s and a personal bankruptcy earlier this decade. Last year, Pizzuti gave up his broker's license and was barred from the securities industry.
"I was naïve," Katz acknowledges. "I let it go on way too long, and only started checking him out thoroughly after the troubles began."
Verify, don't trust
If an investor makes the right calls, asks the right questions and compiles enough facts, he or she can prevent becoming a victim of financial fraud, said Ron Stein, a New York-based financial planner and president of the Network for Investor Action & Protection, a nonprofit group that includes many victims of Bernie Madoff.
Madoff's Ponzi scheme amounted to about $65 billion over many years, until his arrest in late 2008.
Stein said it's important that investors make sure the financial adviser they're dealing with is not also the one sending out their account statements. Those statements should be generated and sent only by an independent, third-party company — something Madoff's victims learned the hard way, said Stein, whose family members lost much of their savings in the notorious case.
Normal due diligence does work in most cases, he said, though he acknowledged that it failed with Madoff because the Wall Street financial guru so cleverly covered his tracks.
"At the end of the day, the responsibility of due diligence falls on investors themselves," Stein said. "They can't just sit back and trust everything will work out. People have to take matters in their own hands now more than ever."
Richard Burnett can be reached at firstname.lastname@example.org or 407-420-5256.