Here be dragons

Fear of missing out is a powerful human emotion, exploited by fraudsters to ensnare even the most conservative of investors.

Those who have not yet burnt their fingers by investing in a fraudulent investment scheme may well wonder how someone could be persuaded to give their hard-earned money to the purveyors of these poisoned apples. Fear of missing out on a great deal has become the modern-day marketer’s weapon of choice, and, in investment terms, it means that more and more people fail to stick to sound investment strategies that have been proven to achieve the desired results over the long haul.

This particular human weakness is by no means a recent development. The famous founding father of these tricksters was US citizen Charles Ponzi, who, in around 1920, collected $US9,8 million from a mere 10 550 people. Ironically, three-quarters of the investors were from the Boston police force. Ponzi offered them no less than 50% return on their investments, every 45 days. Needless to say, they all eventually lost all their money.

According to the Institute for Security Studies (ISS), Ponzi schemes typically rely on the constant inflow of money, using new investors to pay ‘returns’ to existing investors. “The problem occurs when the volume of new investment falls below the volume of returns expected by existing investors or, for some reason, new investment dries up.” Put simply, Ponzi schemes rely on paying old investors with new investors’ money. The money from a newly recruited third rung of investors pays off the second rung and delivers more returns to the first rung — a process that becomes increasingly difficult to keep up. One reason why the scheme initially works so well is that early investors commonly reinvest their money in the scheme. Being urged to reinvest your earnings in the investment should cause you to start asking questions.

One of the biggest Ponzi schemes to hit South Africa was the so-called Tannenbaum scheme that saw Johannesburg-based Barry Tannenbaum rip off strings of local and overseas investors by telling them they were supplying anti-retroviral drugs to South Africa. Barry Tannenbaum was the director of the Frankel investment scheme that operated as an importer of active pharmaceutical ingredients (API) for generic medicines in South Africa. The nature of the investment scheme was discovered when Frankel was unable to pay his investors for over a year. Tannenbaum blamed the global recession for the company’s problems, but analysts believe the reason was that there was no basis for the promised returns.

One would have thought that, with the wisdom of hindsight going back to the 1920s, the estimated R13-billion Tannenbaum Ponzi scheme would have been impossible, but people still got caught. What perplexed analysts about the Tannenbaum fiasco was the high-profile and informed financial wizards it managed to attract, as well as the large amounts of money they were prepared to sink into the fictitious project.

In another Ponzi scheme in the US, it was an actual founder member of the NASDAQ, Bernie Madoff, who pulled the wool over investors’ eyes to the tune of an estimated $US65 billion over two decades. At the end of 2008, he confessed that the asset management arm of his firm, Bernard L. Madoff Investment Securities, was “just one big lie.” The scheme wasn’t revealed until Madoff himself revealed his crimes.

Another well-known scam is the so-called pyramid scheme that has some similarities to Ponzi schemes. A pyramid scheme is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme, often without any product or service being delivered. The key difference between a pyramid scheme and a Ponzi scheme is that the former will offer you an opportunity to make the money yourself, while the latter will ask you to invest in something — you won’t be asked to take any more action than hand over your money.

The ISS recommends that authorities such as the Reserve Bank and the Financial Sector Conduct Authority (FSCA) take more proactive steps to enforce existing regulations aimed at preventing financial scams, but concedes that, even with greater scrutiny by the authorities, it will never entirely stop such schemes.

To protect themselves from becoming victims of a fraudulent investment scheme, investors are advised to only give their money to a company or person that is registered as an accredited financial services provider and a deposit-taking institution in terms of the Banks Act. It is advisable to take the time to check with a respected and registered financial adviser, and to only invest in regulated markets.

Be watchful not to make hasty investment decisions or allow yourself to be pressured into a decision. If returns on investments seem too good to be true, they probably are. At the same time, it’s not always unbelievably high returns that are offered, but sometimes unrealistically consistent returns. Returns on investments that are above board normally fluctuate.

Finally, the devil is in the detail. If anything about a proposed investment opportunity strikes you as too vague or lacking in information, it should raise a red flag.

The information contained in this article is of a general nature and intended for information purposes only. It is neither to be construed as financial advice nor to be regarded as a definitive analysis of any financial, legal or other issue. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner/adviser to take into account your particular investment objectives, financial situation and individual needs.