Watch out for the pump and dump, Ponzi and the Spanish prisoner Cons

Jennifer Birtles 20th Oct 2013 No Comments

Reading Time: 5 minutes

I have just finished reading The Con Men: A History of Financial Fraud and the Lessons you can Learn by Leo Gough. Before reading, I didn’t have much knowledge of scams and fraud within the financial sector and I also had no idea how long some of the cons ran on for, or how much debt they incurred.

It makes for fascinating reading, particularly as the characters are pretty colourful and the scams often brought in eye-watering amounts of money for them.

Ponzi schemes

Charles Ponzi was one of the most famous con artists to have lived and he was the one to give the name to the infamous ‘Ponzi scheme’, which is still used in its principal in many modern-day scams too. Ponzi arrived in America in 1903 with barely any money to his name. He’d gambled away most of his savings on his journey but managed to find work by getting a job in a restaurant as a waiter but was fired shortly after for short-changing customers.

The Ponzi scheme originated from Charles Ponzi’s business idea to make a profit with International Reply Coupons (IRCs). The purpose of an IRC was to allow someone in one country to send it to someone else in another country who would then be able to use to coupon to pay for the postage of a reply. Charles Ponzi thought there was the potential to make money here as the IRCs were priced at the cost of purchase in the country where bought but they could be exchanged for stamps to cover the postage in the country where they were redeemed. If the values were different, there was a potential profit to be made.

Ponzi went to several of his friends and promised that he would double their investment within 90 days. Some of them did invest and were paid off. As he began to promote the scheme word spread and more and more people wanted to invest. By July of 1920 he had made millions of dollars and most people didn’t take their profits but reinvested in the scheme. As long as money kept being invested into the scheme, existing investors could be paid with this new money. And this is how the Ponzi scheme expanded; however the whole thing was running at a huge loss and Charles Ponzi never looked to make legitimate profits but just searched for new investors.

Bernie Madoff and Allen Stanford were both huge con artists who lead their own versions of a Ponzi scheme throughout the 20^th and 21^st centuries. Both of these men were discovered during the height of the financial crisis in 2008. And as Leo Gough has written in the The Con Men: “Although the frauds were discovered during the financial crisis, they were not discovered because of the investigations in response to the crisis, but because the market crash made it increasingly difficult for the fraudsters to conceal the shaky foundations of their schemes.”

His two sons denounced Bernie Madoff to the authorities for running a fraudulent investment business. He had produced false account statements for clients and funded any withdrawals from his business out of other clients’ money. Very few people knew, until the collapse of Madoff’s business, that for several years Madoff had been running a gigantic Ponzi scheme. It is now established that Madoff’s scam had been operating since the early 1990s but many people believe that it may have begun much earlier in the 1960s when Bernie Madoff was setting up his first business.

Allen Stanford is quoted to have said: “I would die and go to hell if it is a Ponzi scheme. It’s no Ponzi scheme.” Stanford claimed to be innocent when he was running one of the largest ever Ponzi schemes – he was chairman of the Stanford financial group and selling Certificates of Deposits (CDs). However, when an employee, Charles Hazlett, who worked for the Stanford financial group started asking questions such as, ‘Why were the sales commissions on the sale of these CDs so much higher than the average commission rate for similar products?’ and ‘Where was the firm investing the deposits it received from its customers?’ and he received no answers, he started advising investors he had sold CDs to to withdraw their money from Stanford.

Bernie Madoff and Allen Stanford were sentenced to 150 years and 110 years in prison respectively. But the publicity and media surrounding such huge schemes doesn’t disappear for a very long time either, and maybe the reminder of these two will help people in the future make sure they feel safe in what they’re investing in.

Other financial frauds

There are so many variations of different scams but many have the same basic principles. Here’s a short list of some of the most common confidence tricks.

Ponzi scheme – The fraudster draws in new investors to pay existing investors their returns. A Ponzi scheme seems inevitable to fail as at some point the fraudster will run out of willing new investors.
Pump and dump scheme – A scheme that involves artificially inflating the price of your owned stock by providing false but positive statements of the stock in order to sell the cheap stock at a much higher price.
Spanish prisoner – The fraudster claims to the victim that there is an aristocrat or rich relative who has been imprisoned and a large sum of money is needed to release them. The con artist gets the victim to supply some of the money needed to release the prisoner with the promise that they will be rewarded generously after the prisoner has been freed.

How to protect yourself

In The Con Men Leo Gough dedicates a whole section of the book to writing about you can protect yourselves from falling for the sort of scams mentioned briefly in this article.

Some of the key points he mentions are:

Make sure you spread your wealth out across different investments to reduce the risk of being completely wiped out by a major fraud. (Investing in 12–18 different investments is a good idea).
The FSA (Financial Services Authority) and SEC (Securities and Exchange Commission) provide useful guidance on fraud prevention on their websites.
If you decided to invest in funds then it is sensible to invest in several different ones to minimize fraud risk – and check that the funds are not closely associated.
Carry out risk assessments of things that could possibly go wrong and see what you can do to minimize these risks.
Remember that share prices are volatile and don’t often offer very high returns.
If you are looking to invest seriously then make sure you read about the financial industry from a range of sources so that you have a good understanding of what you are doing.

I would recommend reading The Con Men: A History of Financial Fraud and the Lessons you can Learn to anyone who is looking to better understand how financial scams work and how to avoid them. Leo Gough doesn’t over complicate his writing in how he explains the financial scams and didn’t scare me off by using too many technical terms too soon either. This book is a good start to learning about financial fraud and the people behind it.

You can buy this book new on Amazon for £17.51