Name:
Jimnanie R. Anter, MBA April 15, 2015
Subject:
Social Philosophy
PhD in Business Management
University of San Carlos
Before and After
Bernie: Ponzi Regulation or Lack Thereof?
By Donald J. Furman
and John S. DeJoy
I. Summary of article
This article is an assessment of the
Ponzi Scheme and a review of its history. This will also identify the role of
auditors in perpetrating these schemes and the role of the Securities and
Exchange Commission to prevent schemes from occurring in the future.
Specifically, it highlights the fraud
committed by Bernard Madoff, dubbed as one of the largest Ponzi Schemes in the
history of financial community, after being uncovered in 2008.
Ponzi scheme is a fraudulent
investing scam promising high rates of return with little risk to investors. It
generates returns for older investors by acquiring new investors. This scam
actually yields the promised returns to earlier investors, as long as there are
more new investors. These schemes usually collapse on themselves when the new
investments stop.
A.
History and Background of
Ponzi Schemes
- Ponzi Schemes have been used
long before Bernie Madoff by defrauders company such as William "520 percent" Miller and
RaeJean "Rapmaster 20K Percent", which has dishonest attempt to
defraud investors to fund their lavish lifestyles.
- Ponzi schemes work on the
"rob-Peter-to-pay-Paul" principle, as money from new investors is
used to pay off earlier investors until the whole scheme collapses. (SEC.gov).
Table 1.0 Difference
between Ponzi Scheme and Pyramid Scheme
|
Pyramid Scheme
|
Ponzi Scheme
|
Typical “hook”
|
Earn high profits by making one payment and finding others to become
distributors of a product. The scheme typically does not involve a genuine
product. The purported product may not exist or it may only be “sold” within
the pyramid scheme
|
. Earn high investment returns with little or no risk by simply
handing over your money; the investment typically does not exist.
|
Payments/profits
|
Must recruit new distributors to receive payments.
|
No recruiting necessary to receive payments
|
Interaction with original promoter
|
Sometimes none. New participants may enter scheme at a different
level.
|
Generally acts directly with all participants.
|
Source of payments
|
From new participants – always disclosed.
|
From new participants – never disclosed.
|
Collapse Fast
|
An exponential increase in the number of participants is required at
each level.
|
Relatively slow if existing participants reinvest money.
|
Diagram 1.1 The chart above demonstrates the fact that
pyramid and Ponzi schemes are, by their very nature, unsustainable (Source:
SEC.gov).
- If each new member needs to recruit just six
others to sustain the fraud, then by going a mere 11 levels deep, a
Pyramid/Ponzi scheme would have to recruit a number of investors into the fraud
that exceeds the entire population of the United States. This is unrealistic to
say the least. By level 13, the scam would need to recruit more people than
exist on the planet. Again, this is an obvious flaw in the sustainability of
the Pyramid scheme. Whether recruiting new members (Pyramid) or new monies
(Ponzi) the results are the same. The fraud is simply not sustainable over the
long term.
- The schemes need to recruit new members and
new money into the fraud and those members must then recruit new members in
order to sustain the fraud.
A.
Who is Charles Ponzi?
- The Ponzi scam is named
after an Italian national Carlo
"Charles" Ponzi, a clerk in Boston who
first orchestrated such scheme in 1919.
- He started the scheme
through a coupon purchased in Italy (worth six times as much in the US as a
result of devaluation in Italian currency), then redeemed the coupons in the US for stamps, and sells the stamps at
a discount to businesses.
- Ponzi began advertising his plan, promising
to pay a 50% return in 45 days and soon was collecting millions of dollars for
his scheme.
- Ponzi's scheme collapsed when investors
demanded their funds after word got out. He spent the next several years in
prison.
- In modern times, fraudsters have perpetrated
Ponzi schemes across the globe.
B.
Regulation or lack Thereof
a.
The Security and Exchange
Commission
- created in 1934 as a result of Congressional
hearings following the stock market crash of 1929 that led to the Great
Depression.
Securities Act of 1933 and the Securities Exchange Act of
1934
- were implemented to restore investor
confidence by providing complete and honest disclosure as well as regulation
regarding honest dealing.
Securities Act of 1933 (Truth in Securities
Law)
- requires that investors receive financial and
other information concerning securities for sale, and prohibits deceit,
misrepresentations, and other fraud in the sale of securities.
Securities Exchange Act of 1934
- created the Securities and Exchange
Commission, which is empowered to register, regulate and oversee the securities
industry.
Investment Company Act of 1940
- oversees the organization of companies that
engage in investing, reinvesting, and trading of securities.
Sarbanes-Oxley Act of 2002
- created the Public Company Accounting
Oversight Board (PCAOB) which requires accounting firms that audit publicly
traded companies to register with the board.
b.
Auditors and the
Accounting Profession
Friehling & Horowitz
- a three-person accounting firm that is
operated out of a 550 square foot office in Rockland County, New York
(Bloomberg News, 2008).
- The SEC's complaint alleges that Friehling
& Horowitz aided Madoff in his fraud by claiming that they had performed
the audit in accordance with Generally Accepted Auditing Standards (GAAS), when
they had not done so.
American Institute of Certified Public
Accountants (AICPA)
- All firms that perform audits are required by
the AICPA to be peer reviewed by other audit firms (AICPA, 2009a).
- The AICPA's Code of Professional Conduct
requires auditors to be "independent in the performance of professional
services" (AICPA, 2009b, Rule 101, Section 101.01).
- The SEC ... alleged that Mr. Friehling and
his family had investment accounts at the Madoff firm worth more than $14
million.
- All firms that perform audits are required by
the AICPA to be peer reviewed by other audit firms (AICPA, 2009a).
* It was found out that the Auditors
of Bernard Madoff Investment Securities (BMIS)
did not perform a meaningful audit and did not perform procedures to confirm
that the securities BMIS purportedly held on behalf of its customers even
existed.
C.
Why Didn’t the SEC
Discover the Fraud Sooner?
- Madoff Investment
Advisory service was unknown to the SEC for many years and Madoff had not
registered with the SEC as an investment advisor.
- SEC was completely unaware of the Ponzi scheme
because BMIS was a broker-dealer registered and regulated by the US SEC.
- Despite extensive contact and regulation,
officials failed to uncover BMIS’s $50 billion
fraud that Madoff revealed in mid-December 2008 and which now appears to stretch back over a decade (Schwartz &
Katz, 2009).
- Until Madoff was busted during an investigation in 2006, when the SEC discovered that Madoff had
more than 15 clients. At that time, the SEC required Madoff to register with
the SEC, and closed its investigation.
D.
RECOMMENDATIONS
- Require all investment advisors,
broker-dealers, feeder funds, qualified purchasers, sophisticated purchasers,
and accredited investors to submit the name of their audit firm, as well as the
name of the firm that audits their money managers in whom they invest to a
national database administered by the SEC
- Firms that audit investment advisors and
broker-dealers, whether their clients are public or private, should undergo a
more rigorous peer review process to ensure to a reasonable level of
satisfaction that the audit firm has the ability, expertise, competence and
resources to conduct audits of such complex entities.
- Investors (individuals and feeder funds) who
invest more than $250,000 with an investment advisor be required to report the
name of their investment advisor to the SEC.
- The SEC establish a whistle blower program.
Such a program will be designed to allow individuals who believe they have
discovered fraud in a hedge fund or some type of a Ponzi scheme the freedom and
anonymity to report their suspicions without fear of reprisal.
E.
CONCLUSION AND FUTURE RESEARCH
- Explore how the system was exploited in
perpetrating, expanding, and continuing Madoff’s, and other Ponzi schemes.
- An evaluation of the SEC’s Securities Act of
1933, Securities Exchange Act of 1934 and Investment Company Act of 1940 should
be completed.
- Future research could consider additional
regulations to be implemented to safeguard future investors considering
investing in hedge funds.
- Future research should consider the SEC’s
policy on how they deal with receiving tips on possible fraud.
II. Analysis/Insight
This study is just a review on the
history of Ponzi Schemes, its mechanism and the loopholes that SEC should look
into. Specifically, it highlights the fraud committed by Bernard Madoff, dubbed
as one of the largest Ponzi Schemes in the history of financial community,
after being uncovered in 2008.
One reason that Madoff was
so successful was that he was a highly respected, well-established and esteemed
financial expert -- his reputation was bolstered by the fact that he helped
found the NASDAQ stock exchange and served a
term as its chair. What's more, at the same time he was running his scheme, he
was also running a legitimate business (source: Appelbaum). He
earned his investors' trust because whenever they requested a withdrawal,
Madoff's investment company got their money to them promptly. In addition,
unlike other Ponzi schemers, he didn't tempt investors with unbelievable
returns. He reported moderate returns to his investors.
III. Critique
In the Philippines, Previous Ponzi schemes have
been featured on national primetime television and yet despite all that media
dissemination — there are still suckers who bite into the next Ponzi scheme.
Preventing Ponzi schemes
should be a government top priority. In our locality (especially in the remote
areas), several cases of fraud still exist citing lack of education and
awareness as one of the main reason. However, in these modern times,
sophisticated investors understand the fraud, but hope to profit by joining
early. Bottom-line is, greed for money is the root cause.
The authors recommendations
cited above should also be practiced here in the Philippines.
IV. Sample Case in Compostela Valley “Diday’s Paluwagan”
A.
Sample Posting of Diday’s Paluwagan Compesation Plan
Diday’s Paluwagan
THIS WILL BE OUR SCHEDULE:
PAY IN CUT OFF SUNDAY 5PM--->Posting
Monday.
>Payout Tuesday-Wednesday
PAY IN CUT OFF Wednesday
5PM-->Posting Thursday
>Payout Friday-Saturday
CREATORS:
Prime Hazel Quijano Restauro
Jossica T. Castro
ADMINS:
Wilfred KrYz
Restauro-->SPREADSHEET ENCODER
Xheniixhamae Restauro LLanes--PAYIN
AUDIT INCHARGE/INSTAGRAD INCHARGE
TEAMS: (TEAM CONCERNS: PM
YOUR RESPECTIVE LEADERS)
L& V
Leslie Alberca Membela &
Valerie Chua
M&C
Marlyn Joy Omega Mistiola
& Chie Paragas
B&C
Mhariel Bautista Tia &
Taka Neshia
COMPLAN-STRICTLY NO REFUND
POLICY.
MONEY ROTATION,HINDI PO
MAGIC,HINDI PO INVESTMENT OR BUSSINESS,PINAPAIKOT LNG ANG PERA PARA MAKUHA NG
BUO NG GRADUATE.
3PAY INS =1GRADUATE
600*3=1800
LESS: 50 SAFETY NET
LESS;100ADMIN FEE
LESS; 100DIRECT REFERRAL
LESS; 100 PAY OUT CHARGES
& INSTAGRAD BONUSES-ETC.
Pay out 1450
PAY IN-
Para maging member need mo
maginvest ng p600.
Nakapost po ang ating Mode
of Payments kng saan nyo po esend ang pay ins ninyo.
Ang 600 po na pay in ninyo
ay naka lock in sa cycle sa loob ng 1month or hanggang sa maka 3graduations ka.
(Kahit alin ang mauuna).
ILANG ENTRY ang pwede sa
isang tao?kahit ilan pwede,pero maximum pay in para sa isang pangalan in a day
ay 6lng po.
PAY OUT
Ito ang matatanggap na pera
pag ikaw ay makakagraduate na.1450pay out, pag naka auto re-entry 850,pag
evicted na or naka 1month na sa cycle or naka 3graduations na makukuha ng buo
si pay out 1450.
DR.(DIRECT Referral)
Bawat entry na marerecruit
mo ay magiging refferal mo.kada recruit mo na ggraduate ay may matatanggap kn
p100.
Ratio
3:1 kada may 3pay ins ay may
1tayong graduate.
Pay in =pay out
PAPAANO GAGRADUATE?
KAPAG IKAW NA ANG NASA PILA,
OR KAPAG NAKAPAGRECRUIT KA NG 9 ENTRIES .TAWAG JAN AY INSTAGRAD +200RECRUITMNT
BONUS PARA SA MGA INSTAGRADS.
RECRUITMENT:
BAKIT MAY RECRUITMENT?PARA
MAIPAGPATULOY NATIN ANG CYCLE.DAHIL MONEY ROTATION po ito.
Auto re entry
Pag graduate mo ang makukuha
mo ay 850,dahil si600 ay nka auto re entr.pra po maipush ntin at mapaikot ang
cycle.
Eviction
Kapag umabot kna sa lock in
due, mag aantay k ng nxt graduation.nasasayo na kng kukunin mo ng buo si pay in
na1450 o sasali sa cycle.
1 MONTH LOCK IN
1 MONTH NA NSA CYCLE ANG
ENTRY MO FROM THE DATE OF THE PAY IN--KNG NAKA PAG PAY IN KA NG SEPT 21 1 MONTH
NG LOCK IN MO IS OCT 21, KAPAG NAKAGADUATE KA AFTER NG OCT 21 MAKUKUHA MO NG
BUO ANG 1450 MO DAHIL DUE NA ANG LOCK IN MO.
"Bakit teamwork"?
dahil need tayo magtulungan
pra may graduates tayo araw2.
Bakit 9recruits para maka
instagrad?para po ka da may 1instagrad may 2 din sa list na ggraduate.
Instagrad advantage:
for the
member-makakagraduate ka kahit malayo sa list
For the cycle- may madaming
graduates at madaming re entries kinabukasan.
WHAT IF WALANG RECRUIT?WILL
I GRADUATE?
YES!DAHIL NA SA CYCLE KNA,
ALL YOU HAVE TO DO IS WAIT FOR UR TURN NA MAKASAHOD/GRADUATE SA PILA.
HOW DO WE COMPUTE THE #OF GRADUATES?
*UPON CUT OFF,WE COUNT THE
#OF NEW PAY INS+#RE ENTRIES AND DIVIDE IT BY 3.
*WE CHECKINSTAGRADSS,AND
COUNT THEM IN AS GRADUATE.
TAKE NOTE, THE NUMBER OF
GRADUATES DEPENDS ON THE NUMBER OF PAY INS AND RE-ENTRY.
THIS IS NOT THE USUAL
PALUWAGAN,THIS IS NETWORKING TOO! WE ENCOURAGE EVERYONE TO INVITE SO THAT WE
CAN SUSTAIN THE CYCLE FOR THE BENEFIT OF EVERYONE
PAYMENT DETAILS
BDO CASH CARD: CELESTIAL
RESTAURO
ACCOUNT NUMBER-601853 906
4878493
SMART MONEY (TEXT NYO REF
NO.)
5577-5193-3033-9103
BPI :PRIME HAZEL RESTAURO
2079-2332-02
PALAWAN, LBC,
CEBUANA,MLHUILLIER
PRIME HAZEL RESTAURO
P-1, BONIFACIO GARCIA ST.
POBLACION COMPOSTELA, COMPOSTELA VALLEY-09076608969
B.
Fraudulent Acts and other reasons for failure of “Diday’s Paluwagan”
1. Cycle will not continue
if there are no new members. Hence, sustainability is based on number of
recruits. A clear Ponzi Scheme.
2. Not a typical “Paluwagan”
because members don’t know the other members and a member gets a bonus cash
whenever he finds a new recruit to “pay-in”.
3. Safety net is
insufficient.
4. Team Leaders are not
properly trained.
5. DTI permit for Online
Selling was used to lure people to join the “Paluwagan”.
6. Admis made members
believe they will shift to coop but Admins are not experts in running one. They
just gave false hopes.
C.
Sample Print Screens
 |
Posting of Proofs
like this lured many people in Compostela, Compostela Valley.
|
 |
A typical Diday’s
Paluwagan Advertisement on Facebook saying “turn your 600 to 1,500 in one
month”.
|
After four months, the cycle
stalled and the following is now happening.
1.
Founder changed her FB account and not responding promptly to customer
complaints. Moved to another place (Compostela to Davao) and works in a call
center.
2.
Members resorted to online selling but admins are not responding fast to
process pre-order shipments. Thus, dissatisfied members and customers.
3.
Team Leaders/Recruiters are asked to reimburse the investments.
4.
Cycle halted and there’s a conservative average of 1,500 members in each
5 groups. They are reimbursing money from Sales at an average of 4 people per week. If we will do our math, it will take at least ten years to reimburse all people from all the teams.
5.
Some complains are erased in their FB page by admins without addressing
those first.
6.
Many members are going nuts on how to get their hard-earned money.
While the intention of other members when they recruit were in good faith, that means they didn't know that this bad event now will happen and that the structure of this "business opportunity" is not sustainable, it can't be denied that it is one's responsibility to research and dig deeper especially if the "business opportunity" is too good to be true before inviting innocent others. Now, the best thing that members will do is to file an Estafa case, which the creator of this system hugely qualifies to the elements, but may drag for years and not financially feasible for most members. Hence, if members will allow, the creator of this "business opportunity" may run free from this.
