Recession forces unraveling Ponzi schemes into the open

In Texas, a financial promoter who raised nearly $11 million from investors by claiming weekly foreign currency trading returns as high as 8.1% allegedly spent some of the money on his son's auto-racing career.

In Hawaii, a financier who took in $4.4 million from investment seminars at community centers for the deaf is accused of spending more than $1.4 million of the money on a new home and other personal expenses.

And in Colorado, an investment manager who raised up to $20 million by promising investors annual stock-trading returns as high as 20% allegedly diverted money to buy Rembrandt masterpieces and other art.

Since the Dec. 11 arrest of Bernard Madoff, federal authorities have filed enforcement actions and lawsuits for dozens of alleged financial scams similar to the massive Ponzi scheme masterminded by the disgraced New York financier.

So many alleged scams have collapsed amid the worst national recession in generations and heightened investor wariness prompted by the Madoff case that Bart Chilton, a commissioner of the Commodity Futures Trading Commission, last month dubbed the phenomenon "rampant Ponzimonium."

"We're definitely finding a lot more of these cases," says Stephen Obie, acting director of the agency's enforcement division. Halfway into the 2009 federal fiscal year, the CFTC has filed civil actions in 22 alleged Ponzi schemes, nine more than in all of 2007-08.

Similarly, the Securities and Exchange Commission has filed more than two dozen emergency enforcement actions to halt alleged scams like Madoff's just since Jan. 1, says Robert Khuzami, the agency's enforcement director.

That tally includes a civil complaint that accused Texas financier R. Allen Stanford of running a Ponzi scheme in which he and a partner allegedly misappropriated billions of dollars in investors' funds. Federal prosecutors are also pursuing a criminal investigation of Stanford, a Forbes 400 list member who earlier this month told ABC-TV in an interview that he expects to be indicted soon.

Federal officials say the recent surge of cases shows little sign of slowing. This week alone, federal or state securities and commodities regulators filed new actions against alleged Ponzi schemes in California, Hawaii and Montana.

"A significant market collapse tends to unravel Ponzi schemes as investors turn cautious or demand a return of their investment," says Khuzami. "Recent market ills will hopefully result in fewer new schemes taking root."

Nonetheless, suspected scams have found a home in cyberspace, where they're luring Americans struggling to make ends meet, the Council of Better Business Bureaus warned last week.

Scams on the Internet

According to TubeMogul, an online video analytics firm, YouTube features nearly 23,000 "cash gifting" videos in which new participants' contributions are funneled to earlier ones in a 21st century online incarnation of an age-old pyramid scam.

"Bernie Madoff isn't the only guy with a Ponzi scheme. Money-making opportunities promising big returns for little work are all over the Internet and are extremely enticing," warns Steve Cox, a Better Business Bureaus spokesman.

There's no comprehensive financial data on Ponzi schemes. But Tamar Frankel, a Boston University law professor who has testified before Congress on financial frauds, said worldwide losses in litigated court cases reached an annual high of more than $9.6 billion in 2002.

What's triggered the spate of alleged scams?

Credit the recession, says Barry Minkow, who became a fraud investigation consultant after serving a federal prison term for using his ZZZZ Best carpet-cleaning business to scam investors during the 1980s. Ponzi scheme operators must constantly raise tens of thousands of dollars from new investors to cover redemption requests and keep the scam running, he says.

"That isn't available anymore. You can't get new money, in short, which is why all these are collapsing simultaneously," says Minkow. "It's not that the SEC hired 500 more people. The SEC is being helped by an economic climate" in which investors "complain quicker, plus they're more suspicious than before because of what's gone on with things like Madoff and Stanford."

Shortly before Madoff's arrest, he said he was struggling to meet $7 billion in redemption requests, according to a sworn FBI deposition. Last month, the former Nasdaq chairman pleaded guilty to running a scam with too-good-to-be-true investment returns that defrauded charities, celebrities, hedge funds, trusts and average investors worldwide.

The collapse prompted participants in other supposedly high-return investments to ask questions. Federal court records show a partner in Florida hedge funds run by Arthur Nadel specifically cited Madoff as an example while pressing for an independent audit of the business.

Nadel agreed in early January, but then disappeared, leaving behind a purported suicide note. He was subsequently captured and accused of criminal and civil fraud for an alleged scam that took in an estimated $60 million from more than 100 investors.

The recent enforcement actions involve losses lower than the nearly $65 billion listed in Madoff's client account records. Yet court and other records show several of the defendants lived large, rivaling the Madoffian lifestyle of multiple yachts, a French chateau, Florida and Montauk, N.Y., vacation homes and a tony Manhattan apartment.

Stanford, a Texan accused by the SEC of misappropriating at least $1.6 billion of investors' money through bogus personal loans, is a cricket fan who successfully lobbied the sport's governing body in England to endorse his plans to spend $100 million on five tournaments.

The first match, pitting teams from England and the West Indies, was played in November at Stanford's cricket facility in Antigua, where he holds dual citizenship and was knighted by the island government.

Stephen Walsh, a former New York Islanders hockey team co-chairman, and business partner Paul Greenwood are charged with orchestrating an investment scheme that allegedly misappropriated at least $553 million from universities, public pension systems and retirement plans.

An SEC civil complaint alleges they used clients' money "as their personal piggy bank to furnish lavish and luxurious lifestyles, which include the purchase of multimillion-dollar homes, a horse farm, cars, horses and rare collectibles, such as Steiff teddy bears."

Texas businessman Ray White was accused in March of defrauding more than 250 investors in a foreign currency trading scheme that raised $10.9 million. He allegedly diverted some of the money to buy a new home, fund the car-racing career of his son, Christopher White, and buy Hurricane Motorsports, a manufacturer of replica sports cars and kits.

Colorado investment manager Shawn Merriman was charged last week with running a $20 million Ponzi scheme that victimized dozens of investors in at least three states. Defense attorney Patrick Ridley said Merriman contacted federal prosecutors and admitted what he had done.

Merriman, a former Mormon church congregation leader, allegedly used some of the money to buy expensive collectible cars, priceless Rembrandt etchings and other art by Peter Paul Rubens, Albrecht Durer and other masters.

"He used to take super, big-deal hunting safaris in Africa and bring back the animals he shot. He had a whole roomful of them that ended up in a museum," says Davis McCann, an investor angry at Merriman for allegedly defrauding him and others who considered him a personal friend.

Alleged affinity frauds

Several of the cases involve so-called affinity frauds, alleged scams in which the operators belong to the same community, church or social niche as the investors.

Marvin Ray Cooper allegedly pitched an investment scheme that purportedly offered monthly investment returns as high as 25% during financial presentations at deaf community centers in Hawaii.

Cooper, accused of using some of his investors' money to buy a new home, take flying lessons, buy computer and electronic equipment and pay travel expenses, is deaf, according to a CFTC civil complaint.

Similarly, Weizhen Tang, the self-proclaimed "Chinese Warren Buffett," is accused of defrauding Chinese community investors in the U.S. and Canada through an alleged scam that took in as much as $75 million.

In late February, the Toronto-based hedge fund operator told clients he'd used money entrusted with him by some investors to pay others, according to a court declaration by SEC attorney B. David Fraser.

In a public letter to investors last month, Tang insisted he did not steal the money and asked for another chance to recover the losses. "I know that only with everyone's supervision and assistance, I can repay everyone in around a year. This will be the most sincere form of apology," he wrote.

Even as they file enforcement actions and ask judges to freeze suspected scammers' financial assets, securities and commodities regulators are moving to find and stop as yet unreported frauds and head off future scams.

SEC Chairman Mary Schapiro last month announced plans to improve the agency's handling of whistle-blower tips about suspected financial scams. The move followed widespread criticism of the SEC's failure to act on Boston whistle-blower Harry Markopolos' repeated warnings about Madoff.

"Often, it's only when the customers complain that we're given good information that somebody has illegally operated as a money manager," says Obie, the CFTC enforcement chief.

Congress recently gave the CFTC increased authorization to pursue foreign currency fraud. The agency this year also won a $35 million increase in its $111 million 2007-08 budget, helping fund an 11% increase in its enforcement staff.

Additionally, both agencies are working with federal prosecutors who have pursued parallel criminal cases against financial frauds. Prosecutors have filed criminal actions in eight of the 20 Ponzi scheme cases brought by the CFTC this year the agency said. Criminal investigations, including some that have produced charges, have been opened in 17 of the SEC's two dozen enforcement actions.

"Nothing has quite the deterrent impact as a significant jail term for wrongdoers," says Khuzami, the SEC enforcement chief.

But some alleged scams defy even the best-planned enforcement and prevention efforts.

In late January, Long Island, N.Y., businessman Nicholas Cosmo was arrested and charged with running a $370 million Ponzi scheme prosecutors say cost hundreds of investors tens of millions of dollars. He allegedly spent some of the money on jewelry, hotel stays, limousine bills and other personal expenses, including a youth baseball league.

But Cosmo allegedly spent more than $200,000 on another expense: satisfying a restitution requirement from his 1999 guilty plea to mail fraud in connection with a previous investment scam.