Kendall J. Anderson, CFA
September 9, 2009
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Charles Ponzi, the creator and namesake of the Ponzi Scheme, began his scam in the spring of 1920 by running a simple $150.00 advertisement. The ad promised to pay 50% interest in 45 days and 100% in 90 to those who would lend just a few dollars to his Colony Foreign Exchange Company. He claimed he could earn enough profit to pay this large amount of interest by purchasing International Postal Union reply coupons overseas. He believed that due to his expertise of the foreign exchange markets, he could redeem these coupons in other locations for a higher price because the currency of the other locations was inflated. His timing and placement of the advertisement was perfect, and the cash flowed into his company. At the peak of his operations, it was estimated that over $1 million a week came into his control. He used the new cash to pay the promised return to earlier investors, adding legitimacy to his claims. However, his scheme fell apart when The Boston District Attorney announced that only $56,000 in International Postal Union reply coupons were issued in 1919 and that, on average, only $75,000 are issued every year. Shortly after this announcement, the Boston Post announced that Ponzi had been involved in a remittance racket in Montreal 13 years earlier. Over just 8 months Ponzi had taken in almost $10 Million.1
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Has Charles Ponzi Visited Rock Hill, South Carolina?
Bernard Madoff is sitting quietly in prison today after running a $65 billion Ponzi scheme. Alan Sanford is awaiting his fate on charges based on an estimated $7 billion Ponzi scheme. With amounts like these, it's no wonder Rock Hill's own alleged $2.5 million Ponzi scheme has received such little notice nationally. However, Rock Hill is my home, and Gene Sullivan is not just a name in the paper like Bernie or Alan, but an individual I have known for over 20 years. I ran into Gene quite often in the past as his children were about the same age as my own. Our children attended the same schools and participated in the same extra-curricular activities, and so Gene and I often served together, as many parents do, in assisting our children with these events.
When I first met Gene, it was the early eighties and shortly after I moved to Rock Hill. There were only a few of us in the investment business locally then, including Don Ferguson and Clyde McFadden at Interstate Securities (Clyde is working as an Independent Representative with Don's son and owner of Ferguson Financial, LLC) and a couple of other individual brokers who lived in Rock Hill but worked for the big brokers in Charlotte. There were a few others who came and went with the tides of the market over the years, and of course there was me, a young broker who came to town and saved the one and only Edward D. Jones & Company office in Rock Hill from closing its doors. Times were much different then than they are today, when it seems every corner has a different individual trying to sell you their investment "expertise."
Gene was a New York Life Insurance Agent, and from what I heard at the time, a pretty good one. Of course, New York Life then was strictly in the "protection" business and not the investment business, as were close to 100% of the large and reputable insurance companies at that time. This changed rapidly during the early 80's. By 1988, the time Gene has been accused of beginning his fraud, the insurance industry and, I admit, the brokerage business, had moved from selling protection or investments only to being a one stop provider for "all your financial needs."
Gene is no lightweight. He is intelligent and had the designations to prove it. He was one of the first insurance agents in town to pass his securities licensing exam, one of the first to earn his Chartered Life Underwriter (CLU) designation, one of the first to earn his Chartered Financial Consultant's (ChFC) designation, and one of the first to earn his Certified Financial Planner Designation. All three of these designations are highly respected in the industry and are difficult to earn.
Gene's alleged fraud lasted over 20 years. When the indictments were announced, the regulatory authorities were quick to say that his alleged fraud was an "enormously serious" case against the "elderly and the vulnerable." However, this is simply headlines. From what I have seen of the fifty or so accounts, most were not those of the elderly and vulnerable, but of individuals of sound mind who unfortunately fell for an age old confidence game, much like those who fell victim to the schemes of Charles Ponzi, Bernie Madoff, Alan Sanford and countless others over the years.
It is easy for us to sit back and tell ourselves that we would never be a victim to schemes like these, but how can so many normal intelligent people lose so much money to these schemes? More importantly, we should ask ourselves why so many financial professionals believe these promoters and encourage others to participate in the schemes. Of course, I am talking about people like the financial professional who operated the "feeder funds" for Mr. Madoff, or the financial professionals who bought into the Alan Sanford story and sold billions of Certificates of Deposits to their clients backed by nothing more than a belief. I am talking about the hundreds of licensed insurance agents who sold billions of dollars of annuities backed by insolvent insurance companies, or the promoters of the get rich quick schemes in stocks, options, real-estate, foreign exchange, micro-cap stocks, and private equity. I am taking about those always popular promoters of schemes based on some academic study of waves, charts, number combinations, the stars and whatever else seems right at the time.
Obviously, I don't know the answers to these questions. However, I can share with you a couple of observations after having worked with and around people, their money, and a multitude of promoters of the "latest, greatest investment idea" over the past thirty years.
The vast majority of investors understand that investing incurs risk, and that salesmen are just that, salesmen. They understand that something sounding too good to be true probably is. They are able to understand and help control the basic urge of people to get the most for their money and pay the least for their choice of provider.
However, those people who are unable to control this urge are the most lucrative victim for a con artist. These are the individuals con artists hope to find, people who believe they can get a little higher rate of return without any additional risk or cost just because they are special or lucky. This is how Allen Sanford, Bernie Madoff, and a host of others have been able to continue fraud year after year.
Just imagine the impeccable broker in a Sanford Office saying to you: "Our Sanford Bank CDs are just like those of any US Bank, except that we can pay a little more than you could get from your bank because we are better investors. Because we earn more than your bank, we can pay you more. Of course, we can't offer these CDs to everyone because we are limited by the amount of money our bank can invest."
Or imagine a Feeder Fund Salesmen saying, "I have met Bernie Madoff, the former Chairman of Nasdaq, and he is just special. I'm not sure how he does it, but he has been able to earn 6% to 12% every year, year after year, for those people lucky enough to have him take care of their money. On top of that, every single month, every investment is sold and put into cash, so you will never have a problem getting your money back. He is willing to take on a few new clients. If you have the money, you better invest or you may never get another chance."
There Must Be Something Magical About 6% to 12% Rates
There must be something magical about 6% to 12% rates of return, as they seem to draw a lot of money from people. Locally, I have seen this rate offered for Christmas Tree Investments costing many people their life savings. I have seen Subordinated Notes from Thaxton & HomeGold (Carolina Investors) paying similar rates which caused huge losses. This is also the same range of returns offered by Gene Sullivan; on his one-page note he promised annual interest between 6 percent and 12 percent.2 By combining a somewhat believable story with a rate of return that is just a little higher, but not too much higher, than what you can get from the bank, it seems you can get people to let their guards down and therefore more easily become victims.
There is a group of people in my own industry who use this knowledge to prey on senior investors. I myself have reached the age to become a member of the elite senior group, and I've been rewarded by receiving vast numbers of invitations to attend "free lunch educational only seminars" led by one of the "best financial minds in the world." This type of sales presentation came to the attention of the Securities and Exchange Commission a couple of years ago and they produced a special report entitled "Protecting Senior Investors: Report of Examinations of Securities Firms Providing "Free Lunch" Sales Seminars." Of the 110 examinations made for the report, only "5 examinations, or 4% of those conducted, passed without a problem." The remaining 105 examinations produced violations to advertising rules (misleading, exaggerated or seemingly unwarranted claims), failed to provide the name of the firm sponsoring the seminar or the product provider paying for the event, activities of the sales representatives conducting the seminars were unsupervised, or recommended unsuitable investments. Thirteen percent (13%) involved "potentially serious misrepresentations of risk and return, liquidation of accounts without the customer's knowledge or consent, and sales of fictitious investments."
The regulators concluded their report with this statement:
... because seniors are targeted as attendees for sales seminars, ongoing investor education efforts for seniors should provide education with respect to "free lunch" sales seminars. Specifically, senior investors should understand that these are sales seminars-that is, they are intended to result in the sales of financial products, and they may be sponsored by an undisclosed company with a financial interest in product sales. Investor education efforts should emphasize that, despite the claims of urgency that are sometimes made by sponsors of sales seminars, and in light of the possibility of misleading or exaggerated statements or claims about investment products or the expertise of the financial adviser, investors should take time to research the firm, the financial adviser as well as the product being offered before opening an account or making a purchase.
This 46 page report is available at www.sec.gov/spotlight/seniors/freelunchreport.pdf. I would strongly recommend that our readers who are financial professionals read this report. If you offer "free lunch" seminars, perhaps it will help keep you out of trouble. If you do not, you should read this report to see what your clients are exposed to when they attend one of these meetings.
Get Rich Quick
There is another type of victim who usually doesn't lose too much money before they figure out what the rest of us already know. These are the buyers of the get rich quick schemes promoted by books, CDs, and the ever present seminar. These schemes promise to teach you how to make money in markets that go up as well as in markets that go down. Most of the schemes are legal and are directed to people with a limited amount of cash looking to get rich quick or to those who have had a bad experience with an advisor. It doesn't take long for the buyers of these products to realize that any system of investing which can be mass produced and sold in bulk is not of much value. Those few unlucky souls who purchase and use these systems in a bull market and make a few dollars will ultimately realize the same thing that others learn earlier, only at a much steeper price.
It is important to remind you that the people who thought they were getting a "good deal" from Gene Sullivan were actually pretty lucky, as all the funds were repaid by New York Life Securities. I cannot even begin to assume why the company chose to take this course. However, you should not believe that this is the norm. Most victims of financial scams will never see a dime. Of the $10 million sent to Charles Ponzi in those eight months of 1920, only $200,000 was recovered.
Until next time,
Kendall J. Anderson, CFA
1 Fisher, Ken. 100 Minds That Made The Market. Hoboken: John Wiley & Sons, Inc., 2007
2 Dys, Andrew & Mullins, Christy. "Feds: 1 victim ruined Ponzi scheme: 70-year-old doubted investor." The Herald [Rock Hill] 23 Aug. 2009: Individual.com 9 Aug. 2009 http://www.individual.com/story.php?story=105753245 .
Anderson Griggs & Company, Inc., doing business as Anderson Griggs Portfolio Management, is a registered investment adviser with the US Securities & Exchange Commission. Pursuant to laws and regulations Anderson Griggs also maintains notice filing with several individual state regulators including North and South Carolina. Anderson Griggs only conducts business in states and locations where it is properly registered or meets state requirement for advisors. This letter has been sent to you for information purposes only and is not an offer of investment advice. The purpose of this letter is to provide information about us. We will only render advice after we deliver our Form ADV Part II to a client in an authorized jurisdiction and receive a properly executed investment Management Agreement. Any reference to performance is historical in nature and no assumption about future performance should be made based on the past performance of any Anderson Griggs Investment Objective, individual account, or index. The authors of publications are expressing general opinions and commentary. They are not attempting to provide legal, accounting, or specific advice to any individual concerning their personal situation. Anderson Griggs Portfolio Management's office is located at 113 E. Main St., Suite 310, Rock Hill, SC 29730. The local phone number is 803-324-5044 and nationally can be reached via its toll-free number 800-254-0874.
Anderson Griggs & Company, Inc., doing business as Anderson Griggs Portfolio Management is a registered investment adviser with the US Securities & Exchange Commission. Pursuant to laws and regulations Anderson Griggs also maintains notice filing with several individuals state regulators including North and South Carolina. Anderson Griggs only conducts business in states and locations where it is properly registered or meets state requirements for advisors. This commentary is for information purposes only and is not an offer of investment advice. We will only render advice after we deliver our Form ADV Part II to a client in an authorized jurisdiction and receive a properly executed investment Management Agreement. Any reference to performance is historical in nature and no assumption about future performance should be made based on the past performance of any Anderson Griggs Investment Objective, individual account, or index. The authors of publication are expressing general opinions and commentary. They are not attempting to provide legal, accounting, or specific advice to any individual concerning their personal situation. Anderson Griggs Portfolio Management's office is located at 113 E. Main St., Suite 310, Rock Hill, SC 29730. The local phone number is 803-324-5044 and nationally can be reached via its toll-free number 800-254-0874.