Secrets behind securities fraud


Secrets behind securities fraud

Thanks to the widespread popularity of retirement accounts and college savings plans, growing numbers of individuals, entities and institutions have poured into the securities and commodities markets in recent years. Increased participation has, in turn, led to increased opportunities for — and incidents of — fraud. When victimized investors turn to the courts for redress, experienced financial experts are essential to building a strong case.

Ponzis, pyramids, pump and dumps

Criminals have found many ways to use the securities markets for ill-gotten gains, but these are among the most popular securities fraud schemes:

Ponzi. This type of fraud became a household name this past year with the discovery of several such schemes, including that of notorious financier Bernie Madoff. Ponzi schemes use funds collected from new investors to pay off earlier investors, rather than using profits from the purported underlying business. No underlying business in fact exists; the scheme’s only source of funding is its victims.

Pyramid. Pyramid schemes are similar to Ponzis, with money from newer victims going to pay off earlier victims. In pyramid schemes, however, the victims are induced to recruit additional victims through recruitment commissions. This can keep a pyramid scheme going indefinitely — or until it runs out of fresh blood.

Pump and dump. These schemes create artificial buying pressure for a specific security — usually a low-trading volume stock in the over-the-counter securities market — that’s largely controlled by the fraud perpetrator. Thieves typically use deceptive sales practices and false public information releases to encourage investors to buy shares. Once the stock’s price is artificially pumped up, the fraudsters quickly sell off, or dump, their shares at a profit.

Pump and dump schemes typically are more prevalent in bull markets. But Ponzi and pyramid schemes have a higher incidence in times of economic crisis and fear, as anxious investors seek ostensibly low-risk investments that promise high returns. Ponzi and pyramid schemes are more likely to collapse early in recessionary environments because the pool of potential victims shrinks and fraud perpetrators are unable to pay off earlier rounds of investors.

Unleashing the financial expert

After the Madoff scheme was uncovered in 2008, an army of financial and forensic experts was brought in to locate what was left of the misappropriated funds and to trace the transactions that led to huge losses. In many securities fraud cases, however, experts are retained before illegal activity is a certainty to look for signs of fraud and wrongdoing.

Most investigations include close scrutiny of accounts, invoices, purchase orders, e-mail and text messages, and any other potentially relevant sources of evidence. One piece of evidence frequently can lead to another. A qualified expert can identify those red flags that, standing alone, might not stir suspicion, and use them to build a case.

In Madoff’s case, for example, his consistently high rate of returns (even when other institutional investors were losing money) raised suspicions among some industry peers. Starting with such an anomaly might have led a financial expert to Madoff’s complicated trading strategies, and then to the fact that he relied on a three-person auditing firm to verify billions of dollars on his firm’s financial statements.

On the money trail

Unfortunately, securities fraud perpetrators are always coming up with new ways to cheat investors. Increasingly common schemes keeping experts on their toes include advance fee, unregulated hedge fund, broker embezzlement and late-day trading schemes. Whichever type of fraud you encounter, forensic accountants are ready to help assemble the evidence and testify in court.