Thursday, 05 November 2009 19:11

Has Anyone Learned Anything?

by Manuel Rodriguez
Another week, another Ponzi scheme emerges: Scott Rothstein, a prominent Broward County, Florida lawyer, has been accused of orchestrating a scheme to bilk investors of hundreds of millions of dollars.

The ruse involved the sale of legal settlements finalized by Rothstein, acting as plaintiffs' lawyer, to wealthy investors, who would pocket the difference between the present value amount paid to plaintiffs in legal cases and the future value of the installment amounts negotiated with defendants. The spread between the present value of the settlements and their future, installment value represented profit, and was marketed aggressively to high net-worth investors seeking high yields and returns. Broward County's Sun Sentinel, which has closely tracked the story, reported yesterday that a local bank, TD Bank, apparently maintained the bank accounts for the investment business.

What is remarkable about this purported fraud are the similarities it shares with other, recently discovered financial schemes: Bernard Madoff (fake investment accounts), Allen Stanford (fake certificates of deposit), Marc Dreier (fake securities and notes), Scott Rothstein (fake legal settlements) and a host of other, lesser known individuals, including recent allegations of missing funds leveled at Lewis Freeman, the Miami court receiver and forensic expert.

The substantive similarities between these schemes is remarkable: 1) The schemes themselves were all fairly unsophisticated and noteworthy for their relative simplicity; 2) they were perpetrated over many years and had long "shelf-lives"; 3) most involved industries that were either highly regulated (Madoff and Stanford) or faced Bar review of their activities (Dreier and Rothstein); 4) all involved highly sophisticated investors with the wherewithal and means to conduct extensive due diligence; 5) all involved schemes that should have been easily uncovered by even cursory due diligence or review, and 6) all involved "feeder funds" or hedge funds, which funneled other people's money into the fraudulent schemes.

Marc Dreier's scheme is remarkably similar to Mr. Rothstein's, in that both Mr. Rothstein and Mr. Dreier were prominent attorneys, and both attempted to sell bogus securities, notes or settlements to unsuspecting hedge funds or investors. Mr. Dreier's story is eloquently discussed by Vanity Fair's Bryan Burrough, and attempts to discern the motivation that propelled Mr. Dreier to steal hundred's of millions of dollars from unsuspecting hedge funds.

While understanding what motivated these individuals to misappropriate huge sums of money certainly appeals to our very basic human need to dissect and understand behavior, the truly interesting angle is why sophisticated hedge funds and rich individuals keep getting duped into forking over hundreds of millions of dollars into very unsophisticated financial schemes. Although I will review each fraud in more detail in later articles, a trend begins to emerge that ties these frauds together: either because of greed or ignorance, most investors are not performing adequate due diligence in the United States.

The motivation or rationale that prevented these investors from conducting even minimal due diligence can be discussed ad nauseam, yet no single unifying theme will probably emerge or suffice to explain these lapses. None of these theories will adequately explain why highly sophisticated individuals, feeder funds and hedge funds purposely failed to perform the due diligence required prior to investing hundreds of millions of dollars into third-party financial schemes, with most of these investments being other people's money, not their own.

After all, most of these schemes could have been detected with even minimal due diligence: 1) Bernard Madoff never actually made any trades on behalf of his clients, yet trade ticket confirmation would have been relatively easy; 2) Marc Dreier never actually had the authority to sell notes or securities to investors, yet the notes were never independently confirmed with the underlying issuer; 3) Scott Rothstein never actually had plaintiffs that settled cases, which a search of the Broward County court cases (or other jurisdictions) might have revealed (or independent verification for un-filed claims), and 4) Allen Stanford never actually invested his clients' funds into CD's at third party institutions or other easily confirmable depositories, providing a huge red-flag to investors.

Although discerning the reasons why these investors failed to conduct due diligence is interesting and perhaps compelling, whether it was greed or simple ignorance, it becomes clear that these investors trusted the fraudsters with their money, oftentimes their life savings. How trust can be so easily granted and dispensed is really a defining characteristic of these crimes, how we have allowed fraudsters to so easily seduce us is an important unresolved issue.

More importantly though, has anyone really learned anything from these massive frauds, or are we trapped by our own greed and ignorance to forever repeat the mistakes of the past?

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  • Jose Suarez Sunday, 06 December 2009 16:15 posted by Jose Suarez Comment Link

    Manny, I like the site very much, well done! I specially enjoyed the bulk condo perspective. Best, Jose

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