How to “spot” an investment Scheme

As the second major alleged scam of 2020 unfolds in court, and in the court of public opinion, South Africans continue to fall prey to investment schemes that promise unsustainably high returns.  From estimates more than 230 000 investors have fallen prey to South African Ponzi and related investments schemes losing more than R35 billion. The table below provides a summary of some of the more recent alleged South African Ponzi and other schemes:



Even though the schemes differ structurally, all of them have a common thread that goes back to the “origin” of Ponzi scheme from the 1920’s. Charles Ponzi was an Italian swindler and con artist in the U.S. and Canada. He promised clients a 50% profit within 45 days or 100% profit within 90 days, by buying discounted postal reply coupons in other countries and redeeming them at face value in the United States as a form of arbitrage. Ponzi was paying earlier investors using the investments of later investors. In the first month, 18 people invested in his company with a total of $1,800. He paid them promptly for the very next month, with the money obtained from the newer set of investors. Word spread, and investments came in at an ever-increasing rate. Ponzi hired agents and paid them generous commissions for every dollar they brought in. If money kept flowing in, existing investors could be paid with the new money, this was the only method Ponzi had to continue providing returns to existing investors, as he made no effort to generate legitimate profits.  While this type of fraudulent investment scheme was not originally invented by Ponzi, it became so identified with him that it now is referred to as a "Ponzi scheme". His scheme ran for over a year before it collapsed, costing his "investors" $20 million. Ponzi lived luxuriously: he bought a mansion in Massachusetts maintained accounts in several banks and he bought a Locomobile, the finest car of that time.

More than one hundred years later we continue to see variations of the Ponzi scheme that continue to “trick” people out of their life savings.  To date the recipe remains the same; the promise of high returns, high commission, initial investors are “paid” with new investor money and at some point, the deck of cards come tumbling down as the continued payment of the unsustainably high returns to investors cannot be sustained as it is not backed by any proper investment or business model.  In all these scams the only beneficiaries are the plan sponsor (or founders) and the agents raking in generous commissions. Early “investors” may also benefit as they often receive their investment and returns, although many subsequently lose this when they reinvest.

The latest in the list for South African schemes is alleged to be Mirror Trading International (MTI) that has been placed under provisional liquidation in December after investors could not gain access or withdraw their investments.  MTI offer investors a platform to trade bitcoin through what they call a sophisticated artificial intelligence-based platform. According to the company’s website they have been able to deliver daily profits of 0,5%. Even though they do mention that historic returns are not an indication of future returns they lure in investors with the promise of these astronomical returns.   The company further offers investors a 10% commission for anybody introduced to MTI i.e., a generous referral commission.  It is estimated that between R6 bn and R9.5 bn has been invested in MTI with the number of investors not known yet.

These schemes vary structurally, ranging from typical pyramid or networking schemes to investment schemes, property investment syndications, unlisted equity schemes to plain fraudulent activity.  The structures are often complex and opaque, disguising the true nature of what investors are investing in, which often only comes to the fore after the scheme’s “collapses”. 

How to identify an investment scheme:

# Insight 1: If returns look to good to be true. It should raise a red flag.

Without exception, every single scheme offered investors better returns than what is available by investing in regulated financial products. These types of returns are especially attractive to the most vulnerable, retirees who cannot survive on their current income and are looking for some way to enhance their income.

What is a realistic market related return?

As Governments are the lenders of last resort, Government Bonds are the true reflection of the “risk free rate”. Investors can find the returns of retail bonds on the RSA Retail Bonds website. Currently the rates vary from +/- 4,7% p.a. for short-dated investments. Any rates higher than this would imply some level of additional risk or lower liquidity.

Investors can also use compounding to do a reality check to see just how sustainable the returns on offer are. If we look at the rate of 0,50% per day average profit supposedly delivered by MTI it looks reasonable to the untrained eye. After all, the JSE shows daily moves of 0,50% or more on any random day. However, if you were to compound the growth rate of 0,50% per day, over one year a R100,000 investment grows to over R600,000. That is a phenomenal average return. Krion’s 10% per month would grow R100,000 to over R300,000 in one year, and to R9.2bn over 10 years – clearly an unsustainable return. A return of 0,50% per day grows to over R8trn in 10 years! The trick to assess sustainability is to look at the promised returns over the long term and not assess them at face value.

Insight # 2:  If the return is better than what is offered by government bonds understand the risk.

How else can a “guaranteed” income be delivered?

Guaranteed products or investment are often complex and requires sophisticated investment modelling and hedging.  Most retail investors are not able to assess the ability of the investment provider to deliver the promised guarantee.  When a guarantee is provided, the institution offering this should have both the experience and capital (balance sheet) to support or deliver on the guarantee.

Questions that can assist in assessing the institution’s ability to deliver the “guaranteed” return:

Is the company licensed to provide/offer the product? 

Investors can approach an accredited financial planner without a vested interest in the company under scrutiny to assist in determining if the company is appropriately licensed.  Alternatively, they can approach the Financial Sector Conduct Authority or the South African Reserve Bank to confirm if the company is appropriately licensed.  Call the FSCA Fraud and Ethics Hotline: 0800 313 626 or visit www.resbank.co.za

Does the company have a demonstrated track record of delivery?

It is important to consider the company’s long term track record, ideally over the last 5-10 years of delivering on this specific proposition.  Sadly, some of the unscrupulous providers will fabricate long term returns. It is therefore important to ensure the reported returns are in accordance with a standard by an industry body or are available through an independent source.   If the returns are not regulated by an industry body investor should ask for audited returns and ensure they are comfortable with the appointed auditors.

Does the company have the balance sheet to back its promises?

Ultimately any company providing a guarantee should have the balance sheet i.e., capital to back its promises.  Scrutinize the terms and conditions to ensure the company does stand behind the advice, and then ask for a copy of the financials.

Investment or Ponzi schemes are complex and structured to mislead, investors, advisors, and regulators.  If returns are higher than what is available in the regulated market, alarm bells should go off and this should at a minimum lead to further investigation to understand the risk involved. Investors need to get a second opinion, an objective opinion from someone not related to the opportunity at hand.

 

Author:

Wynand Gouws, CFP®

Gradidge Mahura Investments