Futures are contracts where an investment instrument is contracted to sell at an agreed-upon price on a specific date. Both the buyer and seller are obligated to carry out their part of the transaction as agreed upon.8 There were 43 schemes involving futures, which may have been just futures, or in combination with other investment instruments such as stocks, options, and commodities. As with many Ponzi schemes, the perpetrators only said they were futures brokers and that investments would be in futures markets. It is a type of investment process that is confusing to many inexperienced investors. Futures examples:
- • Dro Kholamian told his investor-victims that they would be investing in both “leveraged off-exchange” FOREX contracts and futures contracts. Kholamian was not registered as commodities trading adviser. He had accounts with futures commissions merchants but he withdrew the funds in those accounts. Kholamian did no FOREX trading with the funds. In a classic intentional scheme, Kholamian did not trade all of his clients’ funds but instead made Ponzi payments and used his investor-victims’ funds for his own personal expenses. His victims were primarily Armenians (CFTC, 2018, November 30).
- • Scott Bottolfson carried out his futures scheme through two commodity pools. At least one of the pools was registered with the NFA as a commodity pool; however, his trades experienced losses (CFTC, 2011, January 7). A commodity pool when formed legally through the CFTC allows for the pooling investors funds in order to trade on commodities, futures, or options. In this case, Bottolfson used about one-fourth of investor funds to trade, much of which was lost; then the remaining funds were used for Ponzi payments, and by Bottolfson personally (CFTC, 2011, October 19, p.r.).
- • John and Jeffrey Fowler carried out a Ponzi scheme based on gold futures. The two Fowlers, with a third conspirator, promised their investor-victims that their funds would be used to purchase gold futures. Gold futures is an agreement to purchase or sell gold at a specific agreed-upon price at a date set in the future. The investor-victims were issued promissory notes for their funds. The promissory notes were worthless, as were the alleged gold futures that never existed. This was an intentional Ponzi scheme (SEC, 2013, July 5).
Foreign Currency Exchange: FOREX
Foreign currency exchange, known as “FOREX,” are investments based in foreign currency exchange markets. Those who invest in the foreign currency market are buying one country’s currency with money from their own currency, or a currency for another nation, based on the fluctuating values of currencies. As the values of the currency’s rise and decline investors make or lose profits. The CFTC has oversight over these markets. There were 116 foreign currency-based Ponzi schemes in the data set. These perpetrators may make some actual investments in foreign currency markets, but more often than not, there were no actual investments made, only purported investments. These are a few of the FOREX schemes:
• The scheme of Anthony Garcia, Shawn Christie, and Edward Lindsey made use of options on the foreign currency exchange. Garcia pressured victims to invest; however, trades were never actually made. This was a classic intentional Ponzi scheme complete with high pressure and telemarketing tactics. Even though this was an intentional scheme, the offenders were ordered to repay the money, since the scheme had only taken $219,000 (CFTC, 2003, April 3, p.r.).
• Eldon Gresham did engage in some trading in FOREX, but was unsuccessful. Gresham reported gains when there were actual losses to clients. Gresham also targeted Christians as investors, telling them that “the Lord had blessed him” (CFTC, 2009, July 2, p. 7, line 19). Gresham also used the tactic of exclusiveness saying he was only offering his investment to “a limited number of fellow Christians” (CFTC, 2009, July 2, p. 7). This qualifies as a faith-based affinity- fraud scheme as well. Gresham was never registered with the CFTC in any capacity as required by CFTC regulation.
General or Other Investment Instruments
These include other investment instruments such as options, binary options, warrants, annuities, and any non-specific investment tools. Documents may have specified that the schemes were based in these instruments. In the great majority of cases there was little to no real investing or trading; these terms are only what investor-victims were told their funds were being invested in. The more complex the investment tool, the easier it is for perpetrators to use semantics to pull the wool over their client’s eyes.
In most of the options Ponzi schemes the schemes were classic intentional Ponzi schemes, meaning investor-victims were told they were investing in options, but in reality, there were no actual investing in options and all funds went to Ponzi payments and the personal use of the perpetra- tor(s). With standard options, it is a right to purchase or to sell stocks, commodities, or foreign currency for a set price for a specified expiration date. More commonly, the options do not reach the expiration date, and they are usually traded on price fluctuations. If the deadline expires and the purchase has not been made, the buyer loses the money. Binary options are generally trading on whether a stock or commodity reaches a certain price by a certain date; if the option expires the buyer receives a predetermined amount or they receive nothing.
• In this typical classic intentional Ponzi scheme, Jeremy Lundin told his investor-victims, who were friends and associates, that he would invest their funds in options. He falsified account statements to the victim-investors, and put the funds from his business account for Big Island Capital, which were meant for trading in options, into his personal account. He never established a broker account to make it appear that he was making trades. This false-brokerage scheme took place between 2014 and 2017 (DOJ, 2017, September 1, p.r.).
When most of us see the term “warrants” we are thinking of a judicial document asking for an arrest or to search premises. While there have been many of those issued in Ponzi investigations, we are talking about a financial instrument called a warrant. Warrants give the holder the right to buy or sell a security without an obligation; it is a right to purchase or sell, not ownership. Generally, they are issued by the company itself with an expiration date.
• In his Ponzi scheme, Ronald Olear made use of shares of stocks and warrants of shares of stock. A warrant: “entitles the holder to buy a proportionate amount of common stock at a specified price, usually higher than the market price at the time of issuance, for a period of years to perpetuity” (Downes and Goodman, 2014). In this case Olear worked as a coordinator for maintenance, shipping, and security at a company. This position gave him access to shredded materials in a security zone. Olear found shredded stock certificates and used them to fabricate falsified stock certificates, making it appear as if he owned them; he then sold warrants based on these fraudulent stocks (FBI, 2010, December 20).
This unsavory practice uses high-pressure tactics to convince people to invest in whatever financial instrument they are promoting; oftentimes it is penny stocks. Boiler rooms are used in many fraud formats, not just Ponzi schemes. Generally, the brokers use high-pressure tactics through cold-calling. As stated throughout the book, it is possible to purchase lists of names with phone numbers and now email addresses, based on demographics and personal characteristics.
• One Ponzi scheme that used boiler-room tactics is that of Cecil Speight. Speight issued counterfeit securities complete with fabricated CUSIP9 numbers. These counterfeit stock certificates included several different mistakes, such as the wrong person as the signatory, and one country listed as the country of incorporation on one side with a different incorporation country on the back. Speight had individuals who cold-called people using high-pressure tactics. The sellers claimed to be associated with other investment/financial firms that were successful businesses; there was no association, it was all false. Basically, everything they pushed to the 70 investor-victims was untrue. Speight hired two attorneys to receive the funds of investors to give the appearance of legitimacy (SEC, 2014, July 23). These two attorneys were also charged criminally: one received a sentence of 48 months; the other, James Schmidt, died of cancer before sentencing (USA v. James L. Schmidt, 2019, April 15, motion to dismiss). They were making 2 percent on the funds they received. In this case the business was registered as a transfer agent with the SEC. This entity was required to file annual forms (TA-2) with the SEC, but failed to do so. Second, entities registered with the SEC are required to provide up-to-date business addresses; Speight’s business did not have accurate addresses listed with the SEC. These are the types of information that could be uncovered by accessing the SEC’s database in a due diligence search. This scheme took place from approximately 2012 to 2013.
A hedge fund is a private fund, where funds of all investors are pooled. The primary partner has a significant investment, and other partners or investors are generally accredited.10 It is more risk-prone investing designed to support higher returns. To be accredited, an investor should have an income that is more than $200,000 for an individual or $300,000 for a couple, with a net worth that is more than $1 million. Investors are expected to be financially sophisticated and knowledgeable about speculative practices, short selling, and leveraging. In short, investors are expected to have an understanding of the risks in investing and to be able to weather losses. Generally, hedge funds require 65 percent of their investors to be accredited. There were 29 hedge fund-based schemes in all, having been referred to in SEC documents as hedge funds (as opposed to fraudulent hedge funds in name only). Of those:
- • Six schemes began before the housing bubble (2001 or earlier).
- • Ten schemes began during the housing bubble (2002-2006).
- • Seven schemes began during the financial crisis (2007-2010).
- • Six schemes began after the financial crisis (2011 or later).
As with all Ponzi schemes in this study, there were both legitimate hedge funds that failed, and fraudulent schemes that falsely portrayed themselves as hedge funds. There were 41 entities that called themselves “hedge funds” either legitimately or illegitimately. Bruce Johnson states that “The hedge fund industry has long been prone to periodic ‘die offs’ where as many as 15-30 percent of all funds cease trading” (Johnson, 2010, p. xi). In some of the cases in this study, the legitimate hedge funds endured losses, then began paying investors with later investors funds rather than earned profits that did not happen. There may very well be hedge funds that tried this tactic and succeeded in earning enough funds to pay investors back; we will never know.
Dodd-Frank requires hedge fund managers with over $100 million in assets under management to register with the SEC. Mid-sized investment advisers managing assets between $25 million and $100 million are not required to register with the SEC, unless their home state does not have adequate regulation for hedge funds. For the investor, these are unregulated funds; this means that there is a lot of gray area where an investment entity can state that it is operating within SEC regulations when it is operating anything but legitimately. There are also “funds of funds,” investment entities that only invest with hedge funds. These are usually hedge funds investing in other hedge funds, also referred to as “feeder funds” in earlier chapters. In the Dreier and Madoff cases, there were hedge funds that were victims of the Ponzi schemes.
- • Bernie Madoff Investment Securities had individual investors, municipalities, charities and pension funds, hedge fund investors, and fund of funds investors. Until 2006, Madoff was a broker-dealer. In 2006 the SEC required him to register as an investment adviser. Some of the hedge funds and funds of funds were what is classified as feeder funds; they invested their clients’ funds in his fund. In Harry Marko- polos’ 2005 submission to the SEC titled The world’s largest hedge fund is a fraud, he explains that “third party hedge funds and funds of funds” were not allowed to use Madoff’s name in their statements or marketing. There were multiple layers of funds. The actual investors in the hedge funds, funds of funds, and pension holders whose pension funds invested with Madoff had no idea where their money was invested; they never had a chance to carry out due diligence.
- • Marc Dreier was a Manhattan attorney who sold fraudulent promissory notes to hedge funds (SEC, 2008, December 8). This case took place prior to the financial crisis; the notes were alleged to be based in real estate development. In the Dreier case, it was the hedge funds who were victimized. Dreier was a reputable attorney with a successful law firm. He skillfully convinced hedge fund managers, who tend to be quite financially sophisticated in general, to invest in his promissory notes.
- • In their unregistered false hedge fund, John Turant and Russ Luciano convinced investor-victims that they were experts in financial markets. The three business entities whose sole purpose was to perpetrate the fraud were formed in Nevada. The alleged securities promoted for the investments were never registered with the SEC. Very little of the funds acquired from investors were actually invested in daytrading as the investor-victims were told. Turant lied to his investorvictims about having the appropriate licenses and financial markets experience. His work experience was primarily “maintenance work, cutting hedges and ordering office supplies” (SEC, 2003, September 15). This was a classic intentional, false-broker Ponzi scheme.