Investment fraud isn’t relegated to Wall Street: Beware the Ponzi schemer next door

May 7, 2011

John McKenney’s a smart guy. A lawyer and tax expert, McKenney left Washington a few years ago and moved to Sarasota, Fla. He got a tan, took up yoga, started dating a well-heeled local woman. She brought McKenney into her well-heeled crowd.

Soon, all the heels in the group were clicking about a new, can’t-miss foreign currency deal, paying 5 percent a month, 60 percent a year. The trader doing the deal, Beau Diamond, was young but well known around town. His father, Harvey, was a local health and fitness celebrity.

Diamond said he possessed a secret, proprietary method for trading currency futures. Everyone jumped in, including Mc­Kenney. He invested $250,000. One year later it was gone, much of the money having financed Diamond’s hard-partying lifestyle. It ended up at Vegas casinos, the local Lamborghini dealer — Diamond’s was jet black — and more than a few bars.

Today Diamond is in jail in Florida. His business, Diamond Ventures, was a Ponzi scheme. Authorities say he lost $15 million in bad trades, spent $15 million to keep the scheme going and pocketed at least $7 million. He was convicted of money laundering and wire fraud and sentenced to 15 years. But this story is not about Diamond. He’s just your run-of-the-mill thief.

The bigger question is, why would a smart, seasoned investor like McKenney hand over $250,000 to a guy like Diamond?

“I drank the Kool-Aid,” Mc­Kenney said. “This was my ticket to the dance. This was how the rich got richer. Everyone else was doing it.”

Everyone was doing it. It’s a sad and all-too-common rejoinder from those who fall prey to a swindle.

People hear “investment fraud” and they think of high-flying Wall Street types such as Bernie Madoff, a financier with a penthouse and private jets and, at one time, the chairmanship of the Nasdaq stock exchange. He managed billions of dollars for individuals and foundations — and built a $50 billion Ponzi scheme.

Most scams are not carried out as big institutional frauds. Rather, it is a friend or a fellow Rotarian, your accountant or even the local church deacon putting together that Ponzi scheme. He’s in your group. You have the same interests. It’s almost unimaginable that he would rip you off. It’s called “affinity fraud.” Madoff is, perhaps, the most notorious offender in this most common form of investment fraud. It’s common for good reason. It works.

Getting the guard to drop

Ruth and Len Mitchell are spending their retirement years in Arizona, light about $125,000. That’s how much they lost to longtime friend and accountant Barry Korcan. The smooth-talking Korcan joined Ruth’s skating club when she and her husband lived in Beaver, Pa., a bedroom community outside Pittsburgh. Korcan became friendly with the couple and put their money in what they thought were safe real estate investments. He set up a company called Guardian Investment Partners and provided phony quarterly statements. They thought they were earning as much as 8 percent.

Instead, Korcan enriched himself. In all, he stole $7 million from 39 investors, according to authorities. He was convicted of mail fraud and income tax evasion and is serving a seven-year prison sentence.

“He was like a son to my husband,” Ruth Mitchell said, “and he always kept a Bible on his desk.”

The pitches are almost always the same: “Get it now before it’s gone,” for impossibly high, guaranteed returns. The hustlers feed off greed and a quick-buck mentality. And they are not after the little old lady and her meager pension. The most likely victim of investment fraud is a 55-year-old, white-collar, college-educated man with a fair amount of disposable income, according to a study by the FINRA Investor Education Foundation. Just like Willie Sutton, the cons go where the money is.

“If you think you are too smart, then your guard drops and you become an easier target for the con criminal,” said Robert Cialdini, a fraud expert and psychology professor at Arizona State University.

The lure of easy money creates lemmings.

Michael Shinefield is serving an 11-year prison sentence for investment fraud. Before his sentencing, Shinefield sat down to talk. His attorneys hoped his cooperation in telling the world how cons work people over would result in a reduced sentence.

Shinefield had ripped off lots of smart Los Angeles professionals in a sports ticketing scam. He claimed to buy the tickets at face value, sell them at a premium and split the proceeds with investors. But he was no sharp, slick-talking operator.

Shinefield greeted simple questions with long pauses. Compound sentences were rare. “Ya know” and “uh” dominated as he spewed non sequiturs.

How could a guy like this attract investors?

Often he didn’t even meet the investors, he said. They heard of him through word of mouth. Shinefield paid off a few initial investors well, and they in effect became unwitting accomplices, his personal marketing team. These investors, like McKenney, drank the Kool-Aid. They listened to their friends, wanted the quick dollar and never checked Shinefield out.

If they had, they would have known that he had been jailed once for securities fraud and was not licensed to sell investments. The lesson here: Don’t take tips from friends and relatives without vetting the pitchman yourself. If he has no license or tells you the investment does not have to be registered, then watch your wallet — you are about to get scammed.

Thievery in God’s name

Perhaps the most pernicious form of affinity fraud happens at the church, synagogue or mosque. Con men love people of faith — these days, among some Christian groups, not only is it okay to be rich, it is in fact considered God’s will.

“Prosperity theology” has taken root among some Pentecostals and evangelicals who interpret the Bible as saying that Jesus wants you to prosper (get rich) while on Earth. This article of faith is often used by con criminals to scam true believers.

Belief in prosperity theology provides fertile ground for the crook prowling the pews. Although many Christians might find it disingenuous or even sleazy to be pitched an investment in church, adherents of prosperity theology consider it not only appropriate but consistent with God’s teachings.

“I’ve seen more money stolen in the name of God than any other way,” said Joe Borg, the director of the Alabama Securities Commission.

Borg has led many high-profile investigations of faith-based securities fraud, including the notorious Greater Ministries scandal. Greater Ministries was a massive con job masquerading as an evangelical church. Borg busted the group, whose leaders are now in jail. “Preachers” promised church members a 17 percent annual return on their investments, guaranteed by God. In fact, they stole almost $500 million from about 18,000 investors, mostly evangelical Christians. The deal was pitched as God’s Social Security plan.

This is certainly not confined to evangelical churches. Madoff subtlety but effectively played the religion card and enticed wealthy Jews into his scheme. The Mormon church does not want to acknowledge a problem, but there has been a rash of investment fraud in Utah and Colorado among bishops and elders of the church who have used their positions to swindle the Mormon faithful.

Jim and Diane Smart of Salt Lake City, Mormons and parents of eight, are losing their house and moving in with one of their children. They took out a $250,000 equity loan on their home to invest with a fellow church member. The church member promised returns of 20 to 25 percent in real estate investments. Instead, the Smarts say, they were scammed out of more than $200,000. The man running the scheme has been charged with fraud.

“He was in our church. We trusted him,” said Diane Smart, who has taken a job in a school cafeteria to make ends meet.

That thinking exasperates Michael Hines. The director of enforcement for the Utah state securities division, he has investigated many Mormon-related scams.

“If you need a new transmission, you go to a mechanic, not a church member. If you need brain surgery, you see a surgeon,” he said. “I don’t get why so many [Mormons] send their life savings to a church member.”

Beware of the free lunch

It was about the time I received my first AARP card that my first “free lunch” investment seminar invitation came in the mail. Lots more came after that, usually at mildly upscale places with banquet areas and mounds of fettuccine — think Tragara in Bethesda or Maggiano’s in Chevy Chase. Most free-lunch seminars are perfectly legitimate. But some are not. Either way, the folks are not giving you a free lunch because they like you.

“These free lunches and dinners, they are not gifts,” said Gerri Walsh of the Financial Industry Regulatory Authority, or FINRA. “They’re sales tactics designed to get your money.”

The fact that you are getting something for free plays on your age-old guilt.

“From our earliest years, we are taught that if you get something you have to give something back,” Arizona State’s Cialdini said. “The people putting on these free-lunch seminars know this. They want you to feel guilty. They want you to feel like you have to give something back in return.”

The bottom line is, if you have the time and you are hungry, go for the free lunch. But don’t turn over your pension or the equity in your home for a $11.95 plate of ziti.

Con criminals use common sales tactics, which is why so many of us fall for them: Scarcity — ad headlines scream in bold “ONLY THREE LEFT” or “THIS PRICE EXPIRES FRIDAY.” When a car salesman tells you the sale is only for “two more days,” you know, or should know, that he’s full of it. Apply that same skepticism to a broker trying to get your retirement money.

Fraudsters want to put you “under the ether.” The idea is to get you so excited and worked up about an investment opportunity that you don’t bother checking it out.

“You want to believe,” said McKenney, the Florida fraud victim. “You suspend disbelief.”

Words like that drive John Gannon nuts. He is the president of the FINRA Investor Education Foundation and a passionate advocate for honest investing.

“So many [scams] can be prevented,” he said. “It just takes a little time on your computer.”

Gannon’s team at FINRA has a Web site with a “broker check.” Type in a broker’s name and it will show lists of any infractions or complaints — and, most important, whether the broker is licensed to sell securities. The North American Securities Administrators Association offers quick links to state regulators at www.nasaa.org and has a useful tips on spotting fraud. AARP is another source.

What else can you to do protect yourself? Stop the madness. Victims routinely said they continued to invest with the con even after they had suspicions the deal might be dirty. They just didn’t want to give up hope. Good money after bad never works.

Stay away from investments you do not understand. Cons like obscure, hard-to-track products. Generally, stay clear of oil and gas deals; lots of those will be popping up, because oil is around $100 a barrel. Never, ever take equity out of your house to invest in securities. When home prices were rising, that was a favorite of the con criminals.

And finally, if you go to church, pray. Maybe do your investing elsewhere.

Carden, with video editor John Warnock, spent 18 months producing the PBS documentary “Tricks of the Trade: Outsmarting Investment Fraud.”

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