On Wednesday, May 15, representatives of the Securities and Exchange Commission and the United States Attorney’s Office, along with other financial regulators and law enforcement personnel, spoke at a fraud summit in Orlando. The event was organized by Florida A&M University College of Law and took place at the law school’s Orlando campus.
It should come as no surprise that Florida is a hotbed of fraud. Recent reports from the Department of Justice have listed Florida, and particularly South Florida, as having among the highest rates of financial fraud in the United States. A number of factors make the state a breeding ground for Ponzi schemes and investment scams. First, the state has a large senior population. Evidence suggests that senior citizens are particularly susceptible to financial fraud. Second, there is no shortage of wealth in Florida, particularly in places like Palm Beach County (which was hard hit by Madoff’s Ponzi scheme). Add to that a population of transients and plenty of folks with international ties, and you have a fertile environment for financial fraud. At Wednesday’s event, Glenn Stuart Gordon, Associate Regional Director of the SEC’s southeast region noted that in Florida, the Commission tends to see Ponzi schemes and an abundance of affinity fraud. Let’s talk about the later: Affinity fraud.
Often, con artists and fraudsters will become heavily involved in a specific, somewhat insular community, build relationships in those communities and then exploit those relationships. This happens most often in religious communities. For many of us, we have a tendency to trust the people we meet at our churches, synagogues or mosques. When we go to services, we tend to let our guard down. We view church or temple as a safe place, a place of brotherhood and fellowship. We feel a certain kinship with the other members of our congregation. And when new members show up at services, we welcome them with open arms. The fraudster knows this and uses all of this to his advantage. Usually, it works like this:
John Smith shows up at church. He’s new. He tells people his story. For the past few years, he has been entirely preoccupied with running his business. He feels very fortunate, because business is good. But John recently has started to feel that there is something missing from his life. Deep in his heart, he felt a longing to go back to church. He had always gone to church when he was younger, but then he strayed. Now that his business is established and doing well, he has had some time to reflect. He knew he wanted to reconnect with his faith. He wanted to go back to church but he really didn’t know how. It had been so long. He asked around and heard great things about First Baptist. He decided to stop in for services one morning. He hopes people there will accept him back into the flock.
John becomes a regular at services. The members of the congregation embrace him as one of their own. They’re proud of him for coming back into the fold. John attends services every week. He goes to the weekly church business breakfast on Wednesday mornings. He attends the church picnic. People ask John what he does for work. He casually mentions that he runs an investment fund. As the weeks and months go by, John grows closer with the members of the church community. He’s in the proverbial circle of trust. One week at the business breakfast, a fellow churchgoer, Barry, who now considers John a friend, asks John about his investment fund. Barry is in his late fifties. He runs a successful computer repair business. He’s not exactly rich, but he’s been saving money his whole life. He invests in stocks, but does this on his own. He’s just curious about what John does. John tells Barry that he runs a fund that specializes in trading commodities, principally metals. Not just precious metals like gold and silver, but also metals like copper and nickel. Barry says that’s interesting. John says that the fund has done very well and that he thanks God for his good fortune. Barry says amen to that.
A short while later, Barry and John are at another church function. Barry says he’s looking at other investment options and is thinking about investing in precious metals. He asks John what type of returns he’s making in the fund. John says he’s averaging 12% a year over the past five years. Barry is impressed. That’s a great return. John says it’s part knowledge and experience, but a big part of it is the fund’s specialized software that helps predict the market and helps him make good trades. Barry is intrigued. A few weeks later, Barry asks John about investing with the fund. And here’s where John uses one of the oldest tricks in the book: “I’m really sorry, Barry, but I’m not really taking any new investors on right now. I set a limit on the size of the fund and right now we’re at capacity.” Barry is a bit disappointed but also impressed. This just confirms to him that John’s services are in demand and the fund must be a good bet. A few weeks later, Barry follows up with John again regarding investing. John says he’ll make an exception and let Barry in the fund, because they are such good friends and Barry played such a big part in welcoming him into the church. John let’s Barry invest $100,000.
A few months down the road, and Barry’s money has done well with John. He’s on pace to make a healthy 12% return that year. Meanwhile, others in the church have learned about John and his very successful metals investment fund. John has made some space in the fund for new investors. He did this just so he could let other people from the church invest with him. A few months later, and Barry’s money has done so well that he puts in another $200,000. He knows John. He trusts John. He has seen the returns. He has seen his money grow. He might be able to retire soon if things keep going this well.
And then, everything falls apart. Sally from church, who also invested with John, needs to redeem $100,000 worth of her investment because of a family emergency. Sally faxes the redemption request over to John’s company. She needs the money urgently. She knows John personally, so she calls him on the phone and tells him about her situation. He says it will be handled immediately. A week goes by. John sends a check. Sally tries to deposit the check and the check bounces. She calls John. John says it must be a bank error. John says he’ll call the bank and clear it up. Three days later, the check is cleared. But Sally tells another investor about the ordeal. That investor tries to redeem his investment. The same thing happens again— delays, excuses, bounced checks, more excuses. It spreads like wild fire. Within two weeks, everybody who has invested with John, including dozens of folks from First Baptist are trying to redeem their investments. Nobody knows where John is. He has stopped coming to church. He has stopped answering his phone. He does not return calls or emails. Somebody calls the FBI.
Two weeks later, John is arrested by the feds. He was running a massive Ponzi scheme. He took in more than $10 million in investor money, much of which came from other members of the church and connections he made through the church. He spent nearly all of that money on himself, his lifestyle, gambling, strip clubs, art collections. He was a complete fraud. His scheme never would have been possible but for his ties to First Baptist. Had people taken the time to check, they would have learned that John had no real infrastructure. His investment fund was a two or three person operation. The auditor was a small outfit in a strip-mall and the principal had a checkered past.
You can avoid this type of affinity fraud by looking for the red flags that are often present in many investment fraud scams. Investors should always be wary of things like:
- Lone wolf investment managers with no real operation
- Guaranteed returns or incredible returns
- Lack of a credible auditor
- An investment strategy that doesn’t make sense
- Principals with a checkered or criminal history
- The “at capacity” scam
Remember, just because somebody is a member of your church or temple does not mean that you should give them a free pass and implicitly trust them with your money.
Jonathan Pollard is a trial lawyer and litigator based in Fort Lauderdale, Florida. He represents clients in Miami, Fort Lauderdale, Boca Raton, West Palm Beach, Jupiter, Fort Myers, Tampa, and Orlando.
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