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How Forensic Techniques Helped Identify a Ponzi Scheme

Situation 

A bankruptcy trustee hired FSS for the following mission: Determine whether a money manager, referred to as “The Project,” had been conducting a Ponzi scheme. We were asked to investigate and to provide expert testimony in bankruptcy court about what we found.

In a Ponzi scheme, fraudsters promise to invest money and generate a high rate of return with little or no risk. Most or all of the money is not invested, however. Instead, as new investors are recruited, their money is used to pay those who made earlier investments. As a result, the fraudster must bring in a constant flow of new money to keep the scheme afloat. When finding new investors becomes difficult or when many of the existing investors try to cash out, Ponzi schemes often collapse—with investors left holding the bag.

Strategy

On the surface, The Project’s operations had many of the hallmarks of a Ponzi scheme: New investors had been promised an exceptionally high and unusually consistent rate of return, the money manager had aggressively recruited new investors, and after the flood of new investors dried up, The Project imploded. 

Was The Project acting fraudulently, or was it simply very unlucky? To answer this question, our forensic investigation team needed to understand and assess quantitative and qualitative evidence. We collected bank statements, promissory notes, trading statements, and other financial information and created a relational database to help examine the data. 

A key tool in our effort was asset tracing. By tracing assets, we could establish the sources of funds, track how money flowed through The Project, and show the court where investor’s cash ended up. 

Results

FSS’s forensic accountants testified in federal bankruptcy court that The Project did indeed fit the definition of a Ponzi scheme. We found:

  • Extreme Promissory Rates: The Project issued 468 fixed-rate promissory notes during a year and a half and promised returns of up to 120% per year. Exceptional rates of return are a red flag for fraud and a 120% return could not be sustained over a long period by a legitimate venture.
  • Implausible Returns: Investors were promised $11 million, but the actual return on investments made by The Project was less than one-third of this amount. The discrepancy between the projected and actual returns indicated a cover-up.
  • Inadequate Sources of Funds: The Project’s primary source of funds was new investors rather than profitable business activities—a characteristic feature of a Ponzi scheme.
  • Inflating Numbers: Attracting new investors was indispensable to The Project to maintain the illusion of prosperity. Fresh investments were crucial to cover earlier liabilities.
  • Misused Funds: Only a tiny portion of the capital obtained from investors was invested. Funds were deliberately misappropriated to fund the lavish lifestyle of The Project’s organizer. 

Our testimony helped the bankruptcy trustee in its efforts to recover money for creditors. Sadly, only a fraction of the funds were salvaged for the bankrupt estate—a common fallout in the aftermath of Ponzi schemes.

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