Today, the Washington Post published a story detailing an alleged Ponzi scheme that targeted Mormons. (It’s worth noting that one of the alleged fraudsters—the one who seems to have thought up the scheme—was not Mormon. The rest? Yep. Mormon.) Ultimately, Mormons and others lost hundreds of millions of dollars.
Avoid Blaming the Victims
Before I go any further, I want to make something clear. Because I’ve been on the internet long enough to know that people are already formulating comments painting the victims of this fraud as greedy or as overly naive. Both reactions, while appealing, are wrong. The victims of this Ponzi scheme were, in fact, victims of people committing fraud. Blaming the victim of a crime for their victimhood is psychologically natural. But natural doesn’t mean right, morally or substantively. And blaming crime victims is neither right nor moral.
But also, both accusations miss the mark. Were the victims naive? Maybe. But remember Bernie Madoff? His investors/victims included banks, investment funds, charitable foundations, universities, pension funds, and plenty of other sophisticated people and entities. So dismissing victims as simpletons and naïfs doesn’t work.
As for greed: look, very few Americans have access to defined benefit retirement plans. While 67% of private industry workers have access to some sort of retirement plan, only about 15% have access to defined benefit plans (and those are mostly union members). The rest have defined contribution plans. Basically that means that most Americans (or, at least, most Americans who manage to save for retirement) bear the burden of figuring out how much they need to live on in retirement, then to invest in a way that will provide them with that money. The thing is, most Americans—those of us who need to somehow create and maintain and grow our savings to buy a house, to send kids to college and on missions, to retire—are financially illiterate.
Which is to say, I find it hard to blame victims of financial fraud for falling for it. Victims know they need to grow their money, they don’t really know how to do it, then someone comes to them and tells them they can get enormous returns with no risk. And what do we expect them to do?
What’s a Ponzi Scheme Anyway?
The SEC claims that Matthew Beasley and his Mormon business partner Jeffrey Judd operated a Ponzi scheme that preyed on Mormons. But let’s unpack that.
What is a Ponzi scheme? Also popularly known as a “pyramid scheme,” a Ponzi scheme is an alleged investment that pays earlier investors with money from later investors. (This is in contrast to legitimate investments, which pay investors out of the earnings and profits of the investment.) A Ponzi scheme works great. Until it doesn’t. At some point, the promoters won’t be able to get any more investors, won’t bring in any more money, and the whole thing collapses. People who haven’t been paid yet won’t be paid, because their money went to pay earlier investors.
Ponzi schemes can be part of a class of fraud called affinity fraud. Basically, affinity fraud target identifiable groups (based on age, national origin, religion, or other identifiable characteristics). The fraudsters are part of the group or pretend to be part of the group, and use the networks and trust that have been developed within the group. Mormons are a great target for affinity fraud, because our shared values tend to translate into trust in each other, and we have networks that allow the fraud to spread.
What Was This Particular Fraud?
As best as I can tell, it was basically a litigation finance scheme. The idea was that investors would invest their money with Beasley and Judd. The two of them claimed that they would give the money to personal injury plaintiffs to help fund their litigation. When the personal injury plaintiff eventually won their suit, the investment fund would get a percentage of the judgment. That money would then go to investors.
Beasley and Judd allegedly promised 50% annual returns on investment with virtually no risk. If that were right, if an investor put in $10,000, they’d get a $5,000 a year (and, presumably, if they reinvested that $5,000, their gains would compound). But, the SEC asserts, they never actually gave the $10,000 to a slip-and-fall litigant. Instead, the money went into houses and cars and other things for Beasely and Judd, as well as to pay the 50% returns to earlier investors.
Avoiding Ponzi Schemes
Here’s the thing: litigation financing is a real thing. (In fact, it’s currently a more-than-$9.5-billion industry.) Just like investments funds (like the one Madoff claimed to operate) are real things. And, in fact, I suspect that most Ponzi schemes claim to be real businesses.
So how can we protect ourselves from them? The government lists some common characteristics of Ponzi schemes:
- High returns with little or no risk.
- Overly consistent returns.
- Unregistered investments.
- Unlicensed sellers.
- Secretive, complex strategies.
- Issues with paperwork.
- Difficulty receiving payments.
This scheme hit most of these bullet points. Even though litigation finance is a real thing, it doesn’t provide consistent or guaranteed returns. You eventually get paid, but only if the plaintiff wins. Plaintiffs don’t always win, and the judicial system isn’t entirely predictable. If the plaintiff doesn’t win, you lose all of the money you put into the case. You’re certainly not going to pull 50% returns every year, and you’re not going to do it without risk. (In fact, one of the gigantic red flags that brought Madoff down was that year in and year out, he was providing his investors with a 10-11% return. And that kind of consistency just doesn’t happen.)
But here’s the problem with Ponzi schemes: like I said, they reflect actual investments. If you ignore or miss the puffery (or the fraudsters are sophisticated enough to pretend there’s some volatility to the returns), how do you avoid investing in Ponzi schemes?
I mean, one way is just to invest in securities traded on established markets. But, while that provides a market return, maybe you want exposure to more volatility. What do you do then?
I’d suggest not investing more than you can afford to lose. Because a big problem seems to be that the investors in this (and many) Ponzi scheme invested small at first but, happy with their investments, invested more and more. About 900 people invested somewhere in the range of $500 million. The Washington Post reports that some people put their whole retirement accounts into the investment (or, better, “investment”), while some borrowed against their home equity to invest. One 81-year-old retiree put in $2.2 million–about 95% of his money. And those people are, I suspect, unlikely to get any significant portion back. If it were a small investment among a lot of investments, the loss would sting, but the investor would be fine. But here, it’s going to cost people their homes and their retirements. (And before we criticize the retiree: elder investment fraud is a huge problem. I don’t know if it’s diminished facilities or loneliness or growing up in a more trusting world or what, but the elderly as a group are at enormous risk. In fact, even if you would never fall for something like this, it’s worth keeping an eye on your parents/grandparents to make sure they don’t.)
Concluding Thoughts
As Mormons, we’re definitely at risk of affinity fraud. We are socialized to trust each other. And, I would argue, trust and community are both important and good. But it’s important that we exercise the same skepticism when our coreligionists offer us an investment opportunity that we would exercise if a neighbor or coworker or someone randomly knocking on our door offered us the investment opportunity.
But Mormonism is not only a horizontal community—it’s a vertical one. And one of the victims quoted in the article said about the investment, “There was never a hiccup. . . . My bishop was involved and invested, and so were my closest friends.” And that’s one thing that affinity fraudsters do—they recruit high-prestige members of a community. And again it is critical to note that there’s no indication that the bishop was part of the fraud. He was defrauded too! Also, affinity fraudsters count on close-knit communities keeping it quiet and, to the extent there are problems, trying to resolve it within the community, or, perhaps, being too embarrassed about being defrauded (and, perhaps, inviting friends and family to invest alongside them) that they don’t say anything.
And again, the blame rests on the promoters of the Ponzi scheme. To the extent the allegations are true, they acted illegally and immorally. They deliberately defrauded their friends, neighbors, coreligionists, and others.
And I would argue (and, in fact, am arguing) that as members of the church, we have an obligation to protect not only ourselves, but members of our various communities, from this type of affinity fraud.
If you have a subscription to the Washington Post, you really need to read this story. The way it unwound—an accountant saying to himself, “This is too good to be true,” then going to a New York firm that specializes in exposing Ponzi schemes, which went to an old high school friend of one of the founders, who used his private jet to trick the guy into pitching him on it, is just amazing. Also, there’s a standoff with the FBI. And you really just need to read the whole thing.