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Affinity Fraud and Ponzi Schemes: Victimizing One's Own

posted 3 years ago

Last year marked the 100th anniversary of Charles Ponzi’s federal indictment for the infamous scheme that bears his name, in October 1920. Investors who are contemplating investing in a new investment opportunity may be well advised to learn more about affinity fraud and how to evaluate such a new investment opportunity for red flags.

What Is Affinity Fraud?

“Affinity fraud” is sometimes defined as a type of fraudulent investment scheme in which a fraudster targets member of a specific, identifiable group based on characteristics such as their race, language, age, cultural background, minority status, religion, profession or occupation, place of employment, etc. The fraudster either is or pretends to be, a member of the group. Often the fraudster promotes a Ponzi or pyramid scheme.

Affinity fraud is on the rise. It has been estimated by the Association of Certified Fraud Examiners (ACFE) that in the late 80s, affinity fraudsters cheated 13,000 investors out of $450 million, and in the late 90s, more than 90,000 investors in 28 states lost more than $2.2 billion, and since 1998, affinity fraud has been ranked one of the top five investment schemes.

Fraud based on shared religious beliefs or affiliations is a prime example of affinity fraud. For instance, according to the FBI, the problem of affinity fraud is so serious in the State of Utah, presumably where alleged, self-professed members of the Latter Day Saints faith defraud actual, innocent members, that in 2015 the state legislature passed a law establishing an online white-collar crime registry, very similar to the registry set up for sex offenders, and this registry contains over 231 names.

How Does Affinity Fraud Work?

The insidious nature of affinity fraud is described by its very name. Affinity fraud leverages and exploits the inherent trust within a particular group; in other words, other people that you have an “affinity” with, in order to convince them into investing into some fraudulent financial scheme, quite often a Ponzi scheme, as discussed below.

For example, fraudsters have been known to target people within a particular culture, such as Vietnamese Americans, or people within a particular age group, such as the elderly, or, perhaps most unforgivable, within a particular religious congregation, where trust is considered sacred. The problems in Utah, discussed above, presumably occur primarily between members of the Latter Day Saints Church.

Examples of Recent Well-Known Affinity Fraud Schemes

According to the U.S. Securities and Exchange Commission (SEC), some of the more notorious affinity fraud schemes include:

  • On August 8, 2013, the SEC obtained a TRO (temporary restraining order) and froze the assets in a $4 million fraud and Ponzi scheme orchestrated by a financial planner who targeted members of his church, family, and friends.
  • Only two day before, on August 6, 2013, the SEC obtained an emergency court order to halt a hedge fund investment scheme being perpetrated by a former Marine who was masquerading as a successful trader to defraud fellow veterans, current military, and other investors.
  • On April 12, 2012, the SEC brought a civil action against a Ponzi scheme promoter who sold promissory notes bearing purported annual interest rates of 12% to 20%, telling primarily African-American churchgoers that the funds would be used to purchase and support small businesses such as a laundry, juice bar, or gas station. The promoter also sold “sweepstakes machines” that he claimed would generate investor returns of as much as 300% or more in the first year.
  • On April 6, 2011, the SEC charged that a South Florida investment manager defrauded investors by making false claims about his investment track record and providing bogus account statements that reflected fictitious profits. The scheme promoter pulled in at least $11 million from investors by falsely claiming annual returns as high as 26%.
  • The most famous Ponzi scheme in recent history was orchestrated for more than a decade by Bernie Madoff, who defrauded nearly 5,000 clients by pooling their investments into an account he withdrew from, but never actually invested. Once the financial crisis of 2008 hit, he could no longer sustain the fraud. The SEC values the total loss to investors to be around $65 billion.

How Do I Recognize Affinity Fraud?

Investing always involves some degree of risk. A “sure thing” in lawful investing is like a “sure thing” at the track: it is not a sure thing. You may be able to reduce your risk by doing your research, consulting with a variety of experienced investors, and asking questions and getting the facts about any investment before you buy. To avoid affinity fraud and other scams, you should consider taking steps such as:

  • Research Everything. Never buy in based solely on the recommendation of a member of an organization or religious or ethnic group to which you belong. Do your own independent research. Remember that that the person telling you about the investment may have been unwittingly misled him or herself.
  • Do Not Believe in “Guaranteed” Returns. When something sounds too good to be true, it almost certainly is not true. Also, remember that there is no such thing as a risk-free investment. If there were, everyone would be investing.
  • Get It in Writing. Con artists often avoid putting things in writing unlike legitimate investments. Avoid an investment if you are told they do “not have the time to reduce it to writing” the details of the investment.
  • Be Skeptical. You should also be suspicious if you are told to keep the investment opportunity confidential.
  • Do Not Be Pressured. Avoid “once-in-a-lifetime” opportunities when the money “has to be paid immediately.”
  • Beware of Internet Fraud. If you receive an unsolicited e-mail from someone you don’t know, containing a “can’t miss” investment, your best move is to pass up the “opportunity” and forward the spam to the SEC at [email protected], or any number of website used to identify scams.
  • Talk to a Professional. Reach out to a professional, such as a CPA or a lawyer specializing in reviewing investments, before agreeing to invest. Get the paperwork about the investment and show it to your professional. Don’t be afraid to ask: if the promoter of the investment opportunity is on the up-and-up, he or she won’t feel offended, and in fact will be used to investors conducting due diligence. The promoter will be happy to answer your questions and give you the paperwork. On the other hand, if the promoter claims to be offended or argue that you’re questioning his or her integrity, consider walking away. In the investment world, “trust but verify” is the norm. If any promoter has a problem with this, perhaps they might have something to hide.

What Is a Ponzi Scheme?

A “Ponzi scheme” is typically defined as a fraudulent investment program [that] pays supposed profits to earlier investors with money taken from later investors. There are some similarities between a Ponzi scheme and a pyramid scheme, in that both are based on using new investors’ funds to pay the earlier investors.

So, in other words, Investor A invests initially, the Ponzi Scheme uses Investor B’s new investment to pay supposed profits to Investor A, then the Ponzi Scheme uses Investor C’s new investment to pay supposed profits to Investor B, and so on until there are no more investors available to invest. So, Ponzi schemes eventually bottom out when the flood of new investors dries up and there is not enough money to go around. At that point, the entire scheme typically unravels, and the various investors are often times just out of luck.

What connects affinity fraud and Ponzi or pyramid schemes is that scheme promoters use their influence and good name within a particular peer group, such as the neighborhood locals of a particular culture, or members of their church, in order to implement the Ponzi or pyramid scheme upon their peers based the trust they enjoy.

What Should I Do if I Am the Victim of Affinity fraud or a Ponzi/Pyramid Scam?

If have been victimized by affinity fraud or a Ponzi/Pyramid scam, you should contact the SEC at [email protected] or http://www.sec.gov/complaint/select.shtml. You may also consider contacting a lawyer or law firm that are experienced investor advocates.

Alan Rosca is a securities attorney with Goldman Scarlato & Penny, P.C. and an adjunct professor of securities regulation at Cleveland-Marshall College of Law in Cleveland, Ohio.

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