As fraud schemes proliferate--are you the next investor to crash and burn?

Abstract

Purpose--The purpose of this paper is to educate investors on the red flags of Ponzi and other fraud schemes and due diligence measures.

Design/methodology/approach--The paper examines ways in which fraud is executed in Ponzi schemes and then highlights practical precautions every investor should take to prevent being a victim.

Findings--The research outlines specific red flags that the investors in the Madoff Ponzi scheme and other fraud schemes might have recognized and others in the future should recognize to prevent being the next victim. These red flags are consistent in most Ponzi schemes and investors should institute due diligence in examining their investment firm or manager.

Practical implications--Investors should be wary of their investment manager and pay attention to the warning signs that they could be involved in a Ponzi scheme. They should insist on seeing detailed audit information and not hesitate to ask questions.

Originality/value--The paper will be of interest to a wide range of individual and institutional players in the investment community who in light of recent events are concerned about being investment fraud victims.

Keywords Fraud, Investors

Paper type Technical paper

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With the continued frenzy of news stories relating to the next big Ponzi scheme personal and institutional investors have asked themselves whether they too could be potential victims of this type of fraud. Everyone has seen the benefits of investing in alternative investments such as access to extremely talented investment managers with long-track records, opportunity to earn more than average market returns through lower correlation with publicly traded securities, lower portfolio volatility, and tax efficiencies. However, there are also risks where a few investment managers have exploited the system. Many investors who were not affected by fraud schemes are eager to learn how to avoid the potential pitfalls and be better positioned in these uncharted waters.

Ponzi schemes lure investors with consistently high returns on investment which, unbeknownst to investors, are paid …