Fraud Central- Don't invest with skinny dippers

I am fond of quoting Warren Buffett, so get used to it. He once said something you have probably read here in the past that goes "You only find out who is swimming naked when the tide goes out". By this he is referring to business models that can't swim when the water gets rough. It also applies to frauds. As we discussed at length, Madoff's scheme unfolded when too many people wanted their money at the same time.

When the market cratered and fear gripped investors, Madoff couldn't meet redemptions. When the sailing gets too rough, people pull their money out of even the (seemingly) most stable and safe investments. This effect is particularly severe when investors' less liquid investments can't be sold, leaving only the supposedly liquid ones left to sell. Madoff wasn't prepared to keep the charade going under such conditions.

All this you know already. The tide carries all boats up and down, so Madoff isn't the only fraud being exposed now. Since Bernie hit the papers, I count six more Ponzi-type schemes being exposed in less than two months. Second to Madoff's massive abomination is the alleged $8 Billion Allen Stanford fraud.

The SEC complaint accuses the group comprised of the Stanford International Bank, Stanford Group Company and Stanford Capital Management of "orchestrating a fraudulent, multi-billion dollar investment scheme centering on an $8 billion CD program."

More specifically, the group sold certificates of deposit or CD's to investors promising unrealistically high returns (in other words double-digit returns from a CD). How might a bank be able to pay such high rates? Well, while Stanford is headquartered in Houston, its bank is in the Caribbean, Antigua to be exact. According to reports, the bank supposedly invested in portfolio of liquid, but high returing, "investments". Reports are that the investments were anything but liquid, constituting fraud.

The group reported that it lost a mere 1.3% last year in fabricated return data. Stanford pushed these CD's through investment advisors using the falsified performance data which helped it run afoul of the Securities Exchange Act and the Investment Advisors Act. I could go on, but you get the point.

The news is full of stories where people are flying to Antigua and it's other branches trying to redeem CD's, which of course isn't going to happen. As we have said before, if an investment seems too good to be true in terms of risk and reward, you better assume it is and steer clear.

Another giant, neon, buzzing, in-your-face, please-just-try-to-ignore-me, red flag is the international character of any financial institution, particularly a Caribbean address. There is no reason why any investment need be structured in the Caribbean. Most often the only reason for a financial presence in the Caribbean is to exploit a "loophole".

Frequently this "loophole" is a way to cheat on taxes or avoid oversight. In the first case, we are talking about tax cheating, not tax avoidance which is perfectly legal and appropriate. No one wants to pay more than they have to, but there is an enormous difference between cheating and legally avoiding. Just ask anyone who thought they didn't have to pay taxes on money in Swiss banks because Swiss banks could not disclose their identity to U.S. authorities and thus they couldn't be caught. Legally they owed taxes, but thought they could get away with not doing it. Every year people are caught because "tax shelters" turn out to dodge the spirit of the tax code and a court rules them unlawful. The moral here is never invest for "tax benefits" of any kind. You invest in something because it has economic merit, any tax benefits are secondary. This should make fundamental economic sense when you think about it.

The other "loophole" is to avoid oversight or regulation. [Warning: generalization coming.] Now we may never like that the government can stop us from investing where we please, but at least recognize it is usually for a reason and that reason is often to protect you. Regulation and oversight does not exist for fun; it exists to stop an abuse. If an entity can't do something on U.S. soil, then stop to think why. The U.S. has the most sophisticated and deep capital markets in the world- there are few, if any, legitimate investments you have to go to a place like the Caribbean for. Exploiting "loopholes" is not a strategy- it is usually just a way for someone to steal.

So, anytime you hear someone talk about a "fantastic", "great", "amazing" or choose your own adjective "investment" with tax benefits, loopholes and exotic locations- send them here for a scolding. If it *might* be too good to be true, take a pass. And no matter what, if someone asks you to "invest" in something that sounds great, has a Caribbean component of any kind and past performance that is impressive then accept the fact all the red bullshit flags are waving, shut off congratulate your skeptical detector and walk away. Please.

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For those interested, here is my list of disclosed or alleged frauds. So far it totals $58.1 Billion, although I'm sure I missed a few. We'll probably have to update this sooner or later, I doubt this is the last:

• Madoff, $50 billion


• Stanford, $8 billion


• Joseph Forte, $50 million- sold false limited partnership securities since 1995 with annual returns of 18-37% (again, who believes such returns?)


• Mark Trimble/Phidippides Capital Mgmt, $30 million


• Hays/Crossfire Trading, $25 million


• James Ossie/CRE Capital, $25 million- supposedly guaranteed 10-20% every 30 days and planned a $100 million stock offering later this year (the gall!)


• George Theodule/Creative Capital, $23 million- Ponzi preying on Haitian-Americans (another affinity scam)