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The “Well-Known Cloud” over JP Morgan’s Head

If living in hindsight was a reality,  there are many of us who would have taken a different path at times during the road of life.  As reported in today’s New York Times, JP Morgan Chase executives reportedly “expressed serious doubts about the legitimacy of Bernie Madoff’s investment business more than 18 months before his Ponzi scheme collapsed, but continued to do business with him.” Unfortunately now for JP Morgan, the path they chose (which encompassed a “Google search with no follow-up”) may cost them $6.4 billion in civil claims.

According to several internal bank documents unsealed yesterday in connection with the Madoff Trustee liquidation proceeding, several high-ranking JP Morgan risk management executives shared communications in 2007 about Madoff’s “Oz-like signals” which were “too difficult to ignore.”

As described in the court filings:

For whatever its worth, I am sitting at lunch with [JPMC Employee 1] who just told me that there is a well-known cloud over the head of Madoff and that his returns are speculated to be part of a [P]onzi scheme-he said if we google the guy we can see the articles for ourselves-Pls do that and let us know what you find.”

[JPMC Employee 2] warned, “you will recall that Refco was also regulated by the same crowd [SEC, NYSE, NASD] and there was noise about them for years before it was discovered to be rotten to the core. Hopefully this is not the case here but given [JPMC Employee 1’s] view, I think we owe it to ourselves to investigate further.”

Nevertheless, Equity Exotics seemed eager to receive approval, and the further research on Madoff was limited to a Google search with no follow-up. REDACTED [JPMC Employee 8] asked one of her colleagues to “please have one of the juniors look into this rumor about Madoff that [JPMC Employee 2] refers to below.”

The analyst forwarded an article about a proposed change in SEC regulations that would eliminate a loophole in the regulations governing broker-dealers. He speculated the loophole allowed broker-dealers to run “a ‘[P]onzi’ scheme of sorts.” Even though the article made no mention of Ponzi schemes and provided no suggestion as to why Madoff in particular would have had a “well-known cloud” over his head, upon information and belief, no further investigation was conducted—even after [JPMC Employee 2] cautioned, “Mr. Madoff will not allow us to conduct any due diligence on him directly and we are forced to rely on the diligence of third parties. . .

Now getting back to the earlier point of living in hindsight; we are confident that many individual investors and business executives were unfortunately blinded by Madoff’s “well-known cloud” and possibly even ignorant to the subtle red-flags he may have waived.  However, when one of the largest financial institutions in the world considers proper due diligence as “googling the guy” or last “having one of the juniors look into this rumor about Madoff”…something is seriously wrong with the avenue JP Morgan chose to vet Mr. Madoff, possibly even now negligent.

What do you think about JP Morgan’s “due diligence”?  Let us know in the comments.

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An investment fraud can look legitimate in so many ways, but there are many warning signs everyone should be aware of. The key is not only to recognize some of these warning signs, but to act on them.

15 Warning Signs of an Investment Fraud:

1There is Nothing on Google! – Not finding anything on the first few pages of Google might give you some level of comfort.  What you may not know is that a fraudster may have paid someone to bury the results of past discretions. Even so, Google is only the tip of the iceberg as far as the information that you can get.

2Planes, Boats, Yachts – Ponzi schemers love to show their jewelry, vacation homes, cars, planes and yachts. They must  figure that they are going to be caught at some point and should enjoy the fruits of their labor.

3Pedigree – There are certainly a number of successful investors who have come from nowhere, but for the most part, the successful investors have come from prominent firms or have a prominent background in the industry.

4Lofty Credentials – Having a degree from an Ivy League school or having experience at a top flight investment firm instantly gives people credibility. The problem is that the fraudster knows that as well and knows that most people will take their word for it.

5All the trappings of success – In order to get access to people’s money, you have to have their trust, and part of building that trust is acting the part. Making high profile donations to local charities, flying private jets and dressing the part are all ways that a fraudster gives the impression to potential investors that they have all the trappings of success.

6Unverifiable claims – Insider information, patent pending formulas or information that nobody has access to are all examples of things that are either impossible to verify or not verifiable at all.  You can’t always trust people; if it can’t be independently verified, it’s not worth anything more than the paper it’s written on.

7Multiple Aliases – You should always be wary of people that have multiple aliases (John, J. Charles, “Charlie”, “J.C.”, etc.). The fact of the matter is that it’s more difficult to identify issues in someones past if they have multiple aliases.

8Secretive – Bernie Madoff was notorious for his secrecy. Secret, confidential, exclusive clubs of investors may sound tempting, but it should be anything but.

9Verifiable through local regulators? – If local regulatory offices can’t verify the existence of the investment scheme, it’s a big cause for concern.

10“Guaranteed” Returns or “No Risk” Investments – The truth is that no investment strategy is truly “no risk.” The more you are guaranteed the more you should examine what you are being guaranteed against.

11Lack of Transparency – The more transparent that you have to be to investors, the more difficult it is to cover up the fraud.

12It Sounds to Good to Be True? – If it sounds too good to be true, it probably is.

13From a different area – It makes sense not to commit another fraud in the community where they got into trouble before. By moving to a new area, a fraudster may be trying to escape some of his past.

14No name accountant or administrator – The reason for having an auditor and third-party administrator is to have professional/non-biased oversight of the firm, but if that auditor or third party administrator is someone that nobody has ever heard of, there is some good reason to do some extra digging around.

15Too Many Questions – Asking a lot of questions can make an investment fraudster uncomfortable, after all, it’s a sign that someone is doing their homework. Every investor has a right to ask as many questions as they want; it’s their money after all.

What do you do?

If you have recognized any of these warning signs, you can trust your gut instinct and run for the hills, or you can hire a professional private investigator who can help get beneath the surface and find information that can help you make a more informed decision.

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The Securities and Exchange Commission (“SEC”) has recently initiated a program to educate both first-time investors and seasoned professionals on the identification of various red flags of investment fraud to conduct a “do-it-yourself” due diligence investigation. While the SEC outlines several important ways to avoid falling victim to an investment advisor fraud, (e.g. “pump and dump,” pyramid, ponzi scheme or affinity scheme), an experienced due investigator specializing in due diligence investigations is trained to tap into numerous resources to obtain critical facts which often help investors make more “informed” decisions and help you avoid an investment fraud.

In addition to conducting quantitative due diligence on a potential investment advisor/broker/hedge fund manager (i.e. reviewing financial statements, understanding the investment scheme, etc.), here are some additional tips on how to avoid falling victim to an investment-related fraud from a due diligence investigation perspective:

“Googling” is not due diligence

Did you know that by recent estimates, the surface web (a typical “Google” or search engine) accounts for less than 1% of what is actually on the Internet? Consider that the next time you spend an hour “Googling” a particular person or company and come up empty. It is also important to understand that the more successful and more complicated the particular scheme has become, the more likely the fraudster will “bury” any derogatory or damaging information about themselves into the Internet. (See related post, What You Find on the Internet May Not Be True?)

Value your references, but check it out anyway!

Someone who has been referred to you by a respected member of your community should be treated with the same skepticism as anyone else. There has been an explosion of affinity frauds (investment frauds that prey on an identifiable group) over the last few years, including the now infamous Madoff scandal. Former investors, employees and business associates can provide critical details that you may not be able to find anywhere else.

Verify Credentials

It is common for fraudsters to claim numerous memberships to exclusive organizations or relationships with wealthy families. In addition to finding information to support such claims, attempts should also be made to confirm that the broker or advisor really did receive that “ivy league education” or that they are licensed with appropriate regulatory agencies (e.g. FINRA).

Review Litigation

Historical civil complaints filed by current or former investors are oftentimes the first warning sign that trouble has been brewing. Federal and state litigation searches can also identify potential red flags such as divorce petitions, which often provide evidence of stress/tension or information concerning conflicts with former employees, employers, suppliers or business partners.

“Conspicuous Consumption”

A major warning flag for investors is a “showcase” of wealth. Investment fraudsters driven by greed and power, often camouflage the legitimacy of their investments by purchasing luxury homes, automobiles, yachts and one-of-a-kind items (e.g. artwork). In addition, certain fraudsters will make significant contributions to exclusive charities or organizations, often with a big splash or press release attached.

Review Criminal/DMV Records

Would it surprise you that several high profile fraudsters have had criminal records or a history of alcohol abuse, which could have been easily identified during a routine background check? For example, Sam Israel (Bayou Hedge Fund Group), who defrauded over $400 million from loyal investors, had a history of alcohol abuse. While Nicholas Cosmo (Agape World, Inc.), who is awaiting trial on a separate $400 million Ponzi scheme, previously served more than a year in federal prison for stealing client funds.

Confirm Service Providers

Outside accounting firms and fund administrators, who are “independent” third-party providers, provide an important buffer between the investment managers and their victims. But what if these “independent” providers were not so independent after all and were actually aiding in the scheme? Bernie Madoff used a unusually small two-person accounting firm to manage his billion dollar hedge fund while Sam Israel used an accounting firm run by his CFO. Are these arms-length relationships worth knowing bout beforehand?

Conclusion

As the daily headlines reveal more and more fraudulent investment schemes, individuals and businesses should use all of the investigative due diligence resources available today to avoid becoming another statistic tomorrow.

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Conducting an investigation into an alleged Ponzi Scheme has become all too common of an occurrence these days, but you are not the only one.

“Hedge Fund Manager Charged with Running Multi-Million Dollar Ponzi Scheme!”

Does this headline sound familiar…it has become a recurring headline as of late. In 2009 alone, according to research by the Associated Press 150 ponzi schemes collapsed; many of these are names that you have all heard of, but many others, most people have not. The details and aftermath of these frauds all sound the same from its victims…“If I only would have known!”

We live in an age where we have become more intrigued on getting to the bottom of celebrity scandals, versus learning more about who or what we are entrusting with our money and businesses. Like any successful investment scheme, it takes planning, financing and most importantly, word of mouth advertisement from its earliest investors. Most individuals are susceptible to being pulled into these investment schemes by those people they most trust (family and friends), many of whom have unfortunately not done their homework themselves.

How About those Guaranteed Returns?

The idea of conducting an investigation relating to a potential investment to find out the facts behind the “guaranteed returns” used to be considered an unnecessary waste of time and money. Today’s investors are thankfully becoming more aware of their surroundings and are beginning to realize that all investments have risks; knowing the facts of who or what you are planning to align yourself with beforehand can help you avoid being part of the headline.

Do You Need to Hire a Private Investigator to Perform Additional Due Diligence?

Unfortunately even today, some individuals still believe that they can avoid hiring a professional investigator and get everything they need to know about an individual or investment model by reading a subject’s website, “googling” the person, reading blogs or even talking to other investors. Now this is a step in the right direction and every situation may not call on hiring an expert. The SEC outlines several ways to avoid being part of an investment fraud, “pump and dump” scheme or pyramid scheme, but a professional investigator is trained to navigate the Internet and public records, get behind the information readily available to everyone else and to obtain relevant facts to help investors make “informed” decisions.

Conclusion

Word of mouth advertising has succeeded with keeping the investment scheme pool filled. Hopefully now, someone will seek out the facts and consider the consequences before jumping in.

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