The use of anti-money laundering tools to regulate Ponzi and other fraudulent investment schemes
| DOI | https://doi.org/10.1108/JMLC-01-2016-0005 |
| Published date | 03 July 2017 |
| Pages | 231-246 |
| Date | 03 July 2017 |
| Author | Norman Mugarura |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation,Financial crime |
The use of anti-money laundering
tools to regulate Ponzi and other
fraudulent investment schemes
Norman Mugarura
Department of Research,
Global Action Research and Development Initiative Limited, London, UK
Abstract
Purpose –The purpose of this paper is to explore dynamic issues relating to Ponzi and other fraudulent
investment schemes to demonstrate how scammers convince victims of investment opportunities that turn out
to be nothing but fraudulent. Specically, it explores the nature of Ponzi, Pyramid, Advance fees scams and
the mechanisms used to defraud unsuspecting victims of their money. The risks associated with Ponzi
schemes can be gleaned in the fraud case of Bernie Madoff (1998) who had been running a Ponzi scheme in the
USA for 20 years and reaping investors of their returns without ever discovering it until the business
collapsed. The other notorious investment scams include “the Nigerian letter frauds” which combine the threat
of impersonation fraud with a variation of an advance fee scheme in which a letter is mailed to offer recipients
the “opportunity” to share in a percentage of millions of dollars that the author – a self-proclaimed government
ofcial – is trying to transfer out of his country. This article assesses the possibility of using anti-money
laundering regulatory tools such as a “risk based approach” and “Know Your Customer” to protect victims of
fraudulent investment schemes.
Design/methodology/approach –The paper was written by analysis of primary and secondary data
and by utilising newspaper reports on different types of fraudulent investment schemes and the context in
which they normally happen in practice. It has also utilized case studies and relevant examples to demonstrate
different typologies of fraudulent schemes and the possibility of using anti-money laundering regulatory tools
to regulate them.
Findings –The ndings suggest that many people who fall victims of fraudulent investment schemes such
as Ponzi and advance fee fraud are not gullible but lack knowledge of their sophistication and how they
operate to defraud unsuspecting victims of their savings.
Research limitations/implications –The paper was largely a library-based research, and there were
no interviews carried out to corroborate some of the data used in writing it. This minimises inherent bias in the
use of secondary data sources to undertake a study.
Practical implications –The practical implication of the paper is to highlight the inherent risks in Ponzi
and other ctitious investment schemes that are often cleverly conjured to exploit ignorance of the public and
defraud them of their savings. It demonstrates that while nancial institutions can use their regulatory tools
such as KYC to safeguard nancial markets from criminal exploitation, people should be vigilant to avoid
falling victims of criminal exploitation and lose their savings.
Social implications –With globalisation, the market is awash with different types of investment
opportunities, but people need to keep in mind that it has also created opportunities for criminal exploitation.
Some opportunities that are being offered such as advance fee and other schemes are cleverly devised to
exploit ignorance of the public. Therefore, this paper highlights the pitfalls which potential investors need to
bear in mind when deciding on where to invest and how to invest their money.
Originality/value –Research on Ponzi schemes, advance fee fraud and misuse of letters of credit do not
seem to have received proportionate scholarly attention as other forms of nancial crimes. This paper,
therefore, addresses a need in the market on many issues it relates.
Keywords A risk-based approach, Know your customer, Other regulatory measures,
Ponzi and other schemes
Paper type Research paper
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1368-5201.htm
Anti-money
laundering
231
Journalof Money Laundering
Control
Vol.20 No. 3, 2017
pp.231-246
©Emerald Publishing Limited
1368-5201
DOI 10.1108/JMLC-01-2016-0005
1. Introduction
A Ponzi scheme may be dened as a form of fraud where a non-existent enterprise is
promoted by the payment of quick returns to the rst investors from money invested by later
investors. It may be distinguished from a Pyramid scheme, in that Ponzi schemes have only
one “ofcial” promoter, while all who participate in a Pyramid scheme promote it for their
own gain and the fact that the fraud lies in getting people to invest in a fraudulent enterprise
as opposed to promoting the scheme for the investor’s own gain. They were named after
Charles Ponzi (an Italian immigrant) who started a business guaranteeing a 50 per cent
return on money invested to investors in the USA in the 1920s[1]. These schemes promise to
offer high nancial returns or dividends on investment that are not available in other
investment market elsewhere. However, instead of investing the funds received from the
victims, the fraudster pays dividends to initial investors using the funds of subsequent
investors. The scheme generally falls apart when the operator ees with all of the proceeds
realised from this schemes or when a sufcient number of new investors cannot be found to
allow the continued payment of dividends. A Ponzi scheme can be said to be is an investment
fraud that involves payment of purported returns to existing investors from funds
contributed by new investors. Ponzi scheme organisers often solicit new investors by
promising to invest funds in opportunities claimed to generate high returns with little or no
risk. With little or no legitimate earnings, Ponzi schemes are serviced by a constant ow of
money from new investors normally recruited by those who have already joined them for a
commission. Ponzi schemes will inevitably collapse when it becomes difcult to recruit new
investors or when a large number of investors ask for their funds to be returned. These
schemes encourage investors to recruit more people being promised to be paid a commission
when they do. They can also be called “franchise fraud”, “multi-level marketing” or a “chain
referral scheme[2]. ” The inherent risks in Ponzi schemes can be gleaned in the fraud case of
Bernie Madoff who had been running a Ponzi scheme for 20 years and reaping investors of
their returns without ever discovering until the business collapsed. For instance, the
investment balances shown on the statements they had received from Madoff did not
correspond to the real assets held by Madoff or anyone else involved in this business venture
(Dombalagian, 2000). Bernard Madoff’s Ponzi scheme is allegedly reported to have cost
clients US$50bn. For many years, it appeared that Madoff was consistently making large
returns from a sophisticated investment strategy involving purchases of equities hedged by
out-of-the-money put-and-call index options. It later transpired that those returns were
ctitious and payments to investors were being nanced from the proceeds of new
investments[3]. The revelation of the fraud meant that savings for retirement in old age, as
well as estates to be left to families or charities, were dissipated overnight. Bernie Madoff is
said to have been paying a handsome 10-15 per cent or even higher annual returns, the power
of compound interest had turned many small nest eggs into grand ones, and larger
investments into great fortunes. But whether the fortunes were large or small, they all
disappeared and some clients have never recovered their money[4]. Investigators located
some of Madoff assets of more than US$1bn across the world’s offshore locations in the
Cayman Islands, Gibraltar and Luxembourg, with more jurisdictions likely to come. Its tally
of the stated value of all the account statements of every Madoff account holder included, in
some cases, decades of fabricated returns closer to US$20bn. Another legal issue was
the extent to which withdrawals of funds prior to the collapse of the investment enterprise
were protected by statutes of limitations[5]. There was hope that some investments could
have been salvaged, but it later transpired that Madoff had assets transferred to nancial
safe havens or had confederates that retained control of his assets (Henriques, 2011b). The
trustee was appointed with the mandate to uncover those assets or take legal action to obtain
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