Protecting Against Ponzi Schemes

Recently, I got a call from a client asking us to evaluate an investment. It had similarities to other pitches, but this one had a twist.

The pitch offered guaranteed returns of 12% to 18% by investing in real estate projects in south Texas.

Interestingly, it was the third time we’ve heard this pitch.

It reminded us of legal proceedings currently unraveling in upstate New York. Miles “Burt” Marshall promised to invest funds from people, investing into local real estate—things like storage buildings and apartments.

In exchange, Marshall delivered promissory notes earning a guaranteed 8% interest no matter what happened in the financial markets.

This worked for quite some time, until people wanted their money back.

Soon, Marshall filed for bankruptcy. He owed nearly 1,000 people $95 million against assets of $21 million. Most was tied up in illiquid real estate.

During discovery, attorneys concluded that since 2011 Marshall was constantly raising new money to pay obligations from old investors. This is a classic Ponzi scheme.

It remains unclear if Marshall started as a Ponzi scheme or if he hit a rough patch causing his business model to unravel. Trusting investors now face getting back 5 cents for every dollar invested, a 95% loss.

According to Ponzitracker.com, in 2023 a new Ponzi scheme was uncovered every five days costing investors nearly $2 billion, down from $5.3 billion in 2022.

I don’t know if our client’s “opportunity” is a Ponzi scheme or not. But it raises red flags.

To think through this, realize 20% of business start-ups fail in the first year and 50% within five years. Entrepreneurship is brutal.

Understanding this, use this checklist to assess “guaranteed” opportunities.

1. Anytime someone offers a non-FDIC bank guarantee, beware.
2. The 10-Year US Treasury currently yields 4.3%. Any promised return significantly higher than the default risk-free rate of a Treasury is a red flag.
3. Regardless of underlying business model, is there a reasonable chance the net profit margins could sustain guaranteed payouts of 12% to 18% per year or any other figure?
4. Assess the sustained competitive advantage allowing this venture to be so productive. What problem does this solve allowing significantly higher than average returns?
5. When promised returns are significantly higher than the fixed income or stock markets, it often means there is substantial leverage. When it works, it can hide flawed business models. However, when markets turn, the obligation owed to banks or other lenders cause it to collapse. Determine how much borrowed money is at work.
6. Do you have actual collateral or merely a promise to pay? If there is a claim of collateral, get verified third party documentation of the collateral and associated lien holders. Furthermore, determine where you are in the collateral pecking order. Not all debt obligations owe the same level of duty to each investor.
7. Is your money pooled with others? If yes, it is harder to get an accurate accounting of what you and others own.
8. If this is such a great investment, why are the organizers sharing it? If I found an investment paying a guaranteed 12% or more, I’d keep it for myself. Since they want me to put my hard-earned money in tells me the return will not be nearly as good as promised.
9. Are the organizers of this great investment actually writing a check to participate? Or are they raising money from others and taking a piece of the pie in the process? If the entire thing is funded by others, the organizers’ downside is nothing. Make sure they have real skin in the game.
10. Who audits the financial statements? Have you independently contacted the auditors to verify they are responsible for auditing this adventure? Don’t take the word of the organizers. After obtaining the audit, make sure you understand what it says.
11. Run a background check on the organizers. Look for bankruptcies, frauds, felonies and complaints with the Better Business Bureau.
12. Do the organizers have a long-term, verifiable, track record of producing results?
13. What is your liquidity mechanism and time frame? Real estate projects are notoriously illiquid. Not only do they cost more than anticipated, but they take longer to pay out, assuming they are legitimate.

I hope I’m wrong on my suspicions about a Ponzi scheme in my backyard. However, paying guaranteed 12% to 18% returns does not pass the smell test. If it sounds too good to be true, it usually is.

Dave Sather is a CERTIFIED FINANCIAL PLANNER and the CEO of the Sather Financial Group, a fee-only and fiduciary strategic planning and investment management firm.