Beware of Financial Fraud During Troubled Times–Ed Martin, Sage Investigations, LLC

From Bryan Forman, Forman Law Firm, P. C.–In an effort to provide our readers with unique perspective of other professionals in the world of investments and securities regulation, arbitration, and litigation, I will occasionally invite friends, colleagues, and other experts to publish a blog piece from their unique perspective.  If you like what they have to say, please say so and forward!  Thanks for reading.

In this Guest Blog Piece, we hear from Edmond (Ed) Martin of Sage Investigations, LLC in Austin, Texas.  Ed brings some unique experience and perspective to “Ponzi Schemes” a topic that has been around for a while and one on which we have often posted (see, “Ponzi Schemes Recommended By Stockbroker—How Can Firms Miss Them”), but one that is likely to experience a resurgence at the end of the recent bull market and the recession possibly brought on as with the Coronavirus Correction as more and more schemes are revealed as the proverbial house-of-cards comes tumbling down.    Ed is a Certified Fraud Investigator, and gained substantial experience working as a Special Agent for the U. S. Treasury and Internal Revenue Service, Department of Justice, Texas State Securities Board, and other government agency types that you never really want to hear from unannounced–you would always rather call them as a victim of a scam.  Ed has investigated all sorts of financial fraud, with a particular emphasis on Ponzi Schemes, and has told his stories on a number of television programs.    See his CV here.  We invite him here to share his perspective on two of the more notorious Ponzi schemes—Madoff and Russell Erxleben, and to highlight a few of the early warning signs for investors.

Beware of Financial Fraud During Troubled Times.

            –Ed Martin, Sage Investigations, LLC.

With a down-turn in the economy some private investor money will disappear, the veneer of many companies raising money will crack, and the exuberance of pouring money into businesses will wane.  Predictably, fraudulent schemes will be exposed.  Forensic accountants with fraud investigative background will be in demand and will be beneficial to investors and businesses though out the country to determine what happened to the missing money.  Ponzi schemes like that of Bernie L. Madoff Investment Securities LLC (BLMIS) and Russell Erxleben of Austin Forex International Inc. (AFI) will be exposed.  Businesses of all kinds and investors alike will suffer from financial fraudulent activity and internal theft.

The common characteristics of a Ponzi Scheme:

Enticement Through A Fraudulent Means.  A successful Ponzi scheme as those perpetrated by Madoff and Erxleben required the use of a fraudulent means to entice investors.  The enticement were false profits and exclusivity.  Also, Madoff soon became a NYC celebrity and being admitted into Madoff’s funds was perceived as an opportunity for the social and business elite.  In Texas, Erxleben had the reputation of the record-setting field goal kicker for the Texas Longhorns, a status held in high esteem in the Lone Star State.   In both cases, the client account statement was the key that made them successful.  The fraudsters reported fictitious trades on bogus transactions that were reflected on client account statements that were generated by the fraudsters themselves, and not the third-party custodians which held the customers’ funds and securities.  The counterfeit account statements showing false profits made their investors feel secure in their investments.  Madoff appeared to have a legitimate investment business run by his sons on the 19th floor of the Lipstick Building in Manhattan, but he also had a “secret” office on the 17th floor in which the fraudulent client statements were generated.  In similar fashion, Erxleben’s operation was on the 19th Floor of the building at 100 Congress Avenue in Austin, Texas overlooking the Texas State Capitol and he setup a forex trading operation.  Fraudulent client statements from transactions fabricated by Erxleben were created by trusted employees.

Help From Others.  Each scheme required the creation of false client statements by insiders.  Trusted insiders on the 17th floor of BLMIS knew that false client statements were being created to conceal the truth from investors.  Trusted AFI insiders on the 19th floor knew false statements were being created.  Erxleben would state, “what goes on behind the glass door stays behind them,” meaning that the fraudulent nature of the client statements was not to be disclosed to investors.  The law would likely consider these insiders as “aiders” or “abettors” or “control persons” and would hold these insiders liable just as if they were Madoff or Erxleben.

Market Opportunity.  Major events created the opportunity for the schemes.  Madoff admitted his fraud began in the early 1990s at the time the country was in a recession.  He also employed his “split-strike conversion strategy” which he conceived along with hedging investments by buying and selling options.  Russell Erxleben also began his fraud in the mid 1990’s after learning about Forex trading in smaller Ponzi schemes in Texas.  He also had the “Texas advantage” when two events converged including when IRAs controlled by banking and brokerage rules were allowed to be self-directed through trust companies with administrative flexibility to hold alternative assets; and when Texas voters passed a constitutional amendment allowing closed-end home loans which unlocked home equity for investment. These events converged so that greed, ego, and fraudulent motive met market opportunity.

Greed.  In addition to the greed of the con men, both frauds were also fueled by the investor greed—investors wanted “in” and they wanted to participate in the “extraordinary profits” being generated by their celebrity financial mavens.  Based upon the alleged earnings shown on their fraudulent client account statements investor money flowed in.  Madoff received investor funds and placed them in his account at the Bank of New York in Manhattan.  Erxleben received investor funds and placed them in four Austin banks that allowed him instant access to the money which allowed him to kite hundreds of thousands of funds between the bank accounts.

All those involved in the frauds used the funds to improve their life styles.  Madoff used the funds he banked in Manhattan to pay investors, sales commissions, and to create an extraordinarily lavish life style in Montauk, New York, Palm Beach Florida and other locations.  Erxleben gambled on the Forex market with his Russian enablers, paid investors, and created a celebrity athlete’s lifestyle in Lakeway, Texas.  The investors used their Ponzi payments they received to enhance their life style and did not know they were receiving Ponzi payments from “other people’s money.”  Like in all Ponzi schemes, investors entering at the end of the scheme lost money and some investors were required to return preferential payments to the court appointed receivers.   The proverbial house-of-cards came tumbling down.

Both frauds were under scrutiny from outside their entities.  Harry Markpolos, CFP and CFE, while working for a Madoff competitor, realized that something Madoff was doing was not correct.  His investigation into Madoff revealed the investment strategy was inaccurate and could be fraudulent.  The purchase of options to hedge investments required the purchase of more options on the Chicago Board Options Exchange than actually existed. He reported his findings to the Securities and Exchange Commission (SEC) but his evidence was ignored, and the scheme was perpetuated.  In Texas, the watch dogs at the Texas State Securities Board received complaints from investors about AFI and they learned that AFI was offering an unregistered and non-exempt security (investment contract), a practice prohibited under the Texas State Securities Act.  They began an investigation, had a receiver appointed and shortly after brought in IRS Criminal Investigation and the FBI.  Later an expert in foreign currency testified in a Travis County Court that AFI was trading in more foreign currency than most small countries and that Erxleben was gambling by holding trades overnight that cost AFI extra money.

These fraudulent businesses were not initially visible to the general public nor the regulators (SEC or the State Security agencies), but there were warning signs and there were initial complaints and reports that went unheeded.  While our regulatory scheme is that the issuer, traders, and brokers are required to comply with a vast set of statutes, rules and regulations to protect the investing public, the investor shouldn’t turn a blind eye to something that doesn’t smell right.  If the return on an investment seems to be too good to be true, it generally is.  This adage rings true whether the investment is Texas land, gold, forex or other assets or technology.  The best practice is to first check out your financial professional through the regulators’ websites like FINRA BrokerCheck or the SEC’s IARD, and stay very involved in how your money is invested.  If you don’t understand how your money is being invested, why, and at what exposure to what type of risk, you shouldn’t permit the investment until you do understand.

Warning Signs That Should Prompt Further Investigation By an Attorney or Forensic Investigator.

  • Returns are too good to be true
  • Year-end 1099s are not provided timely, and don’t reconcile to money received
  • Investments are too exotic to be understood
  • “Income” or “distributions” are not tied to specific investments in your account
  • You are encouraged to bring in other investors
  • Statements are from the promoter, not a known brokerage firm, or look “different”
  • Questions about the investment strategy are evaded
  • Inability to get your money out immediately

How To Recover.  Oftentimes when trying to recover losses from an ongoing Ponzi scheme, it is imperative that your attorney and your investigator work fast, as it is frequently the case of the quick or the empty-handed. Efficiently and discreetly asking for a return of your capital, supported by well-reasoned and articulated legal analysis and forensic accounting will be, perhaps, the only way of recovering your capital.  In many instances, investor capital has been converted into a variety of assets of the con man and their family or associates, including real estate, jewels, trading accounts, yachts, etc., and knowing the extent of the scheme and where the money is buried is half the battle of recovery.  If/when the scheme’s assets are made the subject of a receivership and/or action by the regulators, your recovery probability goes down, as does the amount that may be recoverable.  Keep in mind that the law in most jurisdiction provides that any profits or other distributions made to investors can be recovered by receivers or others seeking to maximize recovery for victims.

If you are concerned about whether you may have been talked into investing in a Ponzi scheme, consult a good attorney experienced in the area, and as part of the team include an experienced investigator.  Be the quick and well informed, not the empty handed!

-Ed Martin, Sage Investigations, LLC