Ponzi schemes and boiler room frauds - if it sounds too good to be true, it probably is

4 July 2014

Ponzi schemes and boiler room frauds are presented as ways to get-rich-quick.  How can you identify whether you have been a victim of these frauds and what civil actions could be taken going forward?

Ponzi schemes

A Ponzi scheme works by operators paying investors monies which have been paid into the scheme by new investors. They are also known as pyramid schemes as the new investors form blocks supporting and providing capital for payment to the older investors above. The scam gains legitimacy and momentum as the operation initially yields tangible results for the investors and they recommend the scheme to others.  The operators, who have been systematically pocketing a proportion of the capital, will eventually disappear with all the funds at which time the pyramid collapses. 

Boiler room frauds

In boiler room frauds, brokers cold call or email unsuspecting victims promising high returns on shares in which they want the victims to invest but which are actually worthless, overpriced or non-existent.  The brokers may attempt to make the investment seem credible by confiding in the victim that they have insider information.  The brokers will involve as many victims as possible in the scam and then perform a vanishing act with the investments.  

What do these schemes have in common?

The investments may take various forms and guises, from foreign currency to green energy investment. The scams will shed their skin and be reinvented to deceive unsuspecting victims. The scams may form part of a complex lattice, whereby the victim may attend meetings with investment managers, may be provided with advice from a supposed solicitor prior to making an investment, may receive share certificates confirming an allotment of shares or may be sent glossy magazines with a regular update on their investment.

Victims are cherry-picked. For boiler room frauds, fraudsters may target people whose details are taken from shareholder lists and so are classed as open to making investments. Before the snowball effect takes place, Ponzi schemes often commence with the most trusting and vulnerable, who are motivated to invest in a good cause, such as renewable energy. 

Alarm bells should ring if extraordinary returns are guaranteed on a fail-safe investment, at the click of your fingers or on a fixed basis.  If the odds that Colombia will win the World Cup are 20:1, then winnings may be high, but extraordinary returns cannot flow from ‘foolproof’ investments. Think twice if an incredulous ‘investment manager’ pitches a once in a life-time opportunity to you, glazing over the detail and driving home the line “Act now or lose out”. 

Civil action

What civil actions are available?

A person who suffers loss as a result of acting in reliance upon a false statement can seek to recover damages in an action for deceit, where a statement is made:

  1. with knowledge of its falsity;
  2. without belief in its truth; or
  3. recklessly, not caring whether it is true or false.

Or a claim can be brought for misrepresentation where the victim must prove that a material representation was made by the other party to the contract, that in reliance upon that representation the victim entered into the contract and that the representation was untrue.

The appropriate cause of action will, of course, depend on the facts of the matter.

Why take civil rather than criminal action?

  1. In civil proceedings the initiative is in the hands of the victim and the victim controls the civil process. The victim can commence civil proceedings at their convenience. They do not have to wait upon the decision of prosecuting authorities, which may be not to prosecute.
  2. In criminal proceedings the victim has no rights, no voice, no right of representation and no right of appeal.  In civil proceedings the victim takes control.
  3. There are expeditious interlocutory processes available, for example a freezing injunction can prevent the fraudster dissipating his assets, whether or not those assets are within the jurisdiction, or the Court can order the fraudster to provide information about his property or assets - this is a useful weapon in identifying potential assets against which execution can be made after an award.
  4. The burden of proving civil fraud is ‘on the balance of probabilities’, although Judges have stated that the evidence required must be cogent and compelling.  In criminal proceedings it is ‘beyond reasonable doubt’.
  5. The victim in civil proceedings, if successful, will be entitled to damages which can be enforced against the fraudster’s assets (in criminal proceedings victims seldom recover their losses).
  6. Civil proceedings are much quicker than criminal proceedings.
  7. The thrust of civil proceedings is to trace, protect and recover assets for victims.  The thrust of criminal proceedings is to secure evidence which will lead to a conviction of the fraudster.

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