Ponzi schemes exposed: from Bernie Madoff to Melissa Caddick

Garreth Hanley:
This is INTHEBLACK, a leadership, strategy and business podcast, brought to you by CPA Australia. Welcome to INTHEBLACK In this special ‘Crime by Numbers’ episode, we are delving into the murky world of Ponzi schemes. From Charles Ponzi himself to Melissa Caddick and Bernie Madoff. Can you spot the hallmarks of a Ponzi scheme? Here is Jackie Blondell and ‘Crime by Numbers’.

Jaqueline Blondell:
You’ve probably heard the term “Ponzi scheme”, where a fraudster convinces people to hand over money for an investment, but no such investment exists. Instead, the schemer pays their other investors with funds collected from the new investors. In a typical Ponzi scheme, the rate of return on this fake investment is higher than what the general market commands. When early investors receive their first dividend, their confidence is boosted - they think they’re onto a winner. That’s when, quite often, they also encourage their family and friends to invest in the scheme. The people who operate Ponzi schemes are often cunning and elusive. When the house of cards starts to collapse and their deceitful behaviour begins to be uncovered, sometimes they literally disappear. This is what happened in the case of Melissa Caddick who vanished in 2020, shortly after her home was raided by ASIC investigators and the Australian Federal police. There’s been intense public interest in the Caddick case, particularly in the light of her mysterious disappearance. For many accountants, it presents a fascinating case study in forensic audit. Few people know more about this topic, or the Caddick case, than Bruce Gleeson FCPA, a principal with insolvency specialist Jones Partners. Together with his colleague Daniel Soire, he was tasked with forensically reconstructing Caddick’s financial affairs. It was not the first time he’s had to piece together a financial puzzle.

Bruce Gleeson FCPA:
I've had directors that have absconded in shipping containers to the Dominican Republic to avoid further examination and scrutiny. So I think with our role, you have to be adaptable. We realised quite early on there was not a great likelihood that we were going to have the ability to interview Melissa as part of our appointment.

Jaqueline Blondell:
Before we dive into the Caddick case and the lessons it holds for accountants, let’s stop for a few moments to recognise the sheer creativity of Ponzi fraudsters. Schemes have run the gamut from the more obvious foreign exchange, crypto-currency and electronic goods to diamonds and even biblical scripture. We’ll put more information on those in the episode’s show notes. Not even animals are immune from Ponzi scheming. Emus are particularly popular, and so are goats. Californian bankruptcy lawyer Kathy Bazoian Phelps recounts a Ponzi case from India where the operator promised 2 per cent monthly returns from the purchase of goats it claimed to be rearing on a farm in the country’s north.

Kathy Bazoian Phelps:
So investors were told that each goat gives birth to four kids a year, and the new goats would be sold to other investors so they could get up to a fourfold appreciation in the first year. And then each of those four goats could then give birth to three or four kids the following year, and so on.

Jaqueline Blondell:
You’d think investors would ask some questions about this one – say, are they investing in a nanny or billy goat? Kathy has her doubts.

Kathy Bazoian Phelps:
I don't know that anybody bothered to ask how everyone could be promised a fourfold return, when at least half of the people probably realised … their goat was not going to be giving them anything.

Jaqueline Blondell:
Together with retired bankruptcy judge Steven Rhodes, Kathy Bazoian Phelps wrote the literal book on Ponzi schemes. It explains how to unravel these cases from a legal perspective. She also runs a blog that publishes monthly breakdowns of Ponzi activity. The number of cases has been steady since 2012, when she started the blog, but Kathy says they do tend to ebb and flow with the economic times.

Kathy Bazoian Phelps:
The stronger the economy is, the more money that people have in their pockets, I think the more opportunities they're looking to invest. And Ponzi schemers will take advantage of that. But on the other hand, I really see fraud feeding on uncertainty, financial distress, upheaval, and at times of change. We've certainly been in that state for the past few years, and so fraudsters are going use the latest news, and they're going to be very quick to exploit the latest crisis to lure investors into a scheme. And of course, they're going to feed on investors' desire to make money, and on the uncertainty of economic and social times. If interest rates are particularly low, which we are coming off a very historically low time, it's going to fuel investors' desire to make an extra buck by trying to find a clever investment programme. For example, during COVID, we saw a lot of COVID related schemes, you know, promoting stock in publicly traded companies that was about to increase because they had the prevention or the detection ability or, or the cure to COVID-19.

Jaqueline Blondell:
Back to Melissa Caddick. There is much of Caddick’s life that is public knowledge. There’s the hype surrounding her lavish lifestyle, funded by the money she took from a wide network of investors including family and close friends. There’s the ASIC raid of her Dover Heights home. There’s the gruesome discovery of her decomposed foot on a shoreline on the NSW South Coast. And, of course, there’s those conspiracy theories surrounding her disappearance. But that’s not what we will be exploring throughout this episode. Instead, we will focus on the fraud at the heart of Ponzi schemes – what are its defining characteristics? How might Caddick - and other Ponzi fraudsters, like Bernie Madoff, the architect of the largest Ponzi scheme in history – have plotted their crimes? And, most importantly, how do you spot a Ponzi scheme, to protect yourself or to warn your clients of the potential for serious losses? Bruce Gleeson explains.

Bruce Gleeson FCPA:
Melissa Caddick convinced the victims to provide funds to her company, Maliver, which she was the sole director and sole shareholder of under a financial services guide. And, basically, what she was meant to do under that financial services guide is open up a Commsec trading account in the investor's name and invest those monies in Australian domestic equities.

Jaqueline Blondell:
Of course, if Caddick did this, we wouldn’t be talking about her now. A forensic analysis of Caddick's financial affairs showed that, instead, she created phoney documents using a CommSec letterhead and used fake account numbers to show investors the return they were making on the investments.

Bruce Gleeson FCPA:
What did happen is that the funds, as soon as they were introduced into Melissa's company, Maliver, were intermingled with a whole range of other investor funds through a combination of in excess of 20 bank accounts, and then used to fund Melissa's lifestyle, effectively. Now, what was interesting about this is that the financial services guide did reveal an AFSL, being and Australian Financial Services License number, but it did not belong to Maliver.

Jaqueline Blondell:
The false AFSL, or Financial Services Licence number, did not tip off Caddick’s investors. They trusted Caddick with their investments, and some received payouts, most likely sourced from the funds injected into Maliver by other investors. These are the trappings of a classic Ponzi scheme.

Jaqueline Blondell:
You can’t get much more “classic” than the Ponzi scheme operated by its eponymous creator. Charles Ponzi told his would-be investors that he could buy large amounts of international postal-reply coupons from overseas at a discount, and then sell them locally at a huge profit. Ponzi’s early investors were rewarded handsomely, and soon word spread, with more and more investors wanting him to deliver the same remarkable returns for their money. But behind the scenes, Ponzi was only able to pay his investors using money from new investors, not profits. It was a scam that ultimately led to Ponzi being charged with fraud. He may have made them famous, but Ponzi schemes had been in existence long before Charles was even born. The first known Ponzi operator in history was actually a woman. Back in 1879, American Sarah Howe created the Ladies’ Deposit Company, a type of bank that accepted deposits from women largely overlooked by traditional banks - those that didn’t have a husband or guardian handling their money. Howe promised an 8 per cent rate of return. But her bank was quickly revealed to be a fraud, with Howe using the funds from new depositors to pay out earlier clients. Some historians estimate that Howe collected more than 500,000 US dollars, the equivalent of about 13 million dollars in today’s money, before her scam was exposed. A more recent ‘classic’ Ponzi fraudster – and often considered the scam’s archetype – is Bernie Madoff. He stole almost 20 billion US dollars from investors before he was exposed in 2008 during the Global Financial Crisis, earning himself a 150-year prison sentence. Kathy Bazoian Phelps believes the Madoff case can teach even the most sophisticated investors a thing or two about asking more questions.

Kathy Bazoian Phelps:
People just didn't really stop to focus – other than one whistleblower ¬– on the performance of his funds to the market. Despite the fact that the rest of the market was suffering, and the SAP had been down Madoff had only supposedly lost money in three months. There was no correlation to the market there. If people had looked at their statements, they would've seen that trading was taking place on weekends and holidays, which of course can't be. Or that the, the sales on a given day that they were taking place outside of the range of the value. If you don't understand the business model – which nobody understood Madoff's business model – that's raising red flags, and then you need to ask even more questions and try to get answers that make some sense and that are independently verifiable.

Jaqueline Blondell:
What role do accountants play in unravelling Ponzi schemes? Alex Bell, national head of forensic consulting at Grant Thornton in Sydney, provides forensic accounting services and appears as an expert witness in court proceedings. When it comes to investigating Ponzi schemes, he describes his role as taking a deep dive into complex data.

Alex Bell:
We like to think that one of our main skills is taking something hugely complex and putting it in a report that anybody can pick up and understand exactly what we're saying and understand what's happened.

Jaqueline Blondell:
In a Ponzi scheme investigation, the question is typically, "What happened to the money? Where is it now?" It is up to Alex’s team to find the answers.

Alex Bell:
And that means we have to follow the money from when investors deposit funds into the scheme, usually through a large number of bank accounts, into where it is now. And obviously the main aim of this is to try and find the money now, or the assets that the money has been used to purchase. And if we can prove that, then it might be possible to get a return for investors or other creditors of the scheme. So, we need to prove that the money in its final place was actually sourced from investors.

Jaqueline Blondell:
This is generally done through a process known as tracing, which essentially involves proving that a withdrawal from one bank account can be matched to the deposit in another bank account.

Alex Bell:
Say, if an investor has invested into Bank Account A, and that's been transferred into Bank Account B, using a set of rules to match the transactions, we can say that the money that's in bank account B is actually the investor's money and therefore we may be able to recover it. And the rules we apply, for example, might be that if the withdrawal amount is on the same day for the same amount, and then there's a reference number that you can see on the deposit on the other bank account, we would classify that as matched, and there may be other rules we would apply, but hopefully, ultimately we can prove that we can find where investors funds are to start with.

Jaqueline Blondell:
Sounds simple enough, right? Not quite. There are plenty of dead ends and black holes on the Ponzi scheme money trail.

Alex Bell:
Firstly, there are usually large amounts of data to work through and cross reference, and these will be in all sorts of formats. We're probably typically working with imperfect data. So, the format of the data might be sort of PDFs of bank statements, which are quite hard to deal with in large volumes because you have to effectively put those into a database or Excel or whatever program you're using to analyse the information. And one of the things I've realised over the years of doing this is technology has really moved on, and actually dealing with bank statements is now much easier than maybe it was a few years ago.

Jaqueline Blondell:
Another challenge is that most bank accounts under investigation may have both investor funds and other funds that can’t be traced directly to investors.

Alex Bell:
And so, you have to have some principles to show how you treat funds that contain both investor and non-investor funds. And there's a number of legal principles behind that, but essentially the main one is that you have to assume that somebody would use the non-stolen funds first before they use the stolen funds. And then you've got to trace all these amounts through the various bank accounts.

Jaqueline Blondell:
Another challenge, which Bruce Gleeson experienced when he was following the financial trail in Melissa Caddick’s Ponzi scheme, is how murky the waters can be. As he puts it, he couldn’t place any reliance on any of the financial statements that had been prepared for Caddick’s company, Maliver.

Bruce Gleeson FCPA:
In fact, there was no accounting system per se used, such as MYOB or Xero. All the company's accounts have been maintained with reference to using the Excel program. And really what we ascertained was that there needed to be a complete rebuild or reconstruction of the financial affairs of Maliver over the total period that the Ponzi scheme ran. What we had to do was start with all of the source documentation – all the bank statements, coupled with other external information from the investors, and trace all the investor funds through the company's account through to the other accounts to really rebuild what the company's financial position was and rebuild what Melissa's own financial position was. It was more a matter of time, rather than it being an impossible process, but obviously it was not helped by either the quality of the records, or the fact that we actually didn't have Melissa to actually provide any kind of response.

Jaqueline Blondell:
Most Ponzi scheme victims invest their money in good faith, and they are usually promised high returns and low risks. In many cases, they may actually know the person they are trusting to invest on their behalf, or they know others in their community who have vouched for them. As Kathy Bazoian Phelps explains, affinity groups often figure largely in a scammer’s operation.

Kathy Bazoian Phelps:
So, an affinity group is a, a closely connected group of individuals who have some type of a common interest through maybe an organisation, a community, religion or some other affiliation. And so, we have seen time and time again, these schemes will target maybe a religious organisation, maybe a, a church or a synagogue or a group of elderly or retired people. I've seen a number of schemes that involve a group of immigrants who came in together, and maybe there was one person already here in the United States who helped bring other people into the US and then proceeded to take advantage of them and steal their money. So, the reason why I think that these schemes really proliferate in affinity groups is because people trust, and again, they don't stop and they don't ask those hard questions.

Jaqueline Blondell:
When a Ponzi scheme is exposed, investors usually lose most of the money they invested. Bruce Gleeson explains that they may also be exposed to sequencing risk, which means that if they have invested later in life and things don’t go to plan, they have less opportunity to recover from that loss than if they’d invested at an earlier age.

Bruce Gleeson FCPA:
A lot of the people here were investing into the Caddick scheme in their forties and fifties, and so they lose that kind of money and the opportunity for them to make that up through the balance of their working career, or in other investments, is a lot shorter than if it occurred at a much earlier point in time.

Jaqueline Blondell:
Of course, the loss that Ponzi scheme investors experience goes far beyond money.

Bruce Gleeson FCPA:
There are some that have questioned, how could they have been so trusting? Why did they let it get to that point? But I think importantly, we should never forget that this Ponzi scheme, like many other Ponzi schemes – even ranging up to, I guess, the crème de la crème, being the Bernie Madoff one – they operate on the basis that these people are really, really good at convincing people to invest with them. And so, all of the other things that we might say are adequate checks to put in place are kind of pushed to one side, because of this high level of trust that the investor has in the operator.

Jaqueline Blondell:
Not all Ponzi schemes start out as scams, either, as Alex Bell reminds us.

Alex Bell:
One scheme we investigated had a legitimate business, but the cash flows were never going to be sufficient to support the level of returns. And so there was a business there, but they then started the Ponzi element to pay it back. And other ones, products never existed, so they just set it up and immediately it was going to be a scheme. And I'm always interested in the psychology behind someone who does that. And then, in the process of running it, you must know that it will all collapse at some point, and you're likely to spend significant years, or the rest of your life, in jail. And how do you live with yourself through that process?”

Jaqueline Blondell:
Recovering trust and self-confidence after being involved in a Ponzi scheme is not easy. But what about recovering the money? Here’s Kathy Bazoian Phelps.

Kathy Bazoian Phelps:
I have seen everything from zero to a hundred percent when people lose their money. It really depends on many, many different factors. You know, if I had to pick an average range, and again, I'm just guessing, you know, maybe they will recover between 10 and 30 or 40 per cent of their money. Again, I have personally been involved in schemes where they have actually gotten back a hundred per cent of their money. And I know in the Bernie Madoff case, for example, they're doing quite well. I don't know the exact percentage, but it's well over 50 per cent. So, it depends on what types of assets are available at the time that the scheme was revealed and shut down.

Jaqueline Blondell:
Sometimes, money can be recovered to duped investors through the liquidation of the schemer’s assets. What are some of the low-hanging fruit that can be recovered for investors?

Kathy Bazoian Phelps:
Piles of jewellery and maybe even a lot of money left in the bank account, or maybe 60 million dollars of cryptocurrency that they were just about to do something with, but didn't quite get around to it yet. On the other hand, sometimes you get a case where there isn't all of that stuff, and maybe the best you're going to do is try to bring some litigation claims against culpable parties to try to recover some money to get a distribution. So that's why there's such a very, very large range of what the returns look like.

Jaqueline Blondell:
In the case of Melissa Caddick, low-hanging fruit included her jewellery, a designer wardrobe and residential property. As we were recording this podcast, Bruce Gleeson and team were still realising the asset pool from Caddick’s estate, before the court would decide how to divide it.

Bruce Gleeson FCPA:
I'm sure, and as part of that process, we'll be asked to provide further input to the court as far as how our tracing has gone and some proposed distribution methodologies. And equally at that point, investors and other interested parties will be given the opportunity to assert why perhaps they should be given some priority ahead perhaps of other investors. And that can be on things like a basis where a specific contribution or an investment has been made and then used to acquire an asset, which is directly sort of traceable.

Jaqueline Blondell:
Alex Bell has seen cases where early investors have been better off and thinks this may affect the way funds from the asset pool are dispersed.

Alex Bell:
In one of the matters I was involved in, the liquidators ran legal proceedings to see if we could set off the returns that investors got from their original investment. And the idea behind that was that it would produce a fairer outcome for all. So for example, if you have invested 100,000 dollars and got 200,000 dollars in returns, you're actually better off from the scheme even though from a strict investment point of view, you were still owed the 100,000. Whereas if, say, I invested 100,000 recently and didn't get any returns, I'd lost, or was 100,000 dollars down. One way to look at it is to say that we're both owed the 100,000 dollar investment, but a fairer way would be to say, well, the first investor got 200,000 in returns and therefore that should be treated differently to the person who didn't get any returns.

Jaqueline Blondell:
So, how might investors – and accountants – tell if an investment is a real deal or a Ponzi scheme? Firstly, if someone is offering a ‘sure thing’ – whether it’s in goats, crypto or any other type of investment, be cautious. Here’s Bruce Gleeson.

Bruce Gleeson FCPA:
If accountants can stop one person being conned into a Ponzi scheme, then that's a good thing. If we can achieve more than that, then that's even better. But look, we can help educate clients and those people within our sphere of influence. And what we do know is that when we look at the long run average returns of equities or property or other asset classes, if somebody's going to offer you sort of 20, 25, 30 per cent return per annum when we know it's so above the long term run averages, that of itself should ring alarm bells. And should mean that we then make sure that the clients undertake a couple of key searches to find out whether or not there's any substance to this. And I think for accountants too, it's clearly within an area where it's a comfortable conversation to have. And indeed, it's a conversation where it enables the accountant to take an interest in how the client might be looking at investing and just reminding them of the really good resources there are available to check things out. The moneysmart.gov.au website is a really good one, but it's actually having a conversation and re-centering clients around what are some of the long-term run average returns of asset classes because I think that's where people are all a little bit vulnerable.”

Garreth Hanley:
If you enjoyed this special ‘Crime by Numbers’ episode, subscribe to the INTEBLACK podcast, leave us a review and tell your colleagues and friends about us. And we hope you can join us again next time for another episode of INTHEBLACK.