Pennsylvania CPA Journal
The victims of Ponzi schemes are often enticed by the promise of low risk and high reward, but in reality the fraudsters are using funds from later investors to pay off early investors. When the scam inevitably collapses, forensic accountants are often called in to use data analytics and other forensic accounting tools to help investigators.
Ponzi schemes are scams of high promises that are based upon paying off early investors first and long-term liabilities later (if at all). The fraud is susceptible to crash, and usually the perpetrators are long gone before that happens. While the term “investors” conjures images of Wall Street, these are far from the types of investors that Ponzi schemes tend to profit off. Many of the losses are incurred by individuals with limited business or industry knowledge, and often with limited financial resources. They are enticed by the promise of low risk and high reward.
The defining characteristics of an effective Ponzi scheme can vary, but they generally include the following:
- Advertising low risk for a high reward in terms of investment.
- Feigning profitability to earlier investors by providing them with purported returns that are actually money from later investors.
- Growth via word-of-mouth and other marketing approaches.
Ponzi schemes tend to provide only high-level information. There is often a “secret sauce” the fraudsters can’t disclose to investors. They also apply pressure to invest quickly, often using time-sensitive offers. These schemes are characterized by being strategically set up in a manner for which proper SEC registration is not required, so the company, investment vehicle, and adviser skirt regulations.
This column examines how data analytics combined with other forensic accounting tools can help investigators uncover how investors in Ponzi schemes were victimized and how data can be compiled to locate stolen assets and create an analytical report that aids regulators and legal proceedings.
Traditionally, Ponzi schemes take cash investments and lead investors to believe that the return will come from investments in the market, the sale of some product, or the provision of services. A new iteration has evolved from it: cryptocurrency-based Ponzi schemes.
Digital currency has decentralized financial services in a way that has opened a knowledge gap between crypto experts and those who are unfamiliar with the space but don’t want to miss the investment opportunity. A massive influx of cryptocurrency-based Ponzi schemes arose to profit off the general public’s lack of understanding. In 2023, nearly $4 billion (71% of the $5.6 billion lost in crypto-related fraud schemes1) was lost in investment scams.
Regardless of how the funds are sourced, when a Ponzi scheme eventually (and inevitably) fails, the fallout is messy, expansive, and only recoverable through diligent investigation. By centering investigations around a thorough analysis of all relevant available data, forensic accountants and data analysts are instrumental in the distribution of justice and in delivering the resolution that the victims of Ponzi schemes deserve.
Data-Centric Investigation
By the time a Ponzi scheme case reaches the desk of a forensic accountant, the organization in question already has failed and been confirmed to be a Ponzi scheme. Forensic experts are often called upon to identify those affected, attribute each investment and payout to its rightful investor, and calculate the losses (or gains) for each participant. These steps are complex because Ponzi schemes can have tens of thousands of victims, many of whom made several investments. Additionally, scheme operators rarely keep neat or accurate accounting records, although they usually have to establish some records for credibility, which is often a portal for investors, their contributions, and payouts.
The largest challenge facing forensic experts is the sourcing and compilation of reliable data. The perpetrators do not maintain accurate accounting books, and investigators must keep in mind that some of the data sourced from the perpetrating organization helped enable the business’s misconduct. Thus, it is important to understand the difference between unreliable data and the reliable information maintained to establish a veneer of credibility with investors so they continue to invest. But even reliable information is often not maintained in a way that is conducive to the analysis required by forensic experts.
Forensic experts, though, are resourceful and discerning in their use of an organization’s data. Data points such as account information and balances serve as a jumping-off point for investigators. In addition, the organization’s qualitative data in such forms as marketing materials, investment contracts, and communications received by investors is crucial to the investigation. This information provides insight into the nature of the relationship between the organization and its investors, as well as the extent to which the investors were misled or manipulated.
After obtaining and evaluating the organization’s database, investigators will flesh out what it tells by acquiring additional data sources, such as bank statements, marketing materials, investment contracts, or other communications received by investors, among others. As this process unfolds, the team of investigators is often apt to collaborate and share information with regulatory agencies involved in the case. Key touchpoints at this stage of the investigation are the banks that were used while the Ponzi scheme was transacted. Through subpoenas or direct requests from the receiver or trustee, investigators can obtain electronic banking data, bank statements, and check images that add new dimensions to the base of reliable data. This data can be juxtaposed against the financial records provided by the organization to identify additional areas of suspicion.
Individuals who invested in the organization and saw little to no return also tend to be ready and willing to aid in the investigation. These individuals may provide personal records and narratives as individual claimants or members of a class, as it is not uncommon for Ponzi scheme victims to consider a class action to reclaim their investments. The investors are often able to produce records of their investments and account information in a quick and accurate manner, as receivers or a trustee seek to gain financial information from thousands of individuals. This often requires manual review, and the outcome helps verify the reliability of data that can be used on a widespread basis.
After sourcing all the pieces of the data puzzle, investigators must connect them. The process of matching together data points from a variety of sources is largely aided by data analysis and modeling tools such as SQL and Python. These tools allow forensic analysts to grapple with massive data sets and “fuzzy match” data points with similar identifying characteristics. However, because the structure and composition of the data sources can vastly differ, a large portion of the data may be matched manually rather than algorithmically. This requires patience and diligence among the investigators, but the efforts are rewarded with a maximally precise dataset that can be used throughout the judicial process.
Using the bank and/or investment account statements combined with investor information, forensic accountants can track the flow of funds from new investors to older investors and identify unusual transfers or hidden assets, as well as establish the pattern of a Ponzi scheme. This analysis reveals the depth and breadth of the organization’s fraud and the investors’ losses. It aids regulatory bodies in administering justice and often acts as a piece of evidence in forthcoming legal proceedings.
Impact
Forensic accountants and analysts produce expert reports and testimonies that empower investigators and legal teams to effectively dismantle Ponzi schemes and to initiate repair. Additionally, the identification of victims and verification of their contributions and pay outs, resulting in the losses and gains, are necessary for the distribution of the receivership or bankruptcy, which seeks to return the funds of the Ponzi scheme back to the investors.
While the term “investor” is technically accurate, when approaching Ponzi scheme investigations it is crucial to keep in mind that behind each investment is a once-hopeful person who was wrongfully defrauded by a deceptive organization. Although forensic accountants and data analysts are known to deal with the numbers, the accuracy and precision of their work directly impacts the justice and reparations that everyday people will receive in the wake of a Ponzi scheme’s collapse. By championing a data-centric approach, forensic experts continue to support the administration of justice in Ponzi scheme cases.
1 FBI Cryptocurrency 2023 Annual Fraud Report.
Karyl Van Tassel, CPA, CFE, is a senior managing director in J.S. Held’s Global Investigations practice based in Houston. She can be reached at kvantassel@jsheld.com.
Danielle Wolford, CPA, CFE, is a senior director of J.S. Held’s Global Investigations practice based in Chicago. She can be reached at danielle.wolford@jsheld.com.
Ken Feinstein is a managing director in the Digital Investigations & Discovery service line within the Global Investigations practice at J.S. Held based in New York. He can be reached at ken.feinstein@jsheld.com.
A special thanks to Shane Jaeger for providing insight and expertise that greatly assisted this research.