Ponzi Schemes in the Caribbean

Ana Carvajal, Hunter Monroe, Catherine Pattillo and Brian Wynter of the International Monetary Fund

In several Caribbean states, unregulated investment schemes (UIS) grew quickly, particularly during 2006–08, by claiming unusually high monthly returns and through a system of referrals by existing members. Such high returns are usually associated with Ponzi schemes, as defined below. Such schemes are pervasive and persistent phenomena and emerge on a regular basis even in developed countries with strong regulatory frameworks, as shown by the recent experience in the United States with an $50 billion alleged Ponzi scheme run by Bernard Madoff.

However, their impact has been greater in countries with weaker regulatory frameworks. This is illustrated by the well-known case of Albania, and by more recent and ongoing cases in the Caribbean, Colombia, and Lesotho.

This paper details the operation of such schemes in the Caribbean, and places this experience in the context of cases in other regions, where a number of interesting parallels emerge. The paper also describes the recent experience with two high profile allegedly fraudulent schemes involving regulated entities licensed in offshore jurisdictions in the Caribbean, in order to draw common lessons with regard to the detection and prosecution of fraudulent schemes.

BACKGROUND

Investment fraud can plague financial markets regardless of their level of development. It encompasses all types of actions aimed at obtaining a financial gain from investors based on deception. Such fraud can take many different forms from very simple schemes such as outright theft where none of the investor’s money is returned, to more complex schemes such as Ponzi and pyramid schemes. Schemes can be regulated or unregulated entities and can take different legal forms, from joint stock companies to hedge funds or simple pools of assets.

In a Ponzi scheme, returns may be paid to investors out of the money paid in by subsequent investors rather than from genuine profits. These schemes usually offer higher returns than any legitimate business activity could plausibly sustain, in order to lure investors. Ponzi schemes usually have to attract new investments at an exponentially growing rate to sustain payments to existing investors, and inevitably collapse when the new investment needed exceeds the size of the target market. At that point, most investors lose most or all of their investment, while early investors including the scheme’s founders may have obtained high returns. Thus, it can be a matter of plain luck and timing whether an individual turns out to be a victim or a beneficiary of the fraud. Ponzi schemes are insolvent from the moment that they take in money from investors. Their liabilities to investors exceed their assets as the value of liabilities increases at the inflated rate of return, while assets may be depleted by the running costs of the scheme or possibly suffer from other depredations.

As the experience of different countries has shown, the “business opportunity”  advertised to lure investors into putting their money in a Ponzi scheme can vary in nature, from straightforward investments in stocks or bonds, to less traditional financial sector products such as currency trading, to investments in nonfinancial assets, such as real estate, cars and helicopters. These business opportunities are only limited by the imagination of the perpetrator and the gullibility of the investor.

As indicated above, Ponzi schemes can be perpetrated by unregulated entities, through
informal sector vehicles that operate in the shadow of formal financial institutions. In other cases, they are perpetrated by regulated entities, which abuse their regulated condition to lure investors. The types of investor lured into these schemes vary. Many times, the schemes will have drawn in or specifically targeted as investors individuals from among a specific group or community sharing a common affinity, such as ethnicity, religion, or profession. In many instances the perpetrators promote their schemes through leaders of the affinity group. In some cases, investors are given an explicit incentive to recruit new investors. The damage when such schemes reach their inevitable end can be widespread among populations with limited income and means to absorb the eventual losses. The resulting combination of anger, betrayed trust, recriminations and sheer loss of wealth and income can also have significant political and social repercussions.

The experiences of different countries show that the exponential growth rate needed to sustain schemes can lead to large-scale economic and institutional damage. The negative consequences include:

• Undermining confidence in financial markets;
• Diverting savings from productive to unproductive uses and, in some cases, from the
domestic economy to foreign destinations, with a balance of payments impact;
• Incurring fiscal costs, if bailouts occur;3
• Diverting deposits from banks and increasing non-performing loans if loan proceeds
were diverted into schemes;
• Causing swings in consumption driven by paper profits or early withdrawals;
• Causing socio-economic strife if a sufficiently large number of households are
suddenly exposed to losses; and
• Undermining the reputation of political authorities, regulators, and law enforcers for
failing to prevent open frauds and to address money laundering or support of other
illegal enterprises by schemes’ operators.

Pyramid schemes versus Ponzi schemes

The labels Ponzi scheme and pyramid scheme are often used interchangeably to describe specific forms of investment fraud where sustainability depends on the influx of new investors to the scheme. However from a technical perspective, there are differences in the way the two types of schemes operate.

Pyramid schemes are a form of fraud where the expected benefit to members depends primarily on the number of individuals they recruit, which is not necessarily the case in a Ponzi scheme. For instance, each member may be required to recruit five others who each recruit five more, and so on to get the reward, creating a pyramid in which payments flow upward to earlier members - and not necessarily to a central pool of funds, as in a Ponzi scheme. While the large reward draws in members, the number of recruits required to be rewarded grows exponentially, and inevitably exceeds the target population. At that point, the flow of rewards up the pyramid stops, and most members receive nothing in return for their membership fee, as they are unable to recruit new members. Ponzi schemes often grow larger than pyramid schemes as they can take in unlimited amounts from a single individual and can continue to operate indefinitely, as long as payments demanded by investors from the scheme do not exceed payments by investors into the scheme.

A pyramid scheme may attempt to masquerade as a multi-level marketing (MLM) arrangement, which is a legitimate business activity in many jurisdictions. MLM members are salesmen who sell a legitimate product but also receive commissions on sales by their recruits, their recruits’ recruits and so on. The distinction between a legal MLM arrangement and an illegal pyramid may be difficult to establish. A hypothetical MLM arrangement in which members must buy an initial inventory of products which they neither consume nor sell would be an illegal pyramid scheme in many jurisdictions. A methodology for differentiating pyramid schemes from MLM arrangements is described in Vander Nat and Keep (2002).

There are a number of similarities between the life-cycles of pyramid schemes and Ponzi schemes. Both types of schemes typically proceed through the following stages: initiation; validation, when large and easy rewards earned by initial members generate strong word of mouth publicity; expansion, when a large number of people join or massive investments are received; and collapse, when defaults occur, the inflow of new funds or members stops, and the promoters may seek to abscond with money.

The schemes are inherently likely to collapse and default on most members. Pyramid schemes grow exponentially for a given rate of recruitment until they exhaust the pool of potential members. Inflows in a Ponzi scheme must also grow exponentially, if investors do not reinvest all earnings.

In practice, schemes may incorporate elements of both pyramid schemes and may be difficult to classify. For instance, several of the Caribbean schemes described below appear to have characteristics of both types of schemes.

Country experiences illustrate the financial and socio-political damage of such schemes. The most severe case has been Albania. When several schemes collapsed in 1996, there was uncontained rioting, the government fell, the country descended into anarchy, and by some estimates, around 2,000 people were killed. More recently, the November 2008 collapse of allegedly fraudulent investment schemes in Colombia, which had taken in an estimated $1 billion, was followed by riots and violent protests in 13 cities.

In many cases, neither the perpetrators nor the schemes themselves are licensed or regulated, thus making it more difficult for them to appear on the radar of regulators. In addition, in many countries, regulators have not been able to detect and shut down UIS at an early stage. This difficulty is illustrated by allegedly fraudulent schemes described below in Jamaica, Grenada, Antigua and Barbuda, St Vincent and the Grenadines, Colombia and Lesotho. Once schemes become large, the authorities may become increasingly reluctant to trigger their collapse. If government authorities close or suspend a scheme - curtailing its ability to meet cash flow obligations - subscribers could blame the government’s intervention rather than the scheme’s inherent flaws. However, even when the schemes collapse by themselves, the experience shows that governments may also face criticism for failing to act more promptly.

Interestingly, many scheme operators have managed to extend their operations by ostentatious charitable contributions, significant political contributions, and pretentious demonstrations of their own or their scheme’s wealth. Prior to collapse, operators may be regarded as pillars of their communities.

UNREGULATED INVESTMENT SCHEMES IN THE CARIBBEAN

This section describes the emergence of schemes in the Caribbean, the regulatory framework, the policy response and their size and impact. 

Jamaica

Description of the schemes

Jamaica experienced rapid growth in the number and size of UIS, especially during the
period 2006–08. A study conducted by the Caribbean Policy Research Institute (CaPRI), an independent think tank, identified 21 UIS which were operating in Jamaica by January 2008. The business opportunity behind the schemes varied, although a majority of them claimed to be engaged in foreign exchange trading. Some of the schemes were allegedly conduits to invest in other better-known schemes. A few claimed to be investing in a variety of assets including real estate. The schemes shared a number of common features.

They all offered returns significantly higher than those offered by regulated entities; many offered a 10% return monthly, a level usually seen only in Ponzi schemes. A few schemes also paid investors a referral fee for bringing in new investors - a feature shared with pyramid schemes. Neither the operators nor the schemes were licensed or registered by the Financial Services Commission (FSC) or the Bank of Jamaica (BoJ). According to the FSC, they provided limited or no information on their business model that would explain such high returns: investors were not provided with a prospectus or with audited or even unaudited financial statements. In most cases, the promoters apparently had limited financial background before starting their schemes.

A number of these features are “red flags” for investment fraud. OLINT Corporation and Cash Plus Limited are perhaps the most important UIS, in terms of the number of investors they attracted, the amount of attention that they received from the media and the regulatory response to them.

OLINT Corporation

According to court documents, OLINT Corporation claimed to serve as a liaison for members of a club to invest in foreign currency trading through Overseas Locket International, a Panamanian corporation. It was founded by David Smith, a Jamaican national who had worked for several years as a licensed representative of Jamaica Money Market Brokers Limited specialising reputedly in international foreign exchange trading. After leaving the firm, he formed what he described as a club consisting of his friends and other members. New members had to be referred by existing members who were paid a referral commission. The club apparently began operations around 2004.

Members had to sign a customer agreement, which stated that “the sums invested by the customers were to be used as a margin for taking margin leverage speculative currency positions”. According to the agreement, 80% of the investment was guaranteed.

Several other schemes, such as Lew Fam, appeared to be conduits for OLINT. According to court documents,6 the promoter of LewFam, Neil Lewis, held two accounts with David Smith and/or OLINT. OLINT and LewFam had about 1,800 and 800 accounts, respectively.

Cash Plus Limited

Cash Plus Limited claimed to be part of a conglomerate, the Cash Plus Group, with subsidiaries engaged in real estate development, telecommunications, food distribution, hotels, and other economic sectors. Its founder was Carlos Hill, also a Jamaican national, who had worked in the financial sector in the United States in the 1980s according to court documents.

In the documents given to investors, Cash Plus refers to the money received from the public as “deposits” and to the relationship between the investors and Cash Plus as a lender-borrower relationship. Lenders were paid 10 percent per month in interest, but the lender was locked in for 10 months, after which time the lender could redeem the principal. Cash Plus began operations as early as 2002.

Strategies for growth

As has been the case in many other jurisdictions, the UIS engaged in highly visible public relations campaigns. These campaigns involved donations to charitable causes and sponsorship of high profile events.

• In September 2007, Cash Plus began a three-year sponsorship of the Jamaican
National Premier League soccer at J$50 million per year, of which J$24 million was
reportedly disbursed.

• In December 2007, OLINT claimed to have donated $1 million to its charitable foundation to help needy Jamaicans, especially deprived children. It also sponsored the 2008 Air Jamaica Jazz and Blues Festival.

• In January 2008, World Wise, another scheme which later received a cease and desist order from the FSC, became the title sponsor for a Jamaican entry in the Miss Universe beauty pageant.

• It was reported that both of the main Jamaican political parties received campaign donations from OLINT. The UIS succeeded in obtaining support from prominent individuals in Jamaica as well as the media to the point that in January 2007, a business newspaper named David Smith, OLINT’s founder, business personality of the year.

The legal and regulatory environment

The Securities Act (SA) of Jamaica subjects the public offering of securities and of collective investment schemes to authorisation by the Financial Services Commission (FSC) (Sections 16 and 17A of the SA). The SA states that intermediaries who carry on securities services have to be licensed by the FSC (Sections 7 and 8). The SA specifies that breach of the registration and licensing requirements constitutes an offence punishable upon conviction by a fine of up to J$2 million (about $23,000) and/or imprisonment for a period up to two or three years respectively (Section 68(7)). In addition, there are anti-fraud provisions in Section 49 of the SA, violation of which constitutes an offence punishable with a fine or imprisonment for a period not exceeding one year, in the case of a natural person, and a fine in the case of a company.

The SA states that the FSC has the authority to investigate breaches of the securities laws and regulations. The SA designates breaches of the licensing and anti-fraud provisions as criminal offences. Criminal offences may be prosecuted by the Director of Public Prosecutions (DPP), subject to adjudication by the courts.

The SA states that the FSC may issue of cease and desist orders (Section 68 of the SA).
Cease and desist orders can be appealed to the FSC and the courts, and the party affected by the order can request a stay of execution (suspension of the effects) while the court’s final decision is being considered. Section 68 of the SA also contains a general provision that allows the FSC to seek in court other civil remedies, but the SA does not specify those remedies, and there appears to have been no jurisprudence in respect to that provision. In any case, the statutes do not prescribe a specific procedure for the courts to impose these remedies.

The Financial Institutions Act (FIA) indicates that deposit taking is subject to licensing by the BoJ (Section 3). The FIA specifies that failure to comply constitutes an offence punishable with a fine of up to J$500,000 (about $5,700) and up to J$50,000 for each day of continuance. Also, the BoJ Act states that foreign currency trading is subject to authorisation by the BoJ (Sections 22A, 2 and 3). It specifies that violation of this obligation also constitutes an offence punishable with a fine or imprisonment.

The BoJ Act states that the BoJ has the authority to investigate the breach of such obligations. The remedies available are criminal in nature. Criminal offences can be prosecuted by the DPP, subject to adjudication by the courts.

Regulatory response

There was considerable debate in Jamaica concerning whether the activities of the UIS triggered one or more of the provisions described above, and thus required action by the regulatory authorities. According to court documents, the key issue concerned whether the activities of the UIS constituted “issuing securities” therefore covered by the SA, or deposit taking covered by the FIA, or whether they were simply private clubs and as such fell outside of the jurisdiction of both the FSC and the BoJ. Apparently, there was limited jurisprudence on such concepts prior to this case. The lack of clarity over the precise nature of schemes’ activities clouded this debate.

Initially all actions taken against OLINT and Cash Plus came from the FSC, beginning
March 2006. They encompassed: (i) issuing cease and desist orders against some of the schemes for alleged breaches of the registration/licensing requirements described above;
(ii) providing warnings to the public informing of schemes that were not registered with or licensed by the FSC; and (iii) undertaking a public education campaign “think and check before you invest”. In late 2007, the BoJ issued warning letters to the schemes that purported to be carrying on foreign currency trading stating the need for a licence. The Jamaican criminal authorities filed charges against the founder of Cash Plus in 2008, while the Turks and Caicos Island criminal authorities filed charges against the founder of OLINT Corporation in 2009.

OLINT Corporation

The FSC began an investigation of OLINT in early 2006. The FSC and the Financial
Investigations Division of the Ministry of Finance and Planning executed search warrants under the Securities Act on the offices of OLINT and LewFam Investments on March 3 and March 6, 2006 and seized documents.

The FSC determined that although claiming to be carrying on foreign currency trading activities, OLINT Corp./David Smith et al, Overseas Locket International/David Smith et al, and LewFam Investments/Neil Lewis et al were engaged in securities activities in breach of Sections 7 and 8 of the Securities Act. The FSC issued cease and desist orders against them on March 24, 2006.

In response, OLINT initiated a protracted legal struggle and continued to operate for several years. In court documents, OLINT claimed it did not fall under the Securities Act and in its opinion therefore did not require a license from the FSC. OLINT and David Smith appealed to the FSC on March 27 to stay the execution of the order directed at the company, and the FSC denied the appeal. OLINT then appealed to the Supreme Court,16 which in early November 2006 granted a stay of execution of the cease and desist orders on the condition that there be no increase in the membership of OLINT until the hearing of its appeal on March 26, 2007. The appeal was heard in March and June 2007.

The key issue in the appeal was again whether the activities of OLINT constituted a securities business under the purview of the Securities Act and therefore required a license. OLINT’s argument was that it was not in breach of the SA because its activities did not involve securities, but foreign currency trading. On December 24, 2007, the Supreme Court ruled in favor of the FSC and upheld its cease and desist orders. The court considered that there was an investment contract between OLINT and its customers and therefore OLINT’s activities were subject to the SA provisions.

OLINT appealed this decision to the Court of Appeal, which on February 5, 2008 granted a stay of execution, although imposing certain conditions. The court ordered that there should be no increase in OLINT’s membership or clientele pending its determination of the appeal.

In addition, the court instructed OLINT to prepare a list of members and submit it to the court in a sealed envelope. In May 2008, OLINT began failing to make payments to investors according to news reports, and in July OLINT closed its offices in Jamaica. In an e-mail sent to club members, OLINT claimed that the closing was a result of threats to staff including a bomb threat. The e-mail acknowledged that the threats might flow from the failure of the scheme to honour redemptions which it blamed on FSC actions, court conditions for the stay of execution and actions by the banks to close their accounts.

Cash Plus Limited

The FSC issued a public warning in May 2007 that Cash Plus was not licensed by the FSC. As a result, Cash Plus filed an application to the Supreme Court to determine whether its activities fell under the securities or the banking laws.

The FSC instructed Cash Plus in November 2007 to provide its investors and the FSC basic financial information including details about its assets, liabilities, capital, revenue, and expenses. The action followed media reports indicating that investors were having difficulty making withdrawals and that Cash Plus’ founder, Carlos Hill, had served 10 years in a US prison for racketeering, mail fraud, and making a false statement. There were also reports that Cash Plus had made major acquisitions of businesses and real estate.

However, according to the FSC, Cash Plus failed to provide most of the information requested. Based on the evidence gathered during its investigation, the FSC determined that Cash Plus Limited/Carlos Hill/Kahlil Harris were engaged in securities activities in breach of Sections 7, 10 and 26 of the Securities Act. It issued cease and desist orders against them in December 2007. Cash Plus appealed the orders to the Supreme Court, which granted a stay of execution in January 2008.

However, while granting the stay the court imposed certain conditions on Cash Plus including that it could not: (i) take new investors; (ii) accept new funds from existing investors; or (iii) make payouts to existing investors. The court also required Cash Plus to file a list of its investors under seal.

Shortly thereafter, Cash Plus dropped the suit that it had brought for a declaration on whether its activities fell under the securities or banking laws. It informed the court that it intended to submit to FSC jurisdiction, but would continue with the appeal process regarding the cease and desist orders. In the meantime, the court lifted its stay of the cease and desist order.

Cash Plus asked the FSC to lift the order’s provision preventing payment to investors. The FSC conditioned a modification of the cease and desist order on the submission by Cash Plus of information on the number of investors, balances due to all investors, the methodology to determine payments to investors in a fair manner, and the source of funds for payments. In late March 2008, the FSC announced that Cash Plus had failed to provide the information requested and subsequently that Cash Plus had informed it that it did not have funds to repay investors on March 31, 2008 as planned. The Supreme Court appointed a receiver/manager from  PricewaterhouseCoopers several days later. In April 2008, Mr. Hill was arrested on charges filed by the DPP of fraudulent conversion, obtaining money on false pretences and conspiracy to defraud. This action came after investors submitted complaints to the police against Cash Plus for failing to return funds invested.

Actions by commercial banks

Commercial banks also played a role in responding to UIS. The chairman of the
Jamaican National Commercial Bank (NCB) warned the public in September 2006 that the schemes were unsustainable, and would end in disaster.18 Commercial banks also began reporting all UIS-related transactions as suspicious under the Money Laundering Act, according to November 2007 newspaper accounts. In the same month, NCB sought to close the accounts of OLINT on the basis that it failed to provide requested Know Your Customer documents. However, court challenges by OLINT prevented the bank from closing the accounts. A similar injunction prevented NCB from closing the accounts of Cash Plus. The issue was appealed to the level of the Privy Council in the United Kingdom, Jamaica’s final court of appeal, which in January 2009 reversed the injunction by Jamaica’s Court of Appeal that prevented the bank from closing OLINT’s accounts.

The Reaction

A combination of factors, including the “respectability” that Cash Plus and OLINT had gained through their donations and sponsorships, led to a negative reaction from high profile figures, including politicians, and the media to FSC actions.

• In January 2007, a letter to the editor from a junior government minister described the FSC and Financial Investigation Division’s raid on OLINT as a “Gestapo-like invasion” which was a “vulgar abuse of state power.” It argued that OLINT was a boon to the Jamaican economy, and that rather than expatriating capital, OLINT’s payments to club members were generating foreign exchange reflows of $7 million weekly during November–December 2006.

• In November 2007, a prominent attorney wrote that the financial community was trying to sabotage Cash Plus’ obvious success.

• In December 2007, several influential church leaders declared that the country would lose if OLINT and LewFam were forced to close, and that individuals should be free to invest once adequate information is given.

Against this backdrop, there were some public manifestations of support from the government for the FSC. In January 2007, finance minister Omar Davies warned that people who put money in the schemes did so without the protection of the government.

According to a February 2007 FSC press release, the junior minister’s comments described above were condemned by the Cabinet as not expressing the position of the government. Later in 2007, the tax administration indicated that all income, including illegal income from UIS, was taxable. Further support from the government came in January 2008, when the Cabinet endorsed the FSC’s actions against schemes and indicated that the FSC would continue to act against them.

A leading newspaper stated in April 2008 that a review of its coverage of Cash Plus found that eight of 55 stories were promotion pieces, nine of 55 would have failed its current code of ethics, and that it had inaccurately reported several major real estate purchases by Cash Plus which did not actually take place.

Size and impact

It appears that the schemes (Cash Plus and OLINT in particular) grew dramatically after the FSC’s intervention on OLINT and LewFam in late 2006. It seems that the intervention served to advertise the schemes, while there were no immediate follow-up actions charging them or their perpetrators with any crime. Apparently, the court’s decision to prohibit OLINT from accepting new members while not preventing additional investments was followed by a proliferation of new schemes that attracted new investors and channelled their funds into OLINT through the accounts of existing OLINT members. According to the CaPRI study, a November 2007 survey of 400 investors in UIS found that most had invested in the 12 months preceding the survey.

Cash Plus took in investor funds of J$22 billion ($260 million or 2% of GDP) during 2004–07 from 35–45 thousand investors, according to a May 2008 interim report by its receiver. During August 2006–May 2007, two entities associated with David Smith, OLINT TCI and TCI FX Traders, deposited $100 million into its accounts in i-Trade FX LLC.20 For other schemes, there is no reliable information, as they do not provide audited or unaudited financial statements or a list of assets. The January 2008 CaPRI study estimated that Jamaican UIS have taken in investments of 12.5-25% of GDP. The results of the study’s survey of 400 investors suggest that around 50,000 households invested in these schemes, with a typical investment of around J$200,000 to J$300,000 (about $2,800-$4,100). Most of the investors were middle class, which the study argued would limit the potential for social unrest if the schemes collapsed.

Eastern Caribbean Currency Union and the Turks and Caicos Islands

This section describes the operations of OLINT elsewhere in the Caribbean. In addition, it describes two recent cases of apparent fraudulent activities allegedly perpetrated via offshore institutions licensed in the Caribbean: Stanford Financial Group and Millennium Bank.

OLINT

Description of the schemes

OLINT and its offshoots also operated in some Eastern Caribbean Currency Union (ECCU) countries and in the British territory of the Turks and Caicos.

St Kitts and Nevis

In April 2006, OLINT advised its clients that it had been authorised by the government of St Kitts and Nevis to conduct investment business there. In response, the St Kitts Financial Services Commission issued an advisory that OLINT Corp had never been licensed to conduct investment or any other business in St Kitts. This web site posting appears to have prevented OLINT or other schemes from operating in the country.

Turks and Caicos

In August 2006, a company associated with David Smith, i-Trade FX LLC, became registered as a futures commission merchant in the United States. For most of 2007, David Smith was listed as one of the company’s principals and contributed almost 100% of its capital. Smith resided in Turks and Caicos, and registered two companies there, OLINT TCI and TCI FX Traders, which had accounts with i-Trade FX.22 TCI FX Traders was granted a mutual funds license by the Financial Services Commission (FSC) of Turks and Caicos in October 2006. It appears that TCI FX was a vehicle for channelling funds to OLINT TCI. OLINT TCI did not as it claimed hold a licence, according to the FSC of Turks and Caicos. OLINT TCI apparently attracted funds not only from Jamaica but also from Grenada.

Grenada, Dominica and St Lucia

OLINT operated in Grenada via a conduit called SGL Holdings Inc., according to SGL’s investment contracts. SGL began operations in August 2006, and first came to public attention through newspaper coverage in December 2006. It was founded by a physical therapist, the owner of a ferry line, and the owner of a security company. SGL claimed that its members were earning an 8% monthly return through foreign exchange trading and that 80% of the principal invested was not at risk. Its investment contracts stated that it invests through TCI FX Traders, Ltd., which describes itself as “an open ended investment company incorporated in the Turks and Caicos Islands on August 16, 2006, established for investing through OLINT TCI.” SGL’s web site provided on-line access to members’ accounts. SGL also operated in Dominica, and its name also appeared in the Jamaica FSC’s list of UIS operating in Jamaica.

Several other schemes indicated to GARFIN they intended to operate in Grenada. A scheme called Havaway opened an office in Grenada and approached GARFIN regarding a licence. Another scheme in St Lucia, the Wilshaw Forex Club, provided the same web interface and contracts as SGL Holdings and TCI FX Traders.

Legal and regulatory framework

All the countries that are members of the Eastern Caribbean Currency Union share a common central bank, the Eastern Caribbean Central Bank (ECCB). Under the uniform Banking Act that has been transposed into local law in each of the countries, deposit taking is subject to licensing by the minister of finance based upon the recommendation of the ECCB.

The legal and regulatory framework for the non-bank financial sector in the ECCU involves both national and regional regulators. The Eastern Caribbean Securities and Regulatory Commission (ECSRC) regulates the securities industry in all the countries that are members of the ECCU, based on a uniform Securities Act (SA) that has been transposed into local law in each of the countries. The SA specifies that a license from the Commission is required to operate as a broker dealer, investment adviser and certain related activities, such as operating a collective investment scheme. The SA also specifies that public offerings of securities must be registered, and the ECSRC must approve the prospectus.

The SA indicates that the ECSRC has the authority to issue cease and desist orders to entities and individuals operating without a license or in contravention of regulations. The SA also provides for administrative remedies such as suspending or revoking a licence or applying financial penalties. The SA indicates that the ECSRC can also apply to the ECCU’s High Court for an order to restrain a person from acquiring or disposing of securities or to appoint a person to administer the property of an entity contravening the conditions of its licence.

Other legislation specifies which local regulators supervises other financial services. For example, the Grenada Authority for the Regulation of Financial Institutions (GARFIN) began operations in March 2007 under the GARFIN Act. GARFIN was the first Single Regulatory Unit for non-bank financial institutions established in a Fund-member country of the ECCU.

The Act states that GARFIN has authority over a wide range of nonbank financial activities, including money services businesses. It also states that GARFIN may issue cease and desist orders and to take administrative action such as revoking a license or applying financial penalties. The GARFIN Act does not explicitly mention the possibility of applying to the courts for civil relief.

The Turks and Caicos Islands’ FSC Ordinance of 2007 states that the FSC supervises the financial services business carried on and its development, in or from the country. The Ordinance specifies that the FSC licenses and regulates national and overseas banks, insurance brokers, investment dealers, mutual funds, money transmitters, and professional trustees. It indicates that licensees should meet fit and proper requirements. The FSC Ordinance of 2007 states that the FSC may compel licensees, former licensees, or persons believed to be carrying on unauthorised business to provide specified information or documents.

It also indicates that the FSC may apply to a magistrate to have a person examined under oath and that a magistrate may issue a search warrant on the recommendation of the FSC if a person has failed to provide requested information or documents, if such a request could lead to the removal or destruction of documents, or if an offence under the Ordinance is being committed. The Ordinance specifies that the FSC may cooperate with foreign regulatory authorities, including the sharing of information. It indicates that the FSC may inspect premises or assets, undertake compliance visits. The Ordinance provides that the FSC’s enforcement powers include revoking or suspending licences, appointing an examiner to conduct an investigation, issuing directives restricting business as well as cease and desist orders, petitioning the court for a winding up order, issuing public notices and imposing financial penalties.

Regulatory response

The operation of OLINT in the ECCU countries, via SGL, raised a discussion concerning the nature of the activities that SGL was conducting and which regulatory authority had jurisdiction over it. In May 2007, SGL applied for a license to GARFIN, which had commenced operations only two months earlier. SGL’s web site originally encouraged potential investors to contact GARFIN regarding SGL, but removed this reference at GARFIN’s request.

Initially, GARFIN considered SGL for a money services business licence and began due diligence on the principals of SGL and its operations. According to GARFIN, SGL provided almost all information requested, including its own balance sheet. Based on the information gathered, GARFIN considered that its jurisdiction over SGL was not clear, given that the company purported itself as carrying out foreign exchange trading.

GARFIN addressed this lack of clarity on two fronts. First, it sought authority to regulate foreign exchange trading services through a November-December 2007 Statutory Rule and Order (SRO) and the March 2008 amendment to the GARFIN Act. Second, it asked the ECSRC in 2007 to determine whether SGL required a licence under the Securities Act; it made this request in writing in March 2008. Pending this decision, GARFIN did not act on SGL’s application to GARFIN to be licensed. It also instructed Havaway and other schemes that approached GARFIN not to begin operating. In the same month, the ECSRC issued a notice that all persons soliciting or conducting securities business or providing investment advice in the ECCU must be licensed by the Commission.

GARFIN also pursued efforts to educate investors. It issued general warnings to the public in 2007 and in April 2008. The April 2008 advisory was issued in local newspapers and cautioned investors to ensure that any scheme they invest in was licensed and regulated and to ask questions about its liquidity and solvency. Nevertheless, public interest in SGL grew sharply during 2007. Commercial bankers were aware of some borrowing and deposit withdrawals, apparently for investment in the scheme.

The ECSRC met with SGL in April 2008. In May, it determined that SGL was a collective investment scheme subject to the jurisdiction of the Securities Act. The ECSRC subsequently issued cease and desist orders against SGL Holdings in Grenada and Dominica and Havaway. These orders forbade the schemes from taking in new members or new funds from existing members. SGL ceased accepting new deposits and began preparing its application to the ECSRC for a licence.

In July 2008, the Financial Crimes Unit of the Royal Turks and Caicos Islands Police Force raided the offices of OLINT TCI and froze its assets. According to the FSC, the legal authority for the raid was the Theft Ordinance and the Proceeds of Crime Ordinance. TCI FX Traders was placed in liquidation, with PricewaterhouseCoopers as receiver. OLINT TCI is in the process of being petitioned for liquidation by the Attorney General’s Chambers. A study conducted on behalf of the FSC prior to liquidation concluded that the operations represented a Ponzi scheme. In February 2009, David Smith was arrested in Turks and Caicos and charged with forgery, false accounting, and theft. More recently, attorneys for investors have sought the involvement of US authorities.

After the Turks and Caicos authorities froze the assets of OLINT TCI in July 2008, SGL sent a letter to its customers apologizing for its inability to repay investors over the previous two months. At that point, Grenada’s ministry of finance issued a press release describing the developments above, and the ECSRC made public its cease and desist orders against SGL in Grenada and Dominica.

Size and impact

Newspaper reports indicated that SGL had taken in EC$80 million ($30 million) by July 2008. The collapse of SGL does not appear to have had a significant impact on Grenada’s economy or banking system, although it did leave behind many disappointed investors. The potential impact on confidence in the financial sector appears more significant when seen in the context of the financial difficulties of an unsupervised commercial bank in 2008 and of an offshore bank in 2000. The US Attorney for the District of Oregon determined that the offshore bank, the First International Bank of Grenada, was a Ponzi scheme.

Stanford Financial Group

Description of the scheme

Stanford Financial Group (SFG) described itself as a privately-held group of companies specialised in wealth management, with assets under management in excess of $50 billion. The founder and sole owner of the group was Sir Robert Allen Stanford, a prominent financier, philanthropist, and sponsor of professional sports. A fifth-generation Texan, he holds dual citizenship, having become a citizen of Antigua and Barbuda ten years ago. Stanford was the first American to be knighted by that Commonwealth nation.

A US Securities and Exchange Commission (SEC) complaint states that Stanford International Bank (SIB) is an offshore bank in Antigua and Barbuda, licensed by Antigua and Barbuda’s Financial Services Regulatory Commission (FSRC).

By contrast, the UIS described above apparently did not, with the exception of TCI FX, have licences. The SEC alleges that SIB, through a network of Stanford Group Company (SGC) financial advisors, executed a massive Ponzi scheme that sold approximately $8 billion of certificates of deposit (CDs) to investors around the world. The CDs promised higher returns than available through traditional banks.

In addition, the SEC alleges that SGC advisers have apparently sold more than $1 billion of a proprietary mutual fund wrap programme, using misleading information. Moreover, Stanford and another executive allegedly misappropriated at least $1.6 billion of investor money through bogus personal loans to Stanford which were never disclosed in SIB’s financial statements or other communications with investors.

SIB claimed to serve over 50,000 clients in over 100 countries. The SEC alleges that the fraud occurred over a period of 15 years. While the losses initially estimated are not as significant as the Madoff case in the United States, this case has gained significant attention because of the repercussions that it has already had in several countries in Latin America and the Caribbean, where the Stanford Financial Group (SFG) has operations.

Legal and regulatory framework

The Antiguan International Business Corporations (IBC) Act specifies that the Antigua and Barbuda FSRC may provide licenses for international banking, trust, and insurance business. It also regulates entities operating under the Financial Institution Non-banking Act, the Cooperative Societies Act, and the Insurance Act. The IBC Act states that the FSRC has the authority to revoke licences granted under the IBC Act if the licensee contravenes the conditions of the licence. The Act charges the FRSC with ensuring that international banks maintain a minimum level of prescribed capital, provide quarterly data on the return on customers’ liabilities and prepare annual audited returns. It specifies that the FSRC should examine the affairs of international banks at least once per year. It states that the FSRC may seek a court order if information required for the examination is not forthcoming. It states as well that the FSRC may require that remedial actions, which are not specified in the Act, be taken. The Act provides for a penalty of $10,000 if a bank fails to provide information required by the Act, or to comply with written directions from the FRSC.

Regulatory response

The SIB allegedly marketed CDs to US investors through SGC under an exemption which allows the sale of unregistered securities to accredited investors. According to the United States SEC’s Regulation D, accredited investors include individuals with net worth exceeding $1 million or income exceeding $200,000, and certain entities such as banks and investment companies.

On February 16, 2009, the United States SEC brought emergency relief actions in District Court, seeking a temporary restraining order, as well as an asset freeze, an accounting, and other incidental relief, and the appointment of a receiver to take possession and control of assets for the protection of the victims of SFG’s alleged fraud.

On final judgment, the SEC seeks a permanent restraining order, civil monetary penalties and disgorgement of ill-gotten assets. The District Court froze the assets of Sir Allen and other defendants as well as those of SFG, SIB, and another subsidiary, Stanford Capital Management. On February 27, the SEC amended its complaint to indicate that SIB was a Ponzi scheme. By mid March, the court issued preliminary injunctions to all of the defendants, including Stanford, effectively extending the asset freeze. The Antiguan government has publicly expressed its commitment to cooperating with the SEC investigation.

Size and impact

The Stanford case has had repercussions in many countries where the group had had interests, including Antigua and Barbuda, Canada, Colombia, Ecuador, Peru and Venezuela.

Regulators in all these countries have had to take emergency actions.

• Following significant deposit withdrawals from the Bank of Antigua (BOA), an SFG-owned on-shore bank, the Eastern Caribbean Central Bank took over the BOA.
The ECCB then appointed a consortium of five indigenous ECCU banks and the government of Antigua and Barbuda to manage the BOA. The BOA is a local bank that was not named in the SEC enforcement action, but was controlled by the Stanford group of companies. In addition, the Stanford group holds a significant share of Antigua and Barbuda’s public debt and is also the largest private employer in Antigua and Barbuda.

• The Canadian financial regulator restricted the representative office of SIB in Canada to acting as a liaison between other offices of the Bank and any of its clients in Canada wishing to withdraw amounts deposited or otherwise invested with the Bank.

• Ecuadorian and Colombian regulators have suspended the activities of the local brokerage units of SFG.

• Venezuela took control of Stanford Bank Venezuela (SBV), one of the country’s
smallest commercial banks. The Government announced its intention to sell the bank.
It is one of the countries most affected, with an estimated $2.5-3 billion invested in
Stanford’s offshore business.

• The Panamanian bank regulator took over Stanford Bank (Panama).

• In Peru, authorities suspended the local operations of a Stanford-affiliated broker dealer for 30 days.

Millennium Bank

Description of the scheme

Millennium Bank is a licensed offshore bank in St. Vincent and the Grenadines. The US SEC alleges that since July 2004, the bank has offered CDs to US investors with returns that were several times higher than legitimate bank-issued CDs. The bank allegedly advertised itself through its web site and through luxury lifestyle magazines. The bank’s web site claimed that the parent company United Trust of Switzerland S.A., provided “over 75 years of banking experience, correspondent banking relationships, decades of knowledge in privacy and confidentiality as well as extensive training for our customer services professionals.” However, the SEC alleges that United Trust of Switzerland S.A. is not a Swiss-licensed bank or securities dealer. Although investors purchasing CDs were allegedly instructed to deliver checks to the offshore bank, checks were deposited into an account at a US financial institution. The SEC has alleged that none of funds received from investors were ever invested.

Legal and regulatory framework

The International Banks Act of 2004 states that the International Financial Services Authority (IFSA) of St Vincent and the Grenadines may provide licenses for international banking.

The Act states that the licensee must provide the IFSA with written consent of the home country supervisor to establish the branch and be subject to consolidated supervision by the home country authorities. The Act specifies that the IFSA has the authority to revoke licences if the licensee contravenes the conditions of the licence. It charges the IFSA with ensuring that international banks maintain a minimum level of prescribed capital, maintain deposits and ratios prescribed by the authorities, and provide quarterly returns. The Act specifies that the IFSA has the authority to examine the affairs of international banks including through onsite inspections, which are conducted every 12–18 months. The Act also states that the IFSA may, if there are reasonable grounds to suspect a contravention of the Act, petition the court for authority to take any actions it considers necessary to protect the assets of a bank.

Regulatory response

On March 27, 2009, the SEC brought emergency relief actions in District Court, seeking a temporary restraining order, as well as an asset freeze, an accounting and other incidental relief, and the appointment of a receiver to take possession and control of the defendants’ assets for the protection of the victims of the alleged fraud. On final judgment, the SEC seeks permanent injunctions, civil monetary penalties and disgorgement of ill-gotten assets. The SEC charges that the defendants violated the anti-fraud and registration provisions of US securities laws. The District Court froze the assets of the defendants. On the same date, the IFSA appointed KPMG to assume control over the affairs of Millennium Bank to preserve records and assets.

Size and impact

The bank raised at least $68 million from over 375 investors, according to the SEC.

Lessons from the Caribbean Ponzi schemes

The Caribbean Ponzi schemes appeared to have mainly flourished in the form of unregulated investment schemes. Such type of schemes can undermine investor confidence in financial institutions. The longer that they operate, the more damage they are able to inflict. Thus, the main policy lesson that can be extracted from countries’ experiences with Ponzi schemes is the need for a rapid and early response from financial regulators and law enforcement authorities to identify and stop the schemes and protect investors’ interests.

However, responding swiftly has proven to be a challenge in many countries. Other policy lessons involve tackling the social dimensions of the phenomenon by means of programs to enhance financial literacy and personal financial responsibility among members of the public. In the case of Ponzi schemes operated by regulated entities such as offshore banks, the lessons point more simply towards the dangers of weak regulatory frameworks and inadequate supervision.

The recent Caribbean experience has heightened the awareness of regulators and potential investors to the risks associated with UIS. However, awareness alone will not prevent a recurrence, and the experience shows that fraudulent schemes will emerge on a regular basis even in financial markets with strong regulatory frameworks. Thus, it is necessary that countries work together in enhancing their legal and regulatory frameworks. An October 2008 seminar on Understanding and Combating Unregulated Investment Schemes was an important step in this direction (see CARTAC 2009).

The next two sections seek to draw lessons from countries’ experiences in dealing with Ponzi schemes and address the following questions: first, what are the key conditions that need to be in place for regulatory agencies to be able to take adequate actions against the schemes, and second, what are the key actions that authorities should take?

Preconditions

Taking comprehensive actions to stop Ponzi schemes has proven to be challenging for many countries. Analysed altogether, the cases show that regulatory response is influenced by a set of preconditions. When these preconditions are present, regulators are more prone to be proactive and act quickly and decisively. In their absence, regulatory responses come, at best, with significant delay. These preconditions are: 1) independence of financial regulators; 2) broad authority to investigate and prosecute unregulated schemes; 3) effective mechanisms for domestic and international cooperation; 4) adequate resources for enforcement; and 5) speedy courts with the requisite skills and experience.

Independence of financial regulators

In many of the cases studied, political - and even popular - support for regulatory actions to stop the schemes has been absent. Such lack of support has been the result of a complex set of factors, including limited understanding of the nature of the activities carried out by the schemes and thus of the danger that their unchecked operations may entail for individuals and the financial sector as a whole. In some cases the lack of support can be attributed to direct or indirect contributions by the schemes to governmental or social causes - sports, beauty contests, charities, political campaigns - that make them popular with politicians and the public. In this type of environment, it is critical that the financial regulators have sufficient independence to be able to carry out their mandate without the need for any additional approval from the government and even in circumstances where the schemes may have the tacit support of members of the government.

It is also critical that the regulatory framework contains adequate provisions to protect staff and commissioners against law suits arising from the exercise of their duties. In the absence of such provisions, regulators might not feel completely free to take rapid and strong actions against the schemes given that they might end up causing them personal liability which, even if they expect to be vindicated by the courts, exposes them to the uncertainty of lengthy and expensive litigation in their personal capacities.

Broad authority to investigate and prosecute unregulated schemes

The experience of many developing countries suggests that gaps in the legal and regulatory framework to enforce financial laws and regulations have been a key factor in the lack of an adequate response by financial regulators to Ponzi schemes. Four elements are important:

(i) clear provisions to prosecute the schemes; (ii) broad investigative authority; (iii) authority to seek or impose civil/administrative remedies; and (iv) authority to seek emergency relief.

Clear provisions to prosecute the schemes

Key to the ability of countries to combat Ponzi schemes that operate as UIS is the existence of clear provisions that prohibit and punish the undertaking of certain financial activities without a licence/registration from a financial regulator. Such provisions should apply to deposit taking, securities intermediation, and public offering of securities and collective investment schemes. Depending on the definition of such financial activities in a particular jurisdiction, it might be necessary to include additional “catch all” provisions, for example, prohibiting the collection of money from the public without authorisation. In addition, the legal framework should contain provisions that directly prohibit and punish investment fraud.

The experience of some industrialized countries, in particular the United States has been to mainly use the provisions in their securities laws to combat Ponzi schemes. In this regard the US SEC has successfully brought charges against hundreds of schemes based on the registration/licensing provisions and the antifraud provisions of the Securities Act. However, key to the use of such provisions has been the definition of “securities” of the US system, which has been interpreted by courts to encompass a broad range of transactions, including interests in pyramid or Ponzi schemes. Other countries, especially in Africa, have mainly used deposit taking provisions to combat Ponzi schemes carried out through UIS. Other countries have considered that such provisions are too narrow to be able to cover the activities of Ponzi schemes. As a result, they have enacted special provisions, for example prohibiting and sanctioning pyramid schemes (such as Sri Lanka and Afghanistan) or prohibiting the collection of money from the public without a licence (Colombia). As indicated above the need for such provisions should be determined based on the legal framework of each country, in particular, the interpretation of key concepts such as securities and deposit taking.

Investigative authority

Statutes should provide financial regulators with the authority to investigate breaches to financial laws and regulations, including the breaches of the licensing provisions. While that authority is usually given to financial regulators, in many developing and emerging markets they have limited powers to request information, in particular from unregulated entities. That was in part the case in Jamaica where the FSC has stated that it had limited powers to obtain information from the UIS, given their unlicensed status, including the evidence necessary to bring charges. Thus, it is necessary that statutes provide financial regulators with broad authority to request information, including subpoena powers. Particularly important to combating Ponzi schemes and other types of investment fraud is the ability to “follow the money,” for which the regulatory agencies should be empowered to access banking information.

Civil/administrative sanctions and criminal sanctions

The authorities should have at their disposal a wide range of remedies (sanctions) available to combat Ponzi schemes, including both criminal and civil/administrative sanctions. However, as the cases indicate, in some developing and emerging markets, the financial regulators lack the authority to directly impose a broad range of civil/administrative sanctions. As a result, financial regulators lack the authority to prosecute such offenses and have to rely entirely on the criminal authorities. Experience shows that the criminal authorities have other competing priorities and, that in practice they do not pursue all cases. Also, the burden of proof for criminal offenses is significantly higher than that required at the administrative or civil level.

Thus, to be most effective, financial regulators need to be empowered to prosecute this type of misconduct as a civil/administrative breach, irrespective of the fact that the same misconduct constitutes a criminal offense also under the jurisdiction of the criminal authorities. However, as will be discussed below, coordination between the two authorities is critical for an efficient and effective use of enforcement powers.

Empowering regulators with sanctioning powers can be achieved in different ways depending on the legal tradition and culture. In some countries, for example the securities regulator has the authority to investigate and prosecute (litigate) all violations of securities laws, including investment fraud, but the imposition of sanctions is done either by an administrative tribunal or by the civil courts (for example in United States). In others, investigation, prosecution (litigation) and the imposition of sanctions is done by the financial regulator (for example, the Ontario Securities Commission in Canada).

Another problem that some countries face is that actual penalties that can be imposed are not sufficiently serious to have a deterrent effect. That problem appeared to have existed in Colombia, where new provisions enacted by the government following the state of emergency have now increased the penalties for undertaking financial activities without a licence.

Emergency relief

Experience suggests that emergency relief is a key shortcoming in many developing and
emerging markets vis-à-vis more developed jurisdictions where financial regulators can seek relief such as asset freezes, usually in civil courts under expedited procedures and in some circumstances without the presence of the plaintiff, as is the case in the United States. For example, in Jamaica the FSC statute allows it to directly impose cease and desist orders but does not specify what other type of emergency relief could be sought in civil courts. In Colombia, the relevant decrees specify that the Superintendencia Financiera could impose certain types of precautionary measures against entities that appeared to be undertaking financial activities without its authorization; however, according to the Superintendencia, the standard of evidence required to make such a determination was very high, thus making the process to impose them very lengthy.

New provisions enacted by the government following the state of emergency allow the imposition of a broader set of precautionary measures directly by the Superintendencia de Sociedades (SS), without the need to seek court approval. In many developing countries such precautionary measures can be imposed under a criminal investigation or an anti-money laundering (AML) investigation, thus the need for even greater cooperation between the financial regulators and the criminal authorities. However in the end, it is necessary that such authority be given directly to the financial regulators so that they do not have to rely entirely on other authorities to be able to close down the schemes.

Broad authority to cooperate and exchange information with other financial regulators, locally and internationally experience suggests that the lack of authority to exchange confidential information, in particular banking information, and to provide assistance to foreign regulators has hindered the investigation and prosecution of Ponzi schemes in many developing and emerging markets. In the case of securities regulators, this shortcoming also prevents them from being able to sign the Memorandum of Understanding (MoU) of the International Organization of Securities Commissions (IOSCO).

To a lesser extent, some regulators also face problems in exchanging confidential information with other local regulators. Experience also shows that cooperation in practice is a challenge. Thus it is necessary that the legal framework explicitly grants financial regulators with the authority to provide information to their counterparties. As will be discussed below, in particular the ability to follow the money through, among other things, the access to banking information in local financial institutions, but also in financial institutions in other countries where perpetrators might have hide the money taken from the public, is key to the successful prosecution of Ponzi schemes.

Adequate resources for enforcement

A strong legal enforcement framework is necessary but not sufficient to ensure adequate handling of Ponzi schemes. In countries where the problem of Ponzi schemes has just started to be tackled, the lack of experienced personnel has proven to be an important challenge to taking prompt action. Training can help to bridge this gap. In addition, the development of internal manuals on how to conduct investigations can also help to bring an organization up to speed. At the same time, it is important that investigators have at their disposal certain minimal technological tools to allow them to leverage their resources in order to detect, for example, investment fraud conducted via the internet.

Finally, there should be an adequate organizational structure to deal with the investigation and sanctioning of cases. This will, in the case of many countries, include improving the expertise and capacity of the state’s criminal and civil law departments and other state agencies involved with the prevention, detection and punishment of financial crimes (tax, money laundering, fraud). It may in other cases include building the requisite legal capacity and expertise inside the regulator or developing a roster of private sector attorneys with the skills and experience to handle and advise on such matters effectively.As the Madoff case has shown, adequate procedures and controls for handling complaints from the public are also key.

Specialization and speedy disposition by the courts

As part of the due process of law, many decisions that a financial regulator takes to stop
Ponzi schemes are subject to judicial approval or review. As a result, it is critical that judges
have the necessary expertise in financial matters. In addition, it is important that financial
matters, in particular those involving emergency relief, be given priority. However,

experience shows that this is a key challenge in developing and emerging market countries.
For example, in Jamaica the court system required over a year to resolve the legal challenges
to actions taken by the FSC to stop the schemes. Moreover the courts granted stays of
execution, which would probably not have been the case in jurisdictions where a body of
jurisprudence regarding the fraudulent nature of Ponzi schemes had already been developed.
Thus we believe addressing challenges of adequate expertise and speedy disposition of
financial matters by courts requires special attention by governments since it is not easily
achieved in the context of the overstretched and under-funded judicial systems commonly
found in developing countries. As indicated above training and specialization of judges is
key, as well as the development of expedited procedures for these types of actions.

B. Key Regulatory Actions

Prompt and decisive action is required in order to prevent unregulated schemes from taking
root and spreading. Regulators must be prepared to work on several fronts, including:
(1) proactive investigation; (2) emergency relief; (3) civil/administrative and/or criminal
actions; (4) coordination among relevant agencies (financial and law enforcement); and
(5) public awareness.

Be proactive in investigating unregulated schemes

Ponzi schemes, in particular those that flourished in the form of unregulated schemes, are usually not easy to detect, because many of them operate in an opaque—even secretive— way, requesting confidentiality from investors. In addition, the operators use many different strategies to lure investors which might cause confusion regarding the nature of the activities that they carry out. Thus, regulatory agencies should make an even greater effort to detect them by developing effective investigative tools, including:

• Red flags. Experience shows that there are certain hallmarks that point towards the
existence of investment fraud. Thus, the development of such red flags creates a basic
tool for the identification and investigation of fraudulent schemes. The Caribbean UIS
had a number of features considered to be red flags by the Securities and Exchange
Commission (SEC) and the Commodity Futures Trading Commission (CFTC).

• Technological tools to facilitate research on the internet as well as other mass media.
In some cases fraudsters appeal to investors via advertisements in newspapers or via websites on the Internet. Thus it is important that regulatory agencies develop mechanisms and tools that allow them to monitor such advertisements and websites.33

• Mechanisms to receive and act upon complaints from the public. As the recent Madoff case indicates, the public—and market participants—can play an important role as watchdogs of what is happening on the ground. Thus, regulators should develop mechanisms to allow such participation, including effective procedures for encouraging and receiving oral, written and electronic (such as email, instant messaging, web blogs, etc) complaints.

Seek emergency relief such as an asset freeze

Completing a full investigation to bring civil/administrative or criminal charges against unregulated schemes can take a significant amount of time. However, the more time elapses, the greater the likelihood that scheme operators or investors’ money will disappear or be relocated to other jurisdictions making repatriation difficult or impossible. Thus, once a regulatory agency has gathered sufficient evidence of the operation of a Ponzi or other fraudulent investment schemes, it should immediately seek the imposition of emergency relief, such as temporary injunctions and the freezing of assets, aimed at protecting investors’ interests while the investigation aimed at bringing charges continues.

Bring charges (both civil/administrative and criminal)

There should be adequate and prompt punishment of Ponzi schemes as a deterrent against future violations. As indicated above, ideally, authorities should have at their disposal both civil/administrative and criminal remedies. Civil/administrative remedies differ from criminal remedies not only with regard to the authority responsible for their prosecution and imposition, but also with regard to the burden of proof and the gravity of the sanction. Thus in addition to bringing the civil/administrative remedies directly available to them financial, regulators should diligently submit the corresponding files to the criminal authorities, and be ready to assist them to build the criminal case.

Coordinate and cooperate locally and internationally

Depending on the strategy used to lure investors, the operation of a Ponzi scheme can constitute a violation under several financial laws (banking, securities, commodities). For example, the operation of a scheme that allegedly utilizes the funds raised from the public to trade in foreign exchange may constitute a violation of securities laws as well as foreign exchange laws. Depending on the structure of financial regulation in a particular country, the violation might then be pursued by more than one regulator. The fact that two or more regulatory authorities might have jurisdiction over the same misconduct is not necessarily a drawback except when it leads to a situation in which neither authority acts. Thus it is important that local regulators keep a close dialogue with regard to Ponzi schemes and when necessary coordinate actions to tackle specific schemes. Such close dialogue is also extremely important with respect to the criminal authorities since a coordinated strategy can lead to more effective enforcement.

Finally, as the Madoff case and the schemes in the Caribbean suggest, these allegedly illegal activities do not recognize local boundaries. Operators of unregulated schemes can act from several jurisdictions, taking money from investors in different jurisdictions and hiding money in others. Thus, financial regulators should be in close dialogue with regulatory agencies from relevant jurisdictions to share information and to coordinate action. Financial regulators should have in place effective mechanisms for the exchange of information and cooperation in relation to curbing unregulated schemes. The IOSCO’s MoU is becoming an important tool for countries to achieve this objective.34

Keep the public informed

The development of private capital markets rests on the assumption that the public understands how financial markets work, the role of financial regulators, and their rights and responsibilities as investors. Thus, in the long run, broad financial literacy programs can help to diminish the problem of unregulated schemes. In addition, it is crucial that regulators keep the public informed of the existence of unregulated schemes as well as the actions that are being taken by them to stop particular schemes. Tools to raise investor awareness include:

• General warnings regarding the methods used to defraud investors (red flags) and the need to ask questions regarding a potential investment’s financial viability and to invest only through licensed entities.

• Notices and lists of individuals or entities that hold or do not hold a license to carry
out financial activities.

• A database of actions taken against specific individuals and entities (for example, cease and desist orders, monetary penalties, etc). For this purpose the regulatory agency should have a clear policy regarding publicity of enforcement actions.
 
CONCLUSION

The case history demonstrates that Ponzi and pyramid schemes are phenomena that can occur
in any financial market, industrialized or developing.

The business opportunities that they claim to offer and “legal structures” that they use to operate are diverse.  Schemes have offered returns based on foreign exchange trading, real estate investment, and financial  instruments, under structures such as joint-stock company, hedge funds, commercial banks, or simple pools of assets. At the same time, promoters employ many similar techniques to pitch their scheme, to identify target groups, to obtain publicity, and to build credibility. Experience also shows the pervasive effects that such schemes can have if left undetected, from lack of trust in financial institutions to large-scale economic, social, and political damage. Thus, there is a need for a strong governmental response to stop them and protect investors.

There are lessons to be learned from the regulatory response of industrialized countries vis-à-vis more developing countries. In the majority of industrialized countries, regulators have a wide range of tools at their disposal to deal with unregulated and/or fraudulent schemes and use them effectively to stop their operation. The ability to impose precautionary measures, such as freezes of assets, as soon as a scheme is discovered is essential in successfully dealing with UIS. The judiciary has supported such measures and a body of jurisprudence has been developed, making the prosecution of future cases easier. All these measures are complemented with active financial literacy programs that work on the side of investors to help them to understand better how financial markets work and the role of regulation. As a result, while large and long-lasting schemes still can appear, as the Madoff case reminds us, they are more likely to be stopped as soon as they are discovered.

That has not been the case for some developing countries, where unregulated investment schemes, including fraudulent schemes, have been able to flourish. The lack of a strong regulatory response, along with underdeveloped formal financial institutions, have been at the heart of the ability of unregulated and fraudulent schemes to develop. The experience shows that the lack of such response is a reflection of a broader problem, which is the challenge faced by regulators in many developing countries to develop credible enforcement programs. Many regulators in developing countries lack the necessary tools, resources and sometimes political independence to cope with financial misconduct, including the operation of Ponzi schemes. Moreover in a global financial market, effective enforcement requires the ability of regulators to exchange information and cooperate with one another. Such cooperation and exchange of information has proven critical in combating unregulated schemes, given their demonstrated ability to relocate from one jurisdiction to another. However, for many developing-country regulators such cooperation is still an aspiration, given legal limitations to their authority to exchange critical information and cooperate with foreign regulators.