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Many otherwise experienced investors hesitate to step out into the offshore
world. They have heard all the stories of
fraud and lost fortunes, phoney banks, and fake companies. They worry
that, without the protections offered by the
regulatory agencies and familiar legal systems of their home country,
they will fall prey to international con men. This
chapter looks at the dark side of international investing to see if
it's as scary as it seems.
There is no harm in such an investigation. Honest businessmen, whether
in Barbados or Boston, won't object to
having their credentials checked. We'll also look at domestic businesses
and their official protectors to see how
effective these agencies are at eliminating fraud.
THE BANK OF SARK
In 1968, Phil Wilson, who was an experienced "paperhanger" (bad-paper
passer), decided that it was time to go into
the banking business. He may have been trying to make a political statement
about the evils of fractional reserve
banking, or perhaps he was just trying to make a little money. In any
case, he carried the concept of fractional
reserve banking a little too far.
Wilson opened the Bank of Sark on the Island of Guernsey. He named it
after the Island of Sark, one of Guernsey's
neighbours in the Channel Islands. These islands off the French coast
are administratively part of Great Britain but
have a great deal of local autonomy. They have long been popular tax
havens and Phil Wilson chose Guernsey
because it was so easy to incorporate a company there. He printed up
some nice-looking bank stationery, (cashier's
checks, certificates, and letters of credit), and drew up a balance
sheet listing the bank's assets as US$ 72.5 million.
Dr. Samuei J. Wilkinson, Sr., who claimed to be a certified public
accountant in Nassau, wrote a letter certifying that
he had examined the records of the band and that the balance sheet
was correct. Wilson also obtained a telex, a
telephone, a small office, and a listing in Polk's Bank Directory.
Thus equipped, he was able to wholesale large numbers of worthless documents
to his friends in the paper-hanging
profession. They would pass this official-looking paper in banks throughout
the US and try various ruses to get the
banks to advance some cash. The paper was also used by other confidence
men to puff up the assets of their own
shady financial operations throughout the world.
All in all, the bad paper was used to obtain US$ 40 million from other
banks and financial institutions during the four
years that the Bank of Sark was in operation - a very high return on
investment. The fraud went on for so long
because Wilson's agent on Guernsey had a host of form letters that
he used to stall the bank's creditors. Also, banks
were reluctant to admit that they had been taken and did not publicise
the problem.
MORE BAD PAPER
Phil Wilson was doing wholesale what thousands of lesser crooks do on
a more limited bases every day. Securities
are stolen, counterfeited, or fraudulently produced. They are then
used as collateral for loans of sold to legitimate
banks and brokerage houses. Organised crime is active in the business
and profits can be high.
Securities can be stolen directly, in which case their useful life is
limited because they quickly appear on a hot list of
stolen securities. With the help of an insider at a brokerage house,
securities can be taken and not reported as
stolen for a month or so. This makes them highly marketable during
that time. Counterfeit copies of blue chip stocks
are always a popular item because there are so many genuine copies
in circulation. Fraudulent paper of various
sorts, like that produced by the Bank of Sark, has the advantage of
being difficult to identify as fraudulent. Stolen
securities may not stand up to a close physical examination but with
so many financial institutions in the world, it may
take years to establish that a particular bank is a pure fraud.
NON-EXISTENT INVESTMENTS
This is the pure kind of scan. The criminal separates the victim from
his cash with a promise of riches from a fabulous
investment. The only problem is that the investment does not exist.
The forms that the investments can take are
limited only by the con man's imagination. The collapse of Bullion
Reserve of North America (BRNA) sent shock
waves through the hard-money investment community. Alon Saxon, the
president of BRNA, killed himself on
September 26, 1983, and his company filed for bankruptcy on October
3rd. Missing were US$ 60 million worth of
investors' assets that were supposed to have been sitting in BRNA's
vault in the form of gold bullion.
BRNA had become one of the biggest bullion dealers in the country because
of its ads that promised gold at 3-1/2
percent over the spot price and free storage. Apparently, most of the
investors' funds were not used to purchase
gold at all but were used for other investments. The impact of this
collapse was magnified because almost the exact
same thing had happened earlier in the year with the International
Gold Bullion Exchange.
These cases demonstrate the extent to which many people rely completely
on faith for their investments. Variations
on this theme appear frequently on both the domestic and international
investment scenes. There are crooked real
estate deals and phoney companies appearing all the time. Foreign investors
have lost lots of money in American
real estate investment schemes. These frauds trace their lineage back
to such traditional cons as the sale of
(swamp) land in Florida and of glass as diamond. The sucker is led
to believe that he is receiving something for his
money, when all he is actually getting is the con artist's fantasy.
His eye is on the gold but all he gets is the gleam.
PYRAMID FRAUDS
Most popular frauds involve a pyramid in which the early investors are
paid fabulous rates of return from newly
invested funds so that other investors will be encouraged by good word-of-mouth.
When the plan begins to fall apart
because there are to many investors demanding payments, the organiser
absconds with everything he can grab.
A certain amount of American offshore investment activity has been encouraged
by a famous pyramid fraud called
Social Security. This scheme has milked Americans out of billions of
dollars over the years and now provides the
biennial entertainment as politicians scramble to save an unsavable
system. The Social Security system is actuarial
nonsense. Early retirees are paid much more on average than the total
sum of the contributions could have provided
by actual investments. They get their money from the taxes of the then-large
number of active workers. By now, the
ratio between recipients and taxpayers is such that the system will
run into chronic cash shortages even with the new
increased taxes. For more examples, see the descriptions of famous
financial pyramids in the book Extraordinary
Popular Delusions and the Madness of Crowds.
FRONT MONEY SCAMS
A person looking for money to borrow may notice the ads offering quick
financing at competitive rates. The ads imply
that even people with shaky balance sheets can be helped. Unfortunately,
the ad will turn out to be a front money
scam in which the operator hopes to bilk the victim out of a "loan
origination fee" for a loan that never materialises.
The ads are aimed at the financially strapped who have given up on
conventional financing. Those who place the
ads hope that desperation will blind potential borrowers to the risk
of loss. The technique works like this. A person or
organisation is offered a loan of say, US$ 100 million, at substantially
below the going rate. Why the low cost?
"Because it is Arab money and a good Moslem cannot accept an interest
rate beyond a certain limit". Or, "It's Nazi
money and we're getting it out and cannot disclose the source. Or,
It's Mafia money and has to stay under wraps".
Well, to back up a bit, approximately 99 percent of all Saudi funds
are either in certificates of deposit at prime banks
or in US government securities. Nazi money was handled during the war
by the Swiss banks and still is. And as far as
the Mafia goes, it's a well-known fact that Meyer Lansky's trustee
on Paradise Island in Nassau was a prominent
prime Canadian bank. The conclusion is obvious - all of these sources
deal with only prime lending institutions. They
own their own banks in many cases and have controlling interests in
commercial banks around the world. In short,
they don't need you.
What will always come up sooner or later in the scam scheme is the question
of front money. This can be in the form
of cash requested to supposedly pay off a go-between or to smooth the
way with a bank official who will be finalising
the arrangements. With amounts like US$ 100 million at stake, a US$
5,000 front fee might not seem unreasonable -
until the con artist has skipped town with it.
The victim may, on the other hand, be told that the deal is all set
to go but that the agent must first fly to Zurich, (first
class of course), to make sure that all banking arrangements are in
order. The cost of the ticket and first-class hotel
accommodations comes to US$ 5,000, which is to be advanced by you.
If this same story is told to 40 gullible souls,
the amount in question is not trifling by any means - US$ 195,000 tax
free.
The ticket to Zurich is again nothing but front money. Perhaps the largest
area of scam operation in the financial
area are the front - fee scams, which are a bit more disguised than
simply a trip to Europe. Many years ago, the
schemes were primarily the bailiwick of loan sharks, gamblers, and
other Mafia types. Clients were told that they
would receive their loans, but that they first had to put up a few
thousand to be able to approach and pay off the well
- known and formidable lenders so the funds would be expedited. Of
course, the front fee would disappear along with
the so - called go - between, and the legitimate businessman or businesswoman
was so mortified by having thought
he or she could get the funds from such a source to begin with, that
they would not even bother to report the fraud to
the authorities.
Another variation of the same scheme is telling the client that his
money will be coming from XYZ Saving Loan, and
that because of the amount and nature of the loan involved, a certain
amount has to be advanced to pay off
someone on the local committee to finalize the arrangements. Again
the money is advanced, but when the loan itself
does not materialize, the client cannot report it because he has already
been implicated in an attempted illegal act.
Prosecution rarely follows in a scam such as this.
Whereas in the past these scams were hidden in the nether world of the
Mafia and fairly obvious illegal channels,
they have now become much more sophisticated and complex. As a result,
some of the largest banks in the world
have been stung, along with some of the largest borrowers in the world.
It seems to be partly a result of how dismal
things have been getting financially in the last 10 years, along with
how sophisticated scam artists have become.
Those with a criminal bent have used the complexity of the international
banking world to develop all sorts of plans
that have the appearance of legality, but are so complex that many
fairly sophisticated souls do not fully understand
them and can't judge their legitimacy or fraudulence.
Perhaps the longest lasting front money scam is the one that has provided
the livelihood of a Belgium family for
generations. The scheme involves offering loans that are designed no
to be approved. The client is presented with a
complicated loan application package. Buried in the paperwork is a
provision that allows the lender to demand a
prime bank guarantee of principal and interest.
On Friday afternoon at 2:00, the lender then tells the prospective borrower
that his US$ 5 million loan has been
approved and will be funded as soon as he can provide all the documentation
required by the loan application. The
lender adds that there will be a blockage fee of one percent (1%) payable
immediately, because the loan funds are
being set aside over the weekend. The lender then collects the US$
50,000 fee. On Monday, of course, the lender
says, "Where is the prime bank guarantee." If the borrower could get
a prime bank guarantee, he could have
borrowed the money from the prime bank in the first place at a lower
rate of interest. The lender has just made US$
50,000 for a few hours work. This scam has been worked over and over
again.
SELF-COLLATERALIZING LOANS
A person in the business of offering loans to the public will probably
be approached sooner or later by a con artist
offering this sort of deal. He will say that he is an agent for a man
who needs a large business loan, say US$10
million. The loan will be secured by Treasury securities maturing in
10 years with a face value of US$20 million. The
securities will be Fed - wired to the lender and he will want to make
arrangements to complete the transaction in a
single day. His principal will also, he says, want to strip the coupons
from the bonds to establish a "sinking fund" to
pay off the loan when it comes due or to use the funds for another
investment. He will say that the loan is secure
because the face value of the bonds covers it.
What he is trying to get the lender to do is to ignore the time value
of the money. What he intends to do is to use the
loan to purchase the bonds that are to be used to secure it and then
strip half the value from the bonds by removing
the coupons. In this era of electronic money, the con man is hoping
that you will not notice the theft. US$10 million
ten years from now is not the same thing as US$10 million today. If
the bonds were real, rather than bits of computer
data, the lender would notice the loss more easily. But today's electronic
money market can cause the unwary to
overlook the substance of a proposed transaction. A person can avoid
this trickery by always keeping the time value
of money and the importance of full collateral in mind.
The operator who is pulling this particular scam probably doesn't expect
it to come off too often, but he may be
operating a front - money scam on his principal, holding out the hope
of free money from a lender to obtain expenses
for traveling around the country. There must be some profit in the
game because sharp operators keep on trying to
pull it off.
SECRET KNOWLEDGE
This scam is an ancient con that has been updated recently. A con artist
will buy a list of large - portfolio individual
investors with perhaps 60,000 names on it. He will send out a letter
to the mailing list offering a stock
recommendation service. To catch the interest of the investor, he will
give his first few tips away for free. He will have
some story of how he has special knowledge that allows him to pick
winners.
In the past it was a "network of insiders maintained at great expense
in large corporations" or, perhaps, an
astrologer. "At first I didn't believe Madame X could pick winners
either, but seeing is believing." Nowadays the
operator may claim to be conducting electronic surveillance of the
inner circles of large corporations (the Watergate
Ploy) or to have a line to an "insider in one of New Yourk's largest
law firms". Perhaps the investment advisor will
focus on merger and takeover candidates, claiming some secret way of
calling them before they happen.
What he has, however, is no secret knowledge. He recommends a stock
that he knows to be volatile. The current
merger mania provides plenty of those. Then he tells half of his mailing
list that the stock is going up and half that it is
going down. Then, after a strong stock price movement happens, he divides
his list in half. He does a second mailing
- repeating the process with a new stock - to the 30,000 people he
gave the right advice to the first time. He splits the
list once more and gives a new pick to the 15,000 investors he has
rightly advised twice already. After this third
mailing, he has a list of 7,500 names that have seen him provide three
correct predictions. Many of them will be
receptive to his offer to sell them his fourth prediction for several
hundred dollars. He can keep splitting the list for
quite some time. It is possible to make hundreds of thousands of dollars
from this con with almost no effort or risk.
Unfortunately, many otherwise reputable securities and commodities
brokers do this all of the time. Consider for a
moment, which of the many funds which your broker manages will he show
you last year performance record? The
ten that went up or the ten that went down?
REGULATORY AGENCIES
Actually, the individual investor is better able to avoid the problems
caused by crooks than is a large public
corporation. Individuals have a direct and immediate concern about
how their money is being safeguarded. They
have the incentive to thoroughly investigate before they make a business
deal with. They are often forced to try and
collect funds for their depositors, based on bad paper. The depositors,
of course, want to draw against the
uncollected funds right away. The institution may accept the risk of
the bad paper to satisfy an important customer.
There is also less of a guarantee that the institution's funds will
be well cared for. The quality of employees varies.
Since they are dealing with "other people's money", they may not take
as much care as the private investor dealing
with his own funds.
CAVEAT EMPTOR ET CAVEAT VENDOR
The rules of protecting oneself in the international money game are
simple. All that needs to be done is to make sure
they are always applied and that one doesn't allow one's enthusiasm
for a particular deal to carry one away.
International business is just like any other business. It is a community
built upon trust. When that trust is violated,
the violation makes news because everyone is interested in the reputations
of other people that they may someday
have to deal with.
Offshore business is the business of reputation. Most of the financial
institution and brokers in the offshore world are
selling little other than their reputations for honesty and service.
Experienced investors know who has established a
history of trustworthy operations; they also know who are the real
crooks that fleece investors and institutions alike.
One of the first things that one learns, if one does business in the
offshore world, is how to judge the credentials of
those one deals with.
The first rule of the potential investor is to know who he is dealing
with. If he has not met this person before, he must
check the person out. He must not allow himself to be deceived by an
outward display of success. This can be faked.
He must get references and check them out, requiring independent references
to be provided. He must check on the
reputation of the person or institution with other people that he knows
and take his time in the investigation. There
are many deals available in the world and there will be just as many
available tomorrow. Many familiar institutions in
the offshore world will be able to assist such an investigation. Every
prime bank in the United States has a Caribbean
subsidiary. All of the normal credit rating services exist in the international
realm.
The investor must use the same tools to establish the bona fides of
potential clients that he would use at home. He
does not have to avoid dealing with strangers - after all, when he
first enters the international investment community,
everyone will be a stranger to him. All that is needed is to make sure
proper security has been obtained when
dealing with strangers.
Any deal, no matter how bizarre, can be transformed into a rock-solid
business proposition by good collateral. In fact,
it is an old joke among lenders that, if someone comes to them asking
for an impossible rate on a loan, they may say,
"Fine, we'll give you an 8 percent loan but we'll need a compensating
balance of 110 percent of the principal
deposited in one of our accounts paying 6 percent."
Use that approach only when a customer is refusing to answer important questions about the deal he is offering.
A good approach is to pick the people that one wants to deal with, instead
of giving into someone else's sales pitch.
Be the initiator of the relationship. Choose instead of waiting to
be chosen. The investor knows best what he wants.
The second rule is for the investor to know what he is getting into
before he commits himself. He should not commit
resources to investments that he does not understand. If he is not
sure just what is being done with his money, he is
not in a position to protect it. There are many good, simple investments
in the domestic and the international financial
worlds. If a person is not willing or able to follow a complex series
of financial manoeuvres, then he must leave his
investments in simpler forms. One doesn't have to be a genius to be
a successful international investor, but one must
be willing to take some time to familiarise oneself with what one is
getting into.
Many con games are based on confusing complexity. The operators of these
frauds are counting on the laziness of
their intended victims. It is easy to lull some people to sleep with
large amounts of impressive detail. The reader
mustn't let himself become one of these victims. It may be best to
approach someone selling a particular investment,
rather than the other way around. If the potential investor finds that
he knows more about the investment than the
person he approached, perhaps he doesn't need him. The salesman's money
is not at stake after all; the investor's
is. Perhaps one should only invest when one knows more than the person
selling the investment.
The third rule is to know the other party's motives. The investor should
ask himself, why am I being offered this deal?
What's in it for the other party? Know the classic sign of fraud -
someone offering something for nothing. When one
walks down the street, one sometimes finds money just lying there to
be picked up. Unless one has assumed the
burdens of public employment, one has to work to earn the money one
wants.
If someone is offering a deal that seems to good to be true, check it
out very closely. If someone seems to be selling
something on impossibly thin profit margins, like the Bullion Reserve
of North America discussed earlier, it may be
that he sees his profit in the substance of the victim's investment
funds. If the deal being offered is so fantastic, why
isn't the sales company or the salesman just buying it himself instead
of sweating to sell it to a third party? Why is the
borrower with the fabulous collateral coming to the offshore banker
for a loan instead of going to a major lender?
The con artist hopes that a person's greed will overcome his caution.
Don't go through with a deal until all questions
have been answered. A good solid deal will stand close examination
and the balance of benefit between the seller
and the buyer will be clear. The price will also be in line with similar
investments or other investments of similar risk.
The highly competitive nature of the world financial community guarantees
that. If something is way out of line, avoid
it. There are plenty of investment opportunities to choose from. With
proper care, any investor will never have to
experience the pain of having been taken.
The fourth rule is for the businessman to know himself and to be aware
of his strengths and weaknesses. In this way,
he won't get in over his head. If he knows that he has low sales resistance,
for example, then he should not expose
himself to high-pressure sales tactics. He should do his investing
or other business transactions by mail. An
unsophisticated investor should stick to simple transactions until
he increases his understanding. If he is timid about
asking tough questions and making sure that the answers are provided,
then he should probably not be in the
international money game at all.
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