Lessons From A Ponzi Scheme

August 16, 2016

by Robert Huebscher

New Ponzi schemes are uncovered approximately once a week. Rarely, however, are the victims’ details known. That’s what is remarkable about the Wincapita Ponzi scheme, where academics have been able to study the demographic data from over 53,000 pages of police investigation documents.

Wincapita operated from 2003 to 2008 in Finland, defrauding more than 10,000 victims – about 0.2% of Finland’s population – of approximately 100 million euros.

By contrast, the Madoff scheme cost its 50,000 victims approximately $18 billion. But Madoff’s victims were worldwide. Wincapita’s victims were all Finnish, and included many high-profile citizens, including a military commander, professional athletes and corporate CEOs.

Ville Rantala, a finance professor at the University of Miami, spent a year collecting data from the Wincapita fraud. He identified a number of patterns that explained how the scheme was able to grow and who was more likely to be victimized.

I spoke with Rantala by phone on August 10.

Bernie Madoff, Ponzi Scheme
Image source: thierry ehrmann, Flickr
Lessons From A Ponzi Scheme

Background

Wincapita was promoted as a currency-trading scheme. Unlike Madoff, which was a legitimate investment company, Wincapita was operated through the internet with a shell company in Panama. Anyone who investigated its corporate structure should have uncovered it easily.

It lured its victims with promises of high returns. In reality, it operated as a classic Ponzi scheme, using funds from new victims to pay out earlier investors.

Only Wincapita’s founder, Hannu Kailajärvi, knew the details of its operations.

A specific feature of Wincapita, which made it an ideal candidate for academic study, is that investors could join only by invitation from a sponsor. Rantala studied the relationships between sponsors and invitees to learn how the scheme unfolded.

Most Ponzi schemes have a social scheme. But researchers can’t see who invited whom, Rantala said, much less their investment amounts, background characteristics or income (which, in Finland, is public information).

Key findings and implications for advisors

Rantala studied the relationship of personal characteristics between sponsors and invitees. He found that invitees invested more if their sponsors had higher income, were older or more educated. Men were typically sponsored by other males, but women were equally likely to have a man or a woman as their sponsor.

He used a statistical technique to compensate for the fact that sponsors and invitees were not randomly matched.

“Investors made the mistake of relying on the person,” Rantala said, “not the information.” Those interpersonal relationships overrode the natural safety mechanism that would have prevented a costly mistake.

Wincapita’s victims cared about relative wealth, according to Rantala. It was a “get rich quick” opportunity to them, and they needed to join before their friends did in order to keep up. He learned much about the investors’ motives by reading the police transcripts.

One lessons Rantala offered pertains to when clients seek advisors’ counsel on speculative investments. The key, he said, is to not mix one’s judgment about a person with the critical information about an investment.

Clients should ask, “Do I trust this information, and do I believe this person is acting in good faith?” he said. “When information comes from a friend, it overrides safety mechanisms.”

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