Financial Fraud in Canada: Ponzi and Pyramid Schemes

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In an economic set up there are various factors that contribute to its growth. Investment is one of them where individuals expend their money with the expectation that it will yield profit. The investment could be property, financial schemes and commercial ventures. In Canada, Ponzi and pyramid schemes are popular examples of financial schemes. These are schemes that are attractive to the public due to the high financial promises it harbors. This includes huge returns and dividends that are not available in the traditional investments. However, the unknown fact is that the return is paid from their own money or money paid by subsequent investors rather than from the profits.

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Definition of fraud according to Canada Laws

Fraud is the prohibited act, be it an act of deceit, a falsehood or some other fraudulent means; deprivation caused by the prohibited act, which may consist in actual loss or the placing of the victims pecuniary interests at risk. Correspondingly, fraud is established by proof of: subjective knowledge of the prohibited act; and subjective knowledge that the prohibited act could have as a consequence the deprivation of another (which deprivation may consist in knowledge that the victims pecuniary interests are put at risk) In addition, The Court stated in Anderson that fraud in the regulatory context requires evidence that is clear and convincing proof of the elements of fraud, including the mental element. In administrative proceedings before a securities commission pursuant to violations of securities act provisions, the standard is based on the balance of probabilities rather than the criminal standard of having to prove the element beyond a reasonable doubt. More so, the definition of the investment fraud according to the law is for the purposes of this report, FAIR Canada has limited its definition of investment fraud to fraud involving securities that directly affect individual retail investors. The law considers Ponzi as an investment fraud.

Definition, History and Facts about Ponzi

Ponzi originated from Charles Ponzi who was an Italian businessman and a con artiste based in the USA and Canada. He was born in March 3, 1882. He became known in 1920s where he promised clients a 50% profit within 45days or 100% within 90days. Individuals were supposed to buy discounted postal reply coupons in other countries and redeem them at a face value in the United States as a form of arbitrage. Nevertheless, Ponzi was paying early investors using the investments of later investors. While the scheme was continuing it became known and it was even named after him. This system ran for one year before collapsing and costing its investors $20millon.Although, he was still paying back investors he had no yet figured out a way to change coupons to cash. This was because changing the coupons to money was logistically impossible. According to researchers the 18 investors of January 1920 gave $1700 as their investment. This would require 53000 postal coupons to realize the arbitrage profits. For other subsequent 15000 investors would require coupons that would fill a ship in order to be brought in the country. This is not only any other ship but strong ships like the titanic size. This was not practical and it made Ponzi pocket the cash from stockholders. Ponzi was known to be inspired by the fact that when he was employed in Zarossi there was a scheme that was going on. Ponzi witnessed Zarossi the owner of the bank stealing from other clients in order to pay other customers. This scheme worked effectively until it reached a point where the debts exceeded the income received and it led to closure of the bank. Moreover, the arrangement of William F. Miller a bookkeeper who used the scheme to swindle $1millon stimulated him. In addition, individuals like Charles Deville Wells and Lucien River had contributed to influencing Ponzi start up. This is because they had carried out similar patterns and were successful in conning people.

The lifestyle of Ponzi rose rapidly and he started buying expensive mansions and cars. This raised suspicion as the Boston Financial writer wrote him indicating clearly that it would be impossible for Ponzi to have legal returns in such a short period of time. Ponzi intern sued for damages and he won where he was paid $500,000 and the libel law placed the burden of proof on the writer and the paper. However, Ponzis legality was question because of a furniture dealer sued him for he could not afford to cater for the bill of a furniture e he had ordered. The case was unsuccessful but some investors to pull off and the ability to pay off what he owed to them made him be relieved to the rumors of his failure. According to judicial regulations on July 1920, Boston post had printed a paper favorable to Ponzi on how his organizations allows investors to bring in 50% return after 45 days only whereas other banks have 5% returns in a year. In addition, his company was making $250,000 in a day. This attracted people to Ponzi and his clientele increased to a considerable amount. More so, there was an article by Richard Grozier and Eddie Dunn from The Post that was based on an investigation based on the activities that were carried out by Ponzi. This as well brought in the Commonwealth Massachusetts to inspect him. Ponzi met with the state of officials before the process was over and diverted the officials by promising to stop taking money during the inquiry. Despite all these suspicions, the government did not find a ground to prosecute Ponzi. The Post contacted Clarence Barron the financial Journalist who headed Dow Jones and Company to examine Ponzi scheme.

According to Clarence, Ponzi was offering bizarre returns on investments, where he was not investing with his own company. In addition, Clarence observed that investment made with the securities Exchange Company which was approximately $160 million postal returns would have been in circulation. However, only 27,000 were in movement. According to ### gross profit margin in percent on buying and selling each coupons was colossal. But, the overhead required to handle the purchase and redemption of these items which were of extremely low cost and were sold individually would have exceeded the gross profit. More so, Barron perceived that if Ponzi really was doing what he claimed to do, he would effectively be profiting at the expense of a government where he bought the coupons or the United States government. For this reason, Barron argued that even if Ponzi's operation was legitimate, it was immoral to take advantage of a government in this manner.

These publications cased a panic to the Securities Exchange Company and caused Ponzi to pay off over $2 million in a span of three days. The perception that the people had was completely changed and people camped outside his offices and they searched for answers. He had to constantly address the crowd as he convinced them that all would be well in an attempt to build their confidence in investing with him again. There was an order by the attorney General to audit his books. He commissioned Edwin Pride to audit the Securities Exchange Companys records. This was hard because his bookkeeping consisted of index cards and investors names.

In the meantime, Ponzi had hired a publicity agent, William McMasters. However, McMasters quickly became suspicious of Ponzi's endless talk of postal reply coupons, as well as the ongoing investigation against him. He later described Ponzi as a "financial idiot" who did not seem to know how to add. The denouement for Ponzi began in late July, when McMasters found several highly incriminating documents that indicated Ponzi was merely "robbing Peter to pay Paul." According to the case went to his former employer with this information. Grozier offered him $5,000 for his story. On August 2, 1920, McMasters wrote an article for the Post declaring Ponzi hopelessly insolvent. The article claimed that while Ponzi claimed $7 million in liquid funds, he was actually at least $2 million in debt. With interest factored in, McMasters wrote, Ponzi was as much as $4.5 million in the red. The story touched off a massive run, and Ponzi paid off in one day. He then sped up plans to build a massive conglomerate that would engage in banking and import/export operations.

Legal Ramifications of Ponzi

Trouble now came from an unexpected quarter Massachusetts Bank Commissioner Joseph Allen. An initial investigation into Ponzi's banking practices found nothing illegal, but Allen was afraid that if major withdrawals exhausted Ponzi's reserves, it would bring Boston's banking system to its knees. Allen's suspicions were further aroused when he found out a large number of Ponzi-controlled accounts had received more than $250,000 in loans from Hanover Trust. This led Allen to speculate that Ponzi wasn't nearly as well-financed as he claimed, since he was getting large loans from the bank he effectively controlled. He ordered two bank examiners to keep an eye on Ponzi's accounts. On August 9, the examiners reported that enough investors had cashed their checks on Ponzi's main account there that it was almost certainly overdrawn. Allen then ordered Hanover Trust not to pay out any more checks from Ponzi's main account. He also orchestrated an involuntary bankruptcy filing by several small Ponzi investors. The move forced Massachusetts Attorney General J. Weston Allen to release a statement that there was little to support Ponzi's claims of large-scale dealings in postal coupons. State officials then invited Ponzi note holders to come to the Massachusetts State House to furnish their names and addresses for the purpose of the investigation. On the same day, Ponzi received a preview of Pride's audit, which revealed Ponzi was at least $7 million in debt.

On August 11, it all came crashing down for Ponzi. First, the Post came out with a front-page story about his activities in Montreal 13 years earlier including his forgery conviction and his role at Zarossi's scandal-ridden bank. That afternoon, Bank Commissioner Allen seized Hanover Trust due to numerous irregularities. The commissioner thus inadvertently foiled Ponzi's plan to "borrow" funds from the bank vaults as a last resort in the event all other efforts to obtain funds failed. By the morning of August 12, Ponzi knew he was at the end of his tether. He'd held a certificate of deposit at Hanover Trust that was worth $1.5 million, but that total had been reduced to $1 million after bank officials tapped into it to cover the overdraft. Even if he'd been able to convert it into cash, he would have had only $4 million in assets. Amid reports that he was about to be arrested any day, Ponzi surrendered to federal authorities that morning and accepted Pride's figures. He was charged with mail fraud for sending letters to his marks telling them their notes had matured. He was originally released on $25,000 bail and was immediately re-arrested on state charges of theft, for which he posted an additional $10,000 bond. After the Post released the results of the audit, the bail bondsman feared Ponzi might flee the country and withdrew the bail for the federal charges. Attorney General Allen declared that if Ponzi managed to regain his freedom, the state would seek additional charges and seek a bail high enough to ensure Ponzi would stay in custody. Later, he underwent legal proceedings and he was jailed for lifetime until his death.

Legal Actions against Ponzi provided by the law of Canada

No person or company shall, directly or indirectly, engage or participate in any act, practice or course of conduct relating to a security or exchange contract that the person or company knows or reasonably ought to know will

a) Result in or contribute to either a false or misleading appearance...

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