Another Lesson In The Hallmarks Of Fraud

An action brought on Tuesday by the SEC should remind investors — and perhaps regulators — of the fundamental lesson of the Madoff scandal: if it’s too good to be true, it probably is. SEC v. Stanford International Bank, Case No. 3-09CV0298-L (N.D.Tex. Filed Feb. 17, 2009).

In Stanford International, the SEC alleged that the defendants committed an $8 billion fraud which apparently has gone on for years. The defendants are Robert Allen Stanford, Stanford International Bank, an Antigua based company, Stanford Group Company, a Houston-based broker-dealer and investment adviser and Stanford Capital Management, an investment adviser. The court granted a temporary freeze order at the SEC’s request.

The scheme alleged by the SEC is a familiar one. It had two key facets. In the first, the company sold “certificates of deposit” to investors. They promised “high return rates that exceed those available through true certificates of deposits offered by traditional banks.” Those returns were achieved through what was supposed to be a unique investment strategy. It yielded double-digit returns over the past 15 years, according to defendants.

The second part of the scheme is similar. Since 2005, SGC advisers sold more than $1 billion of the Stanford Allocation Strategy, a so-called proprietary mutual fund wrap program. This program was marketed based on false investment data.

In its complaint, the SEC details a number of facts about the operations of the defendants which should serve as “red flags,” not just to the SEC but also to the investing public. Those include:

• Claimed returns year after year which exceed those of other similar investments;

• A unique investment strategy;

• “Safe” investments because investor money is primarily in “liquid” investments;

• Virtually nobody knew the details of the operation — here only two people — making the operation a kind of “black box;” and

• No real oversight — the long standing auditor is retained based on a “relationship of trust with the defendants.”

Not all of these warning signs would be readily known to public investors. The first three are however: Returns others cannot achieve; a unique strategy and complete safety. These should be enough to warn off investors, not draw them in. The others should be readily apparent to any regulator conducting an investigation. When coupled with the first three investigating regulators should be off putting together an enforcement action to protect the public. Hopefully this repetition of the Madoff badges of fraud will serve as a reminder to investors to avoid the “too good to be true” investments.