In a previous post, I thought that a remedy against a Ponzi using a bank was to limit the interest rate on deposits. But I also surmised that a Ponzi operator might find a way around an interest-rate ceiling. It turns out there is indeed a way.
One such possibility is through the use of a “shell” game, using three different entities, all controlled by the operator of the Ponzi: a pre-need firm, an intermediary firm, and a bank. This shell game is one that uses “layering” of transactions.
As suggested in a commentary in the Daily Tribune, it appears that the Ponzi works when a “victim” buys a pre-need plan, sells the plan to the intermediary firm, and then receives his return in the form of a deposit in his name in the bank. For example, a pre-need plan holder may buy a pre-need plan by paying a cash lump sum of P10,000. The pre-need plan promises to pay P20,000 of benefits in, say, 5 years time. The plan itself is marketable, so the plan holder sells the plan to the intermediary firm for P20,000, with the intermediary paying through an IOU that matures, say, in a year. The plan holder and the intermediary firm stipulate that at maturity, the plan holder will deposit the P20,000 in the bank. When the deposit is made, the bank pays P20,000 to the plan holder for the IOU of the intermediary, and no unusual interest-rate agreement need be observed.
The “victim” need not be a victim, since in a Ponzi, those who get out early actually earn the return promised by the Ponzi operator. In the recent Madoff case in the US, the authorities are considering recovery from the “early players,” since they benefitted from the Ponzi along with Madoff himself.
It is, of course, crucial that all three firms (the pre-need plan provider, the investment intermediary, and the bank) are controlled by the Ponzi operator.
What happens in this scheme is that the bank has a liability of P20,000 against a claim on an intermediary firm of P20,000 (at face value). The intermediary has a debt to the bank of P20,000 and a claim of P20,000 against the pre-need firm, but the pre-need firm does not have to deliver P20,000 until after five years. The pre-need firm has P10,000 in cash, and now has to find an investment that will double that to P20,000 in 5 years. In law, there seems to be nothing wrong with this scheme, absent fraud. (Fraud is a knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his detriment – Black’s.) The accused can argue that if the pre-need firm’s business plan was “sound,” there would have been no damage to the “victim,” and the day of reckoning on this matter is 5 years in the future.
Where might that fraud be? It can be argued that there is no detriment to the victim, provided he kept his deposit at the bank that later fails, if he is made whole by PDIC. In fact, the “victim” has gained if he did not stay in the scheme. The fraud will have to be in the misrepresentations made by the bank to the bank regulators, or in the financial statements of the intermediary firm and the pre-need firm. The fraud is one committed against the government, or against the general community of customers and banks that deal with the Ponzi operator, including “innocent” plan holders and bank depositors.
The fraud is difficult to detect because a Ponzi operator will take pains to ensure that his books appear to be in order when examined by the bank and corporate regulators. However, it is a “red flag” if all three firms fail at the same time, since the Ponzi usually unravels only when the supply of “victims” dwindles, and the viability of the shell game requires all three firms to be in business.
Thus, a layered shell scheme can work even if an interest-rate ceiling is imposed on banks.