This article is republished by permission from Issue # 2 of Pat McKeough's free newsletter, The McKeough Report. It differs from his three other newsletters and their associated hotlines which are all subscription based. Where the subscription newsletters include stock analyses and recommendations and reproduction is prohibited, The McKeough Report discusses general investing principles and is free to anyone who wants to subscribe. Information on how to subscribe to any of Pat's newsletters follow the article.
Recently I had a chance to meet and have a long conversation with a highly successful stockbroker. This broker seems to hold conventional opinions on investments. He told me that he sells his clients reasonably high quality stocks, mutual funds and bonds, and that he discourages them from trading excessively. He also said he'd had a few big winners in junior stocks that he heard about from friends and business associates. And, of course, he complained about taxes.
Before long, he asked my opinion on what he described as an irresistible opportunity. He said his biggest client had offered him a chance to lend money to a syndicate set up to finance Saddam Hussein's operations until the UN-imposed oil embargo ends.
This client told the broker that he has already earned 50% on a $3,000 investment in the fund in 90 days. He told the broker that other investors in the deal include a Quebec chanteuse who has recently become rich and world famous, and a top-ranking Liberal cabinet minister known for his support of tax cuts.
The broker's client says the rich and famous often get opportunities like this, but they rarely share them with ordinary folks. Instead, you only get in if you're rich and well-connected, or if somebody owes you a favour. The client said he was only inviting the broker to invest in this deal out of gratitude for some hot tips the broker gave him. Best of all, the deal is structured so that the broker won't have to report his profit to Revenue Canada.
I explained to the broker that this supposed opportunity has all the earmarks of a classic swindle known as a Ponzi game.
You might expect a successful stockbroker to see through something like this. But many successful brokers owe their success to their selling skills rather than investment ability. In fact, a key to successful investing is a healthy sense of skepticism, but that can undermine your sales career. After all, skepticism introduces uncertainty. You'll sell a lot more of an investment or anything else if you're absolutely convinced of its appeal, and if you can transfer that feeling to your client. When I pointed out the suspicious aspects of this deal, the broker just said he planned to check it out more thoroughly before investing.
Every year, people fall for something like this who should know better. They include stockbrokers as well as lawyers, accountants, ministers and any other profession you can name. Entertainers and sports figures are particularly susceptible. They find it easy to believe that their celebrity has won them entry into a select clique. After all, it gets them past the lineup at exclusive nightclubs.
When a Ponzi scheme unravels, many victims are quick to accept any explanation, no matter how ludicrous, of how and why they lost their money. They may lie about their results to themselves and others, rather than admit they've been cheated. Most are so embarrassed that they never complain to the authorities.
On occasion, a well-crafted Ponzi scheme takes root and destroys individuals, marriages, even entire communities. It happened in Albania after the fall of communism. Around the same time, a Protestant congregation in the Midwest U.S. fell prey to a Ponzi scheme launched by one of its members.
You may never hear of a Ponzi game, but you should be aware of how they work. When you fall for one of them, it's all too easy to invest far more money than you ever intended, and to rope in all your friends and relations while you're at it.
Copyright 2000 by Pat McKeough
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