Throughout her long career, legal scholar Tamar Frankel has taught and written about finance, security, and trusts. But in the decade of grand scammers Bernie Madoff and Scott Rothstein, Frankel turned her attention to the topic of another kind of trust, specifically, the human tendency to perpetrate, and fall victim to, Ponzi schemes. Drawing on observations from her new book, The Ponzi Scheme Puzzle: A History and Analysis of Con Artists and Victims (Oxford University Press, 2012) Frankel, a School of Law professor and Michaels Faculty Research Scholar, will deliver the 2012 University Lecture tonight at 7 p.m. at the Tsai Performance Center.
Ponzi schemes—high-return swindles in which investors are paid off with money put up by later investors—are named for the flamboyant Italian confidence man Charles Ponzi, who in the 1920s had no trouble finding victims to whom he promised 50 to 100 percent return on investments in a fraudulent postage stamp enterprise.
Ponzi schemes persist in defiance of the most basic common sense. Frankel wanted to understand why. A former visiting scholar at the U.S. Securities and Exchange Commission and someone who by her own admission has always been intrigued by honesty—or the lack of it—in business dealings, Frankel wrote a book in 2006 titled Trust and Honesty: America’s Business Culture at a Crossroad. “Who are these investors?” she asked herself. “How do the con artists do it?” A tireless observer of human nature, she was intrigued by the notion of financial crimes in which predators are called “artists.”
The Israeli-born Frankel, who served as an assistant attorney general for Israel’s Ministry of Justice, has written and taught in the fields of mutual funds, securitization, financial system regulation, fiduciary law, and corporate governance. She has taught and lectured at Oxford University, Harvard Law School, and Harvard Business School, and has been in private practice in Israel, Boston, and Washington, D.C.
The University Lecture was established in 1950 to honor faculty engaged in outstanding research and to offer an opportunity to hear a distinguished scholar discuss a favorite topic. All faculty members are invited each spring to nominate the subsequent year’s lecturer. University Lecturers from the previous five years act as the selection committee.
BU Today recently spoke with Frankel about what drives Ponzi schemers and their victims, and why neither is likely to go away.
BU Today: What sparked your interest in Ponzi schemes?
Frankel: Mostly I wrote about finance, and that leads to issues of trust. In 2006, I wrote a book about trust and honesty and expressed the concern that as a nation, we are going in the wrong direction, that the belief is, if everybody does it, I must also do it. I later presented the book at Oxford University and met a professor who said, “You’re interested in trust; why don’t you also look at the mimics of trust?”
How did you research the book?
I’m not a journalist. I went to my source, LexisNexis, punched in Ponzi scheme and got hundreds of cases. What I did was to look for patterns, not a story of one person or one fraud, but answers to a series of questions: what is it that makes this type of fraud so hard to uncover? What is it that draws so many smart, able people? How do the con artists do that? This book is descriptive and leaves the reader to make the judgment.
You write that unlike more furtive scammers, Ponzi scheme perpetrators are flashy characters who love to draw attention to themselves. Can you talk about this?
The lifelines of these schemes must be reputation and publicity, because the source of the schemers’ income is continuous investments. So they must reach more and more and more people in order to feed the promises they make. There’s no other source.
Do you believe most Ponzi schemers are sociopaths?
They are called narcissists and sociopaths. They are like the mythological Narcissus, whose punishment by the gods was to fall in love with his reflection, which dissolved upon touch. One of their main features is lack of empathy for other people.
Do most Ponzi schemers start out with legitimate enterprises?
There are those who have some business or finance idea, but don’t check to see if it will work. And there are those who started a business that did not succeed, and as it was failing, they did not stop and say, “This isn’t working; let me return the money to my investors and admit my failure.” Instead they say, “I’ll raise a little more money, and then it’s going to be okay.” And the enterprise dies, but the money raising continues.
So are they, at least for a while, deluding themselves?
Perhaps. They are consuming other people’s money. They have nothing but a story. I think that one of the difficulties in discovering these schemes is that they are so close to legitimate businesses that melted away, and to legitimate borrowing. After all, businesses borrow from Peter to pay Paul all the time. But the difference with Ponzi schemes is, there’s no business behind the borrowing. And that is often hard to discover.
What other pathology is involved?
I believe from what I read that some of these con artists are addicts. If one story fails then there is another. They don’t see failure as the end of the venture; it’s simply a signal that the time has come to create something else.
Don’t people in legitimate business often benefit from manipulative personality traits?
One of the difficulties in discovering these schemers is that they are so close to, quote, normal people. As I wrote in the new book, we all laugh at a joke that we don’t think is funny. Children play make-believe or manipulate parents into buying a toy. So these scammers are like all of us in many ways. But these people are different in that they don’t feel what other people feel. An example I give in the book is Marie Antoinette. She could not understand why the hungry people who asked for bread when there was no bread didn’t eat cake. She couldn’t imagine anything that she did not experience, and she had never starved.
You write that Ponzi schemers often have help, like salesmen. Even if they’re not in on it, shouldn’t they know that what they’re doing is fraudulent?
As with Madoff, some Ponzi scheme salesmen have suspected fraud and terminated their relationships. And some justified it, drawn by the enormous money they got. So the answer is that sometimes the high returns blind not only the victims, but also the salespeople for the con artists.
High-profile con artists seem unrepentant.
They have an ego that can’t afford to be repentant, so they blame others. They blame the government, they blame the law, and they blame the victims. They also justify what they do as a protective measure—if they don’t cheat others, others will cheat them first.
There’s that old expression, you can’t con a con. What type of people would never fall for a Ponzi scheme?
It would be a less trusting person, but not necessarily a con. So when somebody is offering an enormous return in a very short time, for some people the offer raises excitement and for others it raises disbelief. But in addition there are people who are less risk-taking and there are people who are more, whether it’s investing their money or skydiving. And there are people who are followers and those who are not.
Do you think that Ponzi schemes can be prevented?
I did not write about prevention except to make a humble suggestion: that we ought to know ourselves and our weaknesses. One way to protect oneself from such schemes is to never say yes to this kind of offer immediately. One may lose a good opportunity, but I believe that in the end, one will be safer and more secure. I’m now thinking about ways to create preventive measures, before disaster strikes. Warning investors hasn’t worked: “If it’s too good to be true, it ain’t true” is ineffective. But perhaps if investors focus not only on what is being offered to them, but on who offers it to them, they might become more cautious. Also, if regulators found businesses which are not financial businesses, yet continue to offer securities, they might start an investigation, because that is one feature Ponzi schemes share. For example, a shoe factory that’s actually making shoes does not require a continuous distribution of shares.
In your opinion, has all the publicity about the Madoff scheme made people more conservative investors?
I’m not sure. I had assumed that Ponzi schemes rise with market prices and come to an end with falling market prices. But I’m not sure that when people lose money, they won’t seek to replenish it and follow Ponzi schemers in bad times as well. I do hope that Madoff and other cases will help change a culture of belief in quick enormous riches.
Perhaps the time has come for skepticism rather than gullibility. Perhaps the time has come for seeking satisfaction and happiness in what we do, in family and friends and in contributing to an honest society. If that happens, society will exclude Ponzi schemers, and isolate them.
Tamar Frankel will deliver the 2012 University Lecture tonight, Wednesday, October 10, at 7 p.m. at the Tsai Performance Center, 685 Commonwealth Ave. Admission is free and open to the public.