Over the years, we've heard about countless financial and investment scams, including Ponzi schemes and mortgage crises. In 2008, one of the worst financial scandals in history came to light. Today, we'll take a look at the largest financial scams in history and the main types of investment fraud.
When a company is involved in fraud, both its reputation and its stock value usually suffer. However, if an individual is behind the scam, the impact on the company may be smaller, but the person responsible can face severe legal consequences.
Top 5 biggest financial scams
|Year it was uncovered
|Hamanaka, Copper Manipulation
1. The Ponzi Scheme
Back in the early 20th century, an Italian immigrant named Carlos Ponzi became infamous as the pioneer of pyramid schemes in the stock market. What's intriguing is that, even with minimal investigation, it was clear that Ponzi had a history of criminal activity, with two prior prison stays.
Ponzi founded a company called the Securities Exchange Company and attracted millions of dollars by promising investors a 50% return in one month and 100% in three months.
Like most pyramid schemes, it worked initially, and Ponzi consistently made payments to his investors. This led to substantial profits, and thousands of people in Boston mortgaged their homes to invest.
However, everything unravelled when financial analyst Clarence Barron published a report in the English media outlet ‘BBC' in 1920. The report revealed that Ponzi had been involved in a scandal for fraudulently manipulating the prices of international postal coupons in the United States.
Ponzi's scheme involved exchanging the dollars he received for depreciated currencies and then using that money to purchase coupons at a lower price. Ponzi would then pocket the difference.
The problem was that Ponzi had only purchased 27,000 coupons, far from enough to cover the capital he owed to his investors, which should have exceeded 160 million coupons.
Faced with this revelation, hundreds of investors rushed to withdraw their savings and close their positions. However, it was impossible to meet the demands, and the pyramid collapsed within months.
Outraged by losing their life savings (some had even mortgaged their homes), people took to the streets of Boston in protest, demanding the return of their stolen money.
It's estimated that around 40,000 people had invested between $15m and $20m in Ponzi's company.
After thorough investigations, authorities discovered that Ponzi was using new investors' money to pay interest to the old ones—a classic characteristic of pyramid schemes. As a result, Ponzi was sentenced to four years in prison. After his release, he moved to Brazil to work for an Italian airline, which also went bankrupt during an economic crisis.
As an ironic twist of fate, Ponzi ended his days as a struggling hot dog vendor, far removed from his days of fraud.
2. Yasuo Hamanaka and copper investment fraud
Yasuo Hamanaka was renowned for his significant investments in copper as part of Sumitomo Corporation, one of Japan's major commercial firms. He earned the nickname “Mr. 5%” because he controlled roughly 5% of the world's copper supply, often simply called “Mr. Copper.” Hamanaka amassed large quantities of physical copper and futures.
During this period, he leveraged his copper holdings to create artificial scarcity, thereby manipulating copper prices upwards. His primary venue for this manipulation was the London Stock Exchange, which was the world's largest copper market.
However, this strategy crumbled in the mid-90s when China, newly integrated into global trade, began releasing massive amounts of copper, causing prices to plummet. This marked the beginning of Hamanaka's accounting tricks, where he inflated his company's value and disguised losses as profits to maintain the illusion of being the Copper King.
Eventually, the situation became untenable, and in 1996, Hamanaka admitted to $2.6 billion in unauthorised losses. He received an eight-year prison sentence but was released a year early in 2005.
3. Jordan Belfort, The Wolf of Wall Street
Jordan Belfort, born in Bronx in 1962, transitioned to the stock market in the 1990s after initially studying biology and facing career challenges. He worked for various stockbrokers before founding his own company, Stratton Oakmont. His rapid success in the industry earned him the nickname “The Wolf of Wall Street.”
Belfort's scam primarily revolved around his employees selling stocks of companies at prices higher than the market rates, focusing on “penny stocks.” In 1998, U.S. authorities charged him with fraud, money laundering, and stock market manipulation. His story and fraudulent activities inspired the Martin Scorsese film “The Wolf of Wall Street.”
4. Bernard Madoff, the largest Ponzi scheme in history
Bernie Madoff, once synonymous with wealth, orchestrated a Ponzi scheme that defrauded more than $65 billion from a wide range of victims, including individual investors and prominent companies. Notable victims included BNP Paribas, Nomura, Tremont Capital, Ascot Fund, Maxam Advisor, and others, along with the U.S. Jewish community where Madoff held significant influence.
Madoff's pyramid scheme endured for nearly 40 years due to the trust he garnered. He had served as president of Nasdaq for a decade and was known for his charitable efforts. Competitors had previously raised concerns about his unrealistic results, but investigations in 1999 found no issues.
However, in mid-2008, following the Lehman Brothers' bankruptcy, a wave of investors sought to withdraw their funds from Madoff's scheme, leading to its exposure. Madoff was sentenced to 150 years in prison and passed away in 2019. His eldest son, unable to cope with the pressure, tragically committed suicide.
5. Africrypt, the biggest cryptocurrency scam
In 2019, brothers Ameer and Raees Canjee established Africrypt, a cryptocurrency exchange in Cape Town, South Africa, aiming to provide a stable platform for their compatriots amid local currency instability. High promised yields through staking and flash loans attracted significant liquidity, estimated to be up to 69,000 BTC by April 13, 2021.
However, Africrypt abruptly ceased operations, raising suspicions among investors. The brothers claimed it was due to an “exchange hack” and urged customers not to report it to authorities. Despite their advice, numerous lawsuits were filed, initiating provisional liquidation proceedings.
Shockingly, all funds had vanished, and investigations revealed that the funds were moved through the “dark web” using a “mixer,” making them nearly untraceable. The founders disappeared with approximately $3.6 billion in users' bitcoins, marking the largest cryptocurrency scam to date.
To protect yourself from such exchanges promising high returns, consider consulting our article on the best crypto brokers.
Other financial scams
In 2002, the pharmaceutical company Merck faced a financial issue when one of its subsidiaries, Medco, recorded $12.4 billion in income that it hadn't actually received. Merck did this to balance its accounts, even though the income didn't belong to them. This accounting practice, while not technically considered fraud, caused turmoil for Merck on Wall Street until they clarified the situation.
Nick Leeson's career started at Baring's Bank in 1989 when he joined the bank's team operating on the Singapore International Monetary Exchange (Simex). Over time, Nick gained control over various aspects of trading, including the Back Office, Front Office, and Risk Management. This meant he had complete autonomy, and no one was overseeing his operations.
Nick initially traded in Nikkei futures, and as he experienced success, he increased his leverage, leading to larger positions and higher risks. Eventually, his positions became so significant that his trading alone could move the market.
However, a major turning point occurred on January 17, 1995, following a devastating earthquake in Japan. Nick saw an opportunity in the aftermath, believing that the need for infrastructure and construction companies would drive investment.
Unfortunately, the Japanese government decided to fund the country's reconstruction with government bonds rather than private investments. This decision led to a massive drop in the Nikkei, resulting in a $1.3 billion loss for Baring's Bank and its subsequent bankruptcy. Nick Leeson was arrested and sentenced to six years in prison, serving four years.
Enron, one of the largest energy companies, concealed its substantial losses for years. At its peak, Enron's shares traded at $90.56, but when rumours surfaced that the company's profits were tied to dealings with its subsidiaries, the stock plummeted to $30. Enron had used these transactions to mask losses, eventually amassing over $30 billion in liabilities. The total fraud amounted to a staggering $63.4 billion.
Jérome Kerviel is considered the mastermind behind the largest financial fraud in history, causing Société Générale, one of Europe's largest banks, to incur losses of €4.9 billion.
This created financial instability that reverberated across global markets. Throughout 2007, Kerviel executed erroneous transactions that went undetected due to his use of a complex system to hide them as false transactions. In essence, he placed colossal bets on certain stock movements, which ultimately resulted in a spectacular failure.
Worldcom, a significant telecommunications company in the United States, declared bankruptcy in July 2002, marking one of the largest financial scandals during the era of global capital. Worldcom was the second-largest telecommunications company in the U.S. and engaged in the falsification of its accounts, amounting to approximately $3.85 billion.
Following the revelation of Worldcom's actions, its stock price plummeted by over 94%. Bernard Ebbers, identified as the mastermind behind the accounting deception, received a 25-year prison sentence.
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The world of investment can be unforgiving. Therefore, now that you're aware of these 10 major financial scams, it's essential to conduct thorough research into the objectives, projects, and sources of financing of any company or individual before entrusting them with your money.
How can I recognise investment fraud?
Investment fraud can be challenging to detect, but some common warning signs include:
– Promises of guaranteed high returns with little to no risk.
– Pressure to invest quickly, claiming it's a limited-time opportunity.
– Lack of transparency about the investment's details or where your money is going.
– Unregistered or unlicensed individuals or entities offering investments.
– Difficulty in accessing your invested funds.
Are all investment opportunities that promise high returns fraudulent?
No, not all high-return investment opportunities are fraudulent, but it's crucial to exercise caution. Legitimate investments that offer higher returns typically come with higher risks. Always research the investment thoroughly, verify the credentials of the individuals or companies involved, and seek advice from financial professionals before making any decisions.
How can I protect myself from investment scams?
To protect yourself from investment scams:
– Conduct thorough due diligence before investing in anything.
– Verify the credentials and licenses of individuals and companies offering investments.
– Be skeptical of unsolicited investment offers or high-pressure sales tactics.
– Diversify your investment portfolio to spread risk.
– Stay informed about common investment scams and educate yourself about financial markets and investments.