ENGAGING IN PONZI SCHEMES


 

 

Joon H. Kim, the Acting United States Attorney for the Southern District of New York, announced that HAMLET PERALTA pled guilty today to wire fraud in connection with his scheme to obtain money from investors by fraudulently representing that he was using their investments to further a profitable, multimillion-dollar wholesale liquor business. PERALTA pled guilty before United States District Judge Katherine B. Forrest. Sentencing has been scheduled for September 8, 2017, at 10:00 a.m.

Acting Manhattan U.S. Attorney Joon H. Kim said: “Hamlet Peralta swindled millions of dollars from unsuspecting investors who trusted him because of his reputation in the community as a business owner and restaurateur. As Peralta has now admitted, instead of being an honest broker, he stole their money and used it to fund his own lavish lifestyle and to further a massive Ponzi scheme.”

According to the Complaint and Indictment filed in Manhattan federal court and today’s plea proceeding:

From 2013 through 2014, PERALTA solicited more than $12 million from multiple investors by falsely representing that the investors’ money would be used to engage in wholesale liquor distribution for a profit. He made these promises both orally and in written contracts. To bolster the supposed bona fides of his fictitious business, he provided investors with forged invoices and other documentation, purporting to establish the high volume of liquor he both bought from licensed wholesalers in New York and sold to wholesale and retail clients for a profit.

In truth and in fact, however, PERALTA misappropriated the millions of dollars in investments he received. He took out much of the money in cash and used some of it to both support his lifestyle and rehabilitate a failing restaurant he owned. Because he purchased very little liquor and had no profits with which to pay back investors, he then began borrowing large sums of money from new investors on the false promise that he was investing that money in the liquor business, and used that money to repay prior investors.

In or about 2013, for example, PERALTA told a prospective investor (“Investor-1”) who was a frequent customer at PERALTA’s restaurant and who had become friendly with PERALTA that he (PERALTA) owned a separate business called West 125th Street Liquors and that he had been approved as an exclusive wine distributor to a major national restaurant supply company (the “Restaurant Supply Company”) that was beginning a wholesale wine business. PERALTA told the investor that he would receive significant interest on his investments, based on profits from the wholesale liquor distribution business. In truth and in fact, however, PERALTA did not own West 125th Street Liquors, and he had not been approved to be a distributor for the Restaurant Supply Company. Indeed, neither PERALTA nor West 125th Street Liquors ever supplied anything to the Restaurant Supply Company. PERALTA also provided vestor-1 with fake documentation on the Restaurant Supply Company’s letterhead, falsely representing that the Restaurant Supply Company would be electronically transferring PERALTA $1,826,350 within seven days.

Investor-1 provided PERALTA with more than $3.5 million over the course of the next year, a substantial portion of which was used to pay back other investors. Ultimately, PERALTA owed Investor-1 approximately $2 million. In all, PERALTA, who obtained approximately $12 million from investors, failed to pay back millions of dollars of that money.

 

 

We visited Bernie Madoff in prison. Madoff, a renowned stockbroker turned fraudster, lives in FCI Butner, a medium-security federal correctional institution in North Carolina. Madoff is serving a 150-year prison sentence for orchestrating the biggest Ponzi scheme in history.

Madoff told us: In hindsight, when I look back, it wasn’t as if I couldn’t have said no. It wasn’t like I was being blackmailed into doing something, or that I was afraid of getting caught doing it. I, sort of, you know, I sort of rationalized that what I was doing was OK, that it wasn’t going to hurt anybody.

Madoff exhibits several all-too-familiar cognitive biases, psychological tendencies that can lead to irrational behavior. We hear Madoff describe a multitude of common biases. They’re amplified—biases on steroids, in Madoff’s case. But they’re biases that we all have, that we all experience.

Ambition: Madoff describes his ambition, which is something that every person aspiring to be successful in business—can relate to.

Overconfidence: “I built my confidence up to a level where I…felt that…there was nothing that…I couldn’t attain,” Madoff told us. The “slippery slope” that enables a small transgression to grow into a bigger one: “I started to go off the tracks, and I was able to convince myself that this was, you know, a temporary situation,” Madoff said.

Lack of self-control: “I…probably…just didn’t give it enough thought or wasn’t frightened enough…to say to myself, I can’t, you know, I can’t do this, I can’t take the risk,” Madoff told us.

Rationalization of iffy decisions: The piece that’s most humbling in the recording is the realization of rationalization. Madoff recognizes now that it was all rationalization.

Once our readers recognize that this is a smart guy, and he didn’t need to do what he did, but he still did it anyway, there is a degree of humility in the venitism blog. Madoff is an extreme case in many ways, but in other ways, he is just someone who fell prey to biases and the tendency to rationalize.

It’s especially important for budding entrepreneurs to appreciate the link between Madoff’s ambition and his slippery slope to infamy. While Madoff possesses an extraordinary lack of empathy for his victims, he didn’t explicitly set out to commit the crime of the century.

Madoff is respected in prison because it looks like he was the mastermind of this extraordinary plan. But to say that he sat down and planned a two-decade, multibillion-dollar Ponzi scheme, that’s giving him too much credit as an individual financier, or even as a sinister deviant. He couldn’t have planned such a long-running and extraordinarily devastating fraud in advance even if he tried.

Madoff was once best known for pioneering the controversial but legal practice of payment for order flow, in which he would pay brokerage firms a couple of cents per share to send orders through his firm. This made him popular among investors, who previously had to pay brokers for the service of buying shares; now Madoff had turned the practice upside down and was paying them to trade.

That innovation diverted trading away from the New York Stock Exchange floor, and by the early 1990s, Madoff’s firm was handling upwards of 10 percent of all NYSE-listed stock trading. Outside his brokerage business though, in his growing investment management practice, Madoff started to feel greater strain in generating profits.

He began naked shorting to clients. Another controversial but legal practice, this involved short-selling a stock without first borrowing the security, and then acquiring the security after the sale. But then he started conducting short sales without putting them on the books, which is illegal. Eventually he stopped trading altogether, once he realized he couldn’t generate the profits he continued to promise his investors. A few steps down the slippery slope later, he was running a Ponzi scheme.

“It’s like a comedy of errors,” Madoff told us. “I allowed myself—and I really have to say ‘allowed,’ since no one put a gun to my head—to keep taking in more money. I kept on waiting for the environment to change and of course it never did. It turned into a total fiasco.”

It’s a mundane series of errors, one leading to another, which grew into something of remarkable proportions. Even as famous white-collar criminals go, Madoff is an outlier, both in the size of his crime and in its longevity. But it’s important to appreciate the slippery slope of small crimes often becoming bigger ones, especially in today’s entrepreneurial culture, which tends to accept and even glorify bending the law a little.

Within entrepreneurial cultures, there’s often a feeling that it’s OK to ignore or bend some regulation. Sometimes regulations are legitimately outdated or potentially too restrictive to let innovation flourish. But the challenge for entrepreneurs is that the line between appropriate and illicit is often quite murky.

Case in point, the ride-hailing company Uber, which is thriving in spite of pushing legal boundaries—and fighting its case in court—in cities all over the world. In some places Uber is hailed as a brilliant company, and in other places its executives are convicted criminals. Many well-respected entrepreneurs, from Michael Dell to Steve Jobs, have faced their own allegations of wrongdoing, but still managed to build remarkable enterprises. At the same time, many white-collar criminals also break rules in the process of believing they are on the cusp of doing something great. Navigating the fine line of which regulations might be legitimately broken and which cannot is sometimes difficult. But understanding this distinction is critical for entrepreneurs who want to operate on the most innovative frontiers of business. Entrepreneurs who are trying hard to make their mark often need to be aggressive. This sometimes leads to successful businesses like Uber or Airbnb, and other times it leads to terrible failures like Enron.

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