Tales of Charlatans & Chagrin

People love stories and the delivery of a good investment narrative by a skilled and charismatic storyteller is powerful. However, listening to and buying the wrong stories can be very expensive. We’ve previously heard from The Narrator who gets paid for their story and The Sales Advisor who uses stories to sell products. This week, we’ll hear from The Charlatan. Their stories can be the most expensive. Beneath the veneer, they are selling a Ponzi scheme or other scam using trust and greed to bypass our defenses. Total loss is the most common outcome.

Before you scoff and claim that it would never be you, know that these stories take in people from all walks of life. Less financially sophisticated people may not recognize the danger. Financially sophisticated people are juicy targets because they have money and are often looking for new ways to invest. Greed and trust are the weapons used by The Charlaton. You may not hear about these tragic tales from the individual victims because they are embarrassing. However, I will tell you a few today to help you avoid The Charlatan and the chagrin that follows.

Charlatan: Psst! Over here. I have a special business opportunity for you.

You: Why are you standing over there in the shadows?

Charlatan: Because I don’t want to get stampeded and I can only let a few special people in on this. Special people like you.

You: Really? You think I’m special?

Charlatan: Yes, you’ve worked hard to get where you are. You’re obviously smart and astute. You have the financial strength and commitment to see this opportunity through to a wildly profitable success. If you can do that, it is a sure thing, but most people don’t have those qualities. [Charlatan’s inside voice]: You have money.

You: That’s right. I am smart enough to know that “it is priced in”. Risk and return are related. If it is a free lunch, why isn’t everyone doing it? Especially The Loonie Doctor. He runs for a free lunch.

Charlatan [stepping out of the shadows]: Ah, but you can trust me. Look at my nice suit and other trappings of success. We have a lot in common. Trust me. I’m a doctor.

You: Oh, I didn’t recognize you. [You still don’t but are too embarrassed to admit it]. Wait, you’re the guy in The Loonie Doctor post with the outdated suit and funny hat.

Charlatan [slips back into the shadows]

Who is the Charlatan?

The charlatan has all of the wits, charm, and charisma of The Narrator. Like The Sales Advisor, they get paid to sell you stuff. Not just the story. Most commonly, it is paying them for a share in some sort of business or investment venture.

There is a component of deception at play. In the case of The Charlatan, it is a deliberate active deception, like in a Ponzi scheme. Well-intended deception, by omission or ignorance, is technically the realm of the Kook. We’ll visit some Kooky friends or relatives in another post.

The Tales They Tell

The deception or omission usually results in the storyteller focusing on only part of the story.

The pitch may sound sophisticated and clever, as if they possess knowledge or access to options only the elite use. However, they also commonly skimp on stating the details, risks, and alternatives. If you press for details, you may be met with responses about it being an innovative proprietary secret investing formula.

At the other end of the spectrum, the story may also be overly simplistic. The certainty of success is made obvious. However, like the sophisticated version, that simplistic formula omits important details and risks.

Greed & Trust Are Their Tools

There is often tangible money lost to these gossamer webs of deceit. Whether that is a small amount from someone who has little. Or hundreds of thousands of dollars lost by those with more. So, why do people expose themselves to that danger? The stakes are high. So, you would think they would skeptically exercise their due diligence in full force.

Unfortunately, that rational approach is often undermined by powerful emotions. Greed is one of them. Eye-popping returns appeal to that and soften our alertness to danger. The Charlatan commonly adds a sense of urgency. If you don’t commit to the investment quickly, then you will miss out. Fear of missing out is also powerful.

Trust is the other human factor at play. Generally, humans want to trust others and be trusted. It is an integral part of our lives as professionals and members of society. Perhaps, that makes us and others in intimate professional roles even more susceptible. We are used to interacting with trustworthy colleagues, and being trusted by others. We crave that, and it is normally justified.

The Personal Touch

The Charlatan abuses our propensity to trust and often wears the guise of a trusted authority figure – like a doctor of some type, law enforcement professional, religious figure, or an official-sounding financial title. The especially unsavory charlatans will even appeal to those within their social or professional network. Leverage those relationships and trust from other interactions.

The above could describe a relative or other well-intentioned person trying to draw you into a business relationship. Again, if their intentions are good and they are simply ignorant, they are a Kook. Unfortunately, the financial implications are the same. Plus, there are major relationship hazards, in addition to the financial risk. What sets The Charlatan apart is their deliberate deception. A classic example is the Ponzi scheme.

Most people have heard of a Ponzi scheme and know that they are a type of fraudulent crime. However, understanding how they work can better prepare you to avoid them. They can be insidious and even those caught in one may have difficulty recognizing it. Embarrassment is another powerful force that keeps charlatans in business.

In a Ponzi scheme, The Charlatan collects money from investors for some fictional or misrepresented business venture. As more investors are recruited, their capital injections are used to pay existing investors. The robbing of Peter to pay Paul is disguised as the promised return on investment. Eventually, the scheme unravels when it runs out of new cash injections. Occasionally, someone uncovers the disconnect between the return and investments before then.

There are plenty of famous Ponzi schemes to draw examples from. However, I will tell a couple of particularly embarrassing stories that sucked in professionals. That will hopefully remove chagrin from the equation for the rest of us.

Charlie Munger and Warren Buffet are two of the most celebrated investors of all time. For good reasons. However, even a company in their conglomerate has gotten sucked into a Ponzi scheme. Along with numerous other well-run companies. The point of this tale is that if it can happen to them, it can happen to anyone.

Sophisticated scams can actually have a legitimate product or service underpinning it. However, aspects of the business may be misrepresented to draw in more investors. As long as new investors inject cash, the shortfall of the business model is covered up.

The full story of DC Solar is fascinating. They were a company that leased out solar generators. So, there was a tangible product and customers. Plus, the product was given more of a halo because solar power should be better for the planet. In retrospect, there may have been a caution flag waving in that they were major sponsors of NASCAR. One of the world’s most carbon-emission-intensive sports.

Overall, they projected themselves as trusted authority figures and an All-American Success Story. There was even an American flag painted on the side of their factory.

The Desire to Trust & Lures Can Be Subtle

It seems unlikely to me that the famous leaders of Berkshire Hathaway were directly involved. It is a massive conglomerate. However, it was a major company owned by Bershire Hathaway that got taken in. Still, Warren had stated his feelings about solar before. So, the leaders of Geico, their insurance company may have wanted to trust the deal.

“If somebody walks in with a solar project tomorrow and it takes a billion dollars or it takes $3 billion, we’re ready to do it.. There’s no specific preference between the two.. And the more the better.”

Warren Buffet, 2017 Berkshire Hathaway Shareholder’s Meeting

Still, they are not fools. They are serious diligent investors. The head of Geico questioned DC Solar on some of the details. DC Solar’s CFO obligingly provided a report with fictitious leases and revenues. The lure to take the deal was also sweetened by the tax credits that came with it. A strategy that Berkshire has used often. The $1.2 billion dollar deal would save them hundreds of thousands of dollars in taxes.

There were many banks and other major investors that were unknowingly involved with this Ponzi scheme, including the largest investor in North America. The US Government.

The US Treasury Fed the Scheme

DC Solar not only got Geico and major companies as clients, but they also bilked the US Government. Sucking green tax credits from the US Treasury to help pay investors as part of the Ponzi. The US Government and new investors kept payments going to the earlier investors.

Under the surface, there were not nearly enough solar generators being placed compared to the claims for tax credits. As the scheme started to unravel around the edges, DC Solar used another classic Ponzi move. When asked to allow a physical counting of generators, they appealed to fake authority. They provided detailed “commissioning inspection reports” of solar generators by an “independent engineer”.

The Unravelling

The IRS started denying tax credits to the companies buying into the Ponzi scheme. They correctly identified it as just money moving around without a product. Those companies were left holding the bag. Still, that didn’t collapse the Ponzi right away because IRS audits are confidential. The chief Charlatans of DC Solar were still constantly cooking up new schemes. One of their senior employees actually referred to the founder, Carpoff, as “Willy Wonka”.

Eventually, more employees noticed that the number of products they were producing and the astronomical amounts of revenue claimed were not matching up. An investigation led to the key players fleeing with millions in off-shore accounts and FBI sting operations.

The DC Solar fiasco had a tangible product and the disconnect between the physical evidence and the money is what eventually shed daylight on the fraud. Unfortunately, there are plenty of intangible products or services out there. That makes them even more susceptible to fraud and Ponzi schemes.

Cryptocurrencies only exist electronically and rely on people’s belief in their value to give them value. Just like the Emperor’s belief in the value of his expensive robes. That makes them the perfect candidate for multiple scams. Crypto Ponzi schemes extracted at least $7 billion dollars in 2022. Many multiples of the DC Solar case.

Cryptocoin Disappearing Tricks

The OneCoin fiasco is a good example of a pyramid scheme. It brought in $4 billion dollars during the early days of crypto. Like the real money, the man behind the scam also disappeared. His partner is in jail, but the money is still gone. On the crypto front, there actually was no blockchain. They did have an e-wallet and claimed that coins could be used for transactions like other cryptocurrencies.

However, what the scheme centered around was a multi-level marketing pyramid. To mine their coin, you bought tokens that gave access. The “mining” actually took place on their internal servers rather than a de-fi approach like blockchain.

To access their “crypto marketplace” you had to buy a higher level of their educational material. Ponzi schemes rely on new money to pay earlier investors. So, new levels of access are used to draw in new money. You also got incentives for recruiting new investors. That is what makes it a pyramid.

There are other ways that scammers have jumped on the cryptocurrency bandwagon. For example, Bitconnect allowed you to exchange a Bitcoin for their digital currency and invest it to earn 1%/day interest. That obviously unrealistic return is a red-flag tactic. The Charlatan uses greed to blast through the walls of logic.

As blockchain and cryptocurrencies evolve, the scams will too. An unregulated financial industry and an intangible asset are fertile ground, as the recent FTX crypto exchange scandal showed. I can’t even understand all of the techniques used by these recent scammers. Having the humility to admit that you don’t understand an investment is the first part to avoid getting taken in by The Chalatan. The embarrassment of admitting ignorance is less than the chagrin that follows in the wake of a tragic Charlatan’s tale.

Admitting ignorance and not investing in something that you don’t understand is the first part of avoiding Ponzi schemes and other Charlatan Tales. Understanding asset pricing and how markets work to know that risk and return are “priced in” is the next step. If it sounds too good to be true, then there is either fraud or unrecognized risk.

That understanding of markets and obtaining information from truly trustworthy sources is at the core of recognizing and avoiding Ponzi schemes. The Rational Reminder discussed this topic briefly. Hopefully, you consider my blog another trustworthy source. If not, the SEC has also published red flags to be aware of.

Ponzi Scheme Identifying Features

In a Ponzi scheme and other scams, the storyteller exhibits characteristics of The Charlatan. It usually centers around the leader’s charisma rather than a licensed and registered firm with registered investments. Registration requires access to information about management, products, services, and financial statements. To hide that deficit, Ponzi schemes will claim to use complex and secretive strategies. When you try to dig deeper, there may be errors in the documentation provided. Finally, a Ponzi scheme relies on having enough bums in seats and recruiting more. So, there will be barriers to exiting and incentives to stay. A pyramid scheme even gives incentives for the participants to recruit more victims.

If you re-read the stories that I just told, you will recognize many of these features in them. Those features and the tips to avoid them apply to a wide range of scams that The Charlatan may employ. Hopefully, my storytelling today will help you to steer clear of becoming a character in the tragic tales of Charlatans that will come your way. And the chagrin that will eventually follow if you do buy their expensive stories.

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