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How to spot the red flags of a Ponzi or pyramid scheme

Time has yet to heal the painful financial and emotional wounds inflicted on a victim of one of Canada's most notorious Ponzi fraudsters.

"It's five years ago now that it happened to us with Earl Jones and we're still feeling the effects," says Joey Davis, whose 84-year-old mother, Margaret, lost $200,000 of her retirement nest egg.

The Montreal man behind a $50-million scam that cost many people their life savings was recently released from prison after serving one-third of his 11-year sentence for defrauding 158 investors.

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Davis said it was devastating for his mother to lose 90 per cent of her life's savings, almost throwing her into "a survival mode of existence."

Like many others, she also endured the shock of having her trust broken by someone who had provided financial advice to her for 27 years.

"Of all the devastation affected I think, surprisingly, the money is the least shocking," he said in an interview.

Davis said such fraudulent schemes are more widespread than people think.

Ontario's securities regulator called it a global issue.

While several schemes have been unearthed across Canada, they pale to the activities of Bernie Madoff, the American poster boy for Ponzi schemes who is serving a 150-year sentence for losing nearly US$20-billion entrusted to him by thousands of investors, including charities and Hollywood actors.

"I do think that Madoff made people aware, but people, sadly, forget pretty quickly and also they don't see themselves necessarily being a potential victim," said Eleanor Farrell, director of the Office of the Investor at the Ontario Securities Commission.

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In addition to investigations, regulators across Canada are focused on prevention by educating investors to watch for red flags.

These include unsolicited calls/emails, the promise of high returns with little risk, high-pressure sales tactics, suggestions that a company is about to be listed on an exchange and encouragement to recruit family and friends.

One of the first things investors should do is check to see if the soliciting person or company is registered on a national data base, said Sylvain Théberge of Quebec's Autorité des marchés financiers.

"It's not 100 per cent protection but, if you have that reflex to call us, you will increase that level of protection," he said in an interview.

The challenge with Ponzi and pyramid schemes is that fraudsters like Jones and Madoff exploited the trust they built over a long period of time with the victims.

Both schemes fool investors with the promise of extraordinary returns, but are only self-sustaining as long as new money comes in to pay for outflows. Ponzis have a ring leader who promises a high level of return on an investment but merely transfers funds from one client to another. Pyramids provide returns based on recruiting new participants.

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Canada's two largest securities regulators couldn't provide an estimate for the size of the Ponzi and pyramid problem in this country, but a Florida attorney who specializes in securities crimes say they've robbed investors of US$50-billion over the past five years in the United States.

"They're very common now, unfortunately," said Jordan Maglich, who also publishes the blog ponzitracker.com.

"The government has used Madoff as a wake-up call and there's certainly a much larger priority given to investigating these things, but the reality is they're not discovered until the person runs out of money and the whole thing collapses," he said from Tampa.

Many of the most notorious frauds are Ponzi schemes. But a spotlight was recently shone on pyramids by hedge fund manager Bill Ackman of Pershing Square Capital.

The activist investor claims that clubs run by distributors of Herbalife, a weight loss and nutritional supplements company, focus on recruiting instead of selling products which is by definition a pyramid scheme.

Herbalife has vigorously denied Ackman's arguments, and says it operates a multi-level marketing company similar to Avon, Amway and Mary Kay.

The Securities and Exchange Commission, the Federal Trade Commission and the Attorneys General of New York and Illinois are investigating Herbalife, but no charges have been brought against the company.

Experts say the best way to avoid heartache is to be careful with your money and vigilant about who you trust.

They recommend that investors not shy away from asking questions, demand proof that the investments are held, including insisting that financial statements are sent directly from the source, not the investment adviser.

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