THE “grand” part of the title of this riveting book needs perspective. The investment scam the book meticulously describes is conservatively estimated to have been in the order of R12.5bn – that is 12.5 thousand million rand (say that very slowly).
To get a sense of the enormity of this number, no human being is capable of counting to one billion in a single lifetime, even if he never slept and just kept counting. If you could count one number in one second (which you cannot if the number is 9 722 842,) it would take you almost 32 years to count to one billion. This scam was in excess of R12bn.
Some background: Charles Ponzi, an Italian, landed in Boston in 1903 with $2.50 in cash. He died in poverty in a charity hospital in Rio de Janeiro, but he left a legacy – the Ponzi scheme.
Desperate to get rich, Ponzi discovered that Italian prepaid stamps - the sort used to facilitate the return of mailed goods - sold at four times their price in the USA. So he sent for stock to sell in the USA, expecting profits of hundreds of percent. Unfortunately, it was much more complicated than he expected, but that did not stop him from telling others about his scheme and inviting them to invest with him.
He promised to double their money in 90 days, and they came in droves. Ponzi paid out the profits after 90 days, despite never having bought any prepaid stamps ever again.
How did he do it? He simply paid out investors with funds taken in from new investors. As long as investors got paid, there were many new investors excited to get an effective 1 500% per annum when interest rates elsewhere where 5%. Charles Ponzi lived in grandeur as money flowed into his fund.
The problem was the liability side of the balance sheet. Effectively, every 45 days the liability increased by 50% while Ponzi raided the asset side. It all had to end when investors could not be repaid because new investors could not be found fast enough. It ended in tragedy for all those left in the scheme, losing all their money and often their homes as well.
And so the Ponzi scheme was born.
Put simply, Barry Tannenbaum attracted investors to his scheme on the following grounds. There was a large demand for specific chemical ingredients that go into the manufacture of pharmaceuticals. The Tannenbaum family had been instrumental in the building of the renowned pharmaceutical company Adcock Ingram, and so Barry was totally familiar with the workings of the industry.
The investment opportunity was funding to purchase enormous quantities of some of the ingredients used, for example, in antiretroviral drugs. Prestigious companies such as Aspen placed orders for the chemicals that Tannenbaum imported from sources in countries like India, and paid for in cash.
These orders had enormous profit margins. With a confirmed order from a blue chip company, the only issue was funding the deal.
Tannenbaum chose not to go to banks for funding, but rather to offer the opportunity to share in the profits to friends and friends of friends, exclusively. Investors received returns in weeks that normally require years to achieve. He was able to show investors the orders and other documents attesting to the legitimacy of the investment.
He was even prepared at give post-dated cheques at times as guarantees against the investment.
Question: would you invest your life savings in a scheme that returned hundreds of percent per annum, when regulated investments only offer returns in single digits? Would you invest if the founder of the scheme knew the industry intimately and could take advantage of opportunities others had not seen?
Would you invest if there was documentation showing a purchase order? Would you invest if your friends had already invested and made startling returns? Would you invest if well-known South African business people were doing the same? Would you invest if you knew that a sovereign fund has chosen to invest millions of dollars?
Answer: many would. Many did.
How did something so right go so wrong? Simply put, the orders people where shown were fraudulent, none had been placed. The shipping documents were fraudulent, no shipping took place.
How could so many people be repaid the money they invested with whopping interest? Simply by getting more investors into the scheme, and paying existing investors with the new investors' money - a classic Ponzi scheme.
Ponzi schemes all have exponentially increasing liabilities and inadequate assets. The original Ponzi scheme had no business that generated income, and neither did Tannenbaum’s.
These schemes can only occur when five factors are in place.
The first is deceitful accounting, so that investors have every reason to believe that the affairs of the investment are being carefully controlled and that all is well.
The second factor is feeble regulators or regulations. The veil is not punctured, nor are the tell-tale signs read until it is too late. This was true in the cases of Charles Ponzi, Bernard Madoff and Barry Tannenbaum.
The third factor is a get-rich-quick culture, where the correlation between hard work and generous rewards has been broken. This leads people to believe that it is possible to make outrageous amounts of money without putting in the intelligence and hard work.
The fourth factor is the ignorance or laziness of investors. Consider a law firm that administers a trust fund on behalf of clients. Should they invest these funds in a project that generates uncommonly good returns for their clients?
I recall being told by a banker that he was approached by Madoff’s agents and offered the opportunity to invest. After a thorough investigation of what was “under the hood”, and concluding that they did not understand how Madoff made the money, they passed on the investment. The lawyers would not have been in a position to do such an evaluation. It is simply not their field of expertise.
The fifth factor is the capacity for self-delusion. Why would Barry Tannenbaum not go to banks for the money, especially after building up a track record of successes? Why would he share profits with strangers, when he could keep it all to himself? Why would large firms with clever procurement departments allow an intermediary to make huge profits that they could be making?
The book is a masterful account of a very complex web into which people were lured. Tannebaum could not do what he did alone, and he did not. The Grand Scam is a careful construction of how this awful project ruined the lives of many, including people who should have known better and people who could not have known better.
The author is an award-winning journalist who knows how to tell a story and keep the reader intrigued through all 300 pages.
Read this book, it is a cautionary tale. It will make you very pleased you use an authorised financial adviser, who has your investments in a regulated industry, and who carries indemnity insurance.
Readability: Light ---+- Serious
Insights: High -+--- Low
Practical: High ----+ Low
* Ian Mann of Gateways consults internationally on leadership and strategy. Views expressed are his own.