Author: Jessica Green
Financial Analyst
Jessica Green

The Biggest Financial Trading Scandals

Financial Trading Scandals

What a fascinating subject! So much so that some of the most notorious trading scams and scandals have been the basis for numerous documentaries and Hollywood films.

If you are a trader, it is almost a certainty that you will have heard of many (or all) of these already. Some date back many years, but there have been several in much more recent times that will possibly ring much bigger bells.

Similarly learning the history of your favourite trading tool, learning about the scams and scandals surrounding trading is also important. Not only are they good reading (or viewing), but are also worth knowing about to avoid falling into similar traps!

In this guide, you will learn:

  • About notorious scams and scandals
  • The info about how they were performed
  • How to avoid similar situations yourself

Charles Ponzi

Charles Ponzi

Here is a man whose name is synonymous with the word ‘scheme’. Charles Ponzi became notorious for his creation of a fraudulent investment opportunity back in 1919. Although he is long gone, his name lives on and is used routinely to describe all kinds of scam investments.

A Ponzi scheme offers investors extraordinarily high rates of return, with low risk to their initial investment. As new investors came on board, their financial input was used to pay profits or dividends to the original investors. In basic terms, it was a system of “robbing Peter to pay Paul”.

The very first ‘Ponzi Scheme’ took shape when Charles Ponzi saw an opportunity to exploit the US Mail international reply coupon service, whereby senders could include a coupon for return postage.

When purchased in certain countries, the cost of buying the vouchers was far less than the value of the stamps. Having spotted this, Ponzi hired agents to send bulk quantities back to him in the US and then sold the stamps.

It was only a small-time enterprise, but Ponzi was offering unrealistically high returns, that became the issue which led to his investigation and eventual demise.

Belfort defrauded investors out of around $200 million using a method colloquially known as “pump and dump”.

Enron

Enron

Enron was a US energy provider which regrettably and inadvertently found itself at the centre of a major trading scandal. Mismanagement and innovative, but premature, technologies caused the main issues for Enron.

In 1999 Enron formed an online collaboration which offering energy trading across the US with the intention of providing customers with better prices for their fuel. However, the trading grew out of all proportion, demand far exceeded supply and Enron were indeed out of their depth and actually in debt.

Desperation led to Enron ‘cooking the books’ and using sharp practices (instigated by its own Chief Financial Officer in collaboration with its accountancy practice) to make it appear that the company was still growing and making big profits, thus keeping shares at an artificially high price.

Inevitably, rumours that started inside Enron leaked out and in October 2001, the Securities and Exchange Commission launched a full enquiry into Enron’s financial position. The outcome was somewhat inevitable and Enron was obliged to declare its actual status, making its shares almost worthless and ultimately leading to bankruptcy.

Bernie Madoff

Bernie Madoff

Feeling dispirited and shunned by Wall Street, Bernie Madoff started to accept trades from small clients, which his stockbroker peers would have dismissed out of hand. Madoff later developed an electronic trading platform, which he claimed had “artificial intelligence capabilities” and his tiny business branched out rapidly.

Madoff was known as being both charismatic and believable. The opportunities he presented to potential investors appeared to be very respectable and have a low-risk level for the exceptionally high returns on offer. Madoff had created one of the biggest Ponzi schemes ever known which continued for almost 50 years.

The original clients Madoff attracted received the promised returns and anyone who elected to redeem had their investment repaid promptly. However, these payments did not come from company profits. Madoff had not invested any of the money he received; when he needed more, he merely acquired new investors.

From 1999, Madoff had been investigated sporadically by the Securities and Exchange Commission (SEC), but it was a few years later in 2005 that his scheme began to fall apart, when a financial analyst named Harry Markopolos launched something of a ‘vendetta’ against Madoff.

Unfortunately, this is not a story with a happy ending. In 2008, Bernie Madoff’s sons turned him over to the authorities, leading to a sentence totalling 150 years in prison. Many of his investors had lost their life savings and several committed suicide, as did Madoff’s eldest son.

Lehman Brothers

Lehman Brothers

At one time the fourth largest investment bank in the world, Lehman Brothers were a truly titanic enterprise and were considered to be equally as unsinkable as the famous ship.

Perhaps the epic (and relatively recent) collapse of Lehman Brothers is at best described as a scandal, at worst an event that caused global economic tidal waves. The way events turned out; it was much more the case that they were ‘playing ostrich’ and became victims of circumstance, rather than having an out and out intention to defraud.

The main scapegoat was Richard Fuld. It was he who led the way to the bank’s heavy involvement in selling mortgage securities, having observed the vast profits made by others. Eventually, his greed meant that Lehman Brothers owned thirty times more real estate than liquid capital.

What Fuld was ignoring, was the sheer number of sub-prime mortgages sold with low-interest starts. When the repayments rose, buyers could no longer afford them and there were numerous repossessions. A glut of property led to real estate losing value and the housing bubble burst, taking Lehman Brothers with it.

Jordan Belfort

Jordan Belfort

Possibly one of the most memorable scandals of recent times was centred on Jordan Belfort; a man who is best known as ‘The Wolf of Wall Street’. Belfort defrauded investors out of around $200 million using a method colloquially known as “pump and dump”.

In essence, Belfort’s business, Stratton Oakmont, was a legitimate brokerage. It would buy large amounts of cheap shares (penny stocks) and promote them heavily by releasing misleading statements as to their positive future potential and thus cause the stock prices to become artificially inflated (pumped).

His team of young brokers, known as “Strattonites” would then offer these shares using ‘hard sell’ tactics to unsuspecting investors. Once they took the bait and bought in at the high price, Belfort would sell (dump) his shares and they would return to their original low value.

The amount of money Jordan Belfort was making allowed him to live the ‘high life’ and he was less careful about covering his tracks. As a result, Stratton Oakmont became the subject of SEC investigations mid-way through the 1990s and Belfort himself was charged with fraud and banned from running any financial business.

Meet The Author
Jessica Green
Jessica Green
Financial Analyst

Jessica has written for us for 5 years and offers a unique perspective due to her having worked in the financial industry internationally. In fact, Jessica has worked in a staggering 8 countries including Germany, China and the USA. Learn more.

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