Mindy Jensen: Today’s episode is a bit different, and we wanted to give a warning that this episode deals with potentially distressing material dealing with suicide. This conversation may activate distressing feelings for you. If that’s the case, feel free to skip this one. Help is available at the Suicide and Crisis Lifeline by calling or texting 988. Today’s episode is about investment fraud and the steps you can take to ensure it doesn’t happen to you.
Scott Trench: Yeah, we’re going to talk to James Brandolino, convicted investment fraudster turned anti-fraud advocate. James is going to tell us about his own story, about how he found himself leading a fraud scheme, and about the warning signs of fraudulent investment activity that you should be looking out for.
Mindy Jensen: Hello, my dear listeners, and welcome to the BiggerPockets Money Podcast. My name is Mindy Jensen, and with me as always is my anti-fraud advocate co-host, Scott Trench.
Scott Trench: Thanks, Mindy. Great to be here with you. We’re going to have a serious intro today, and we’re going to tell everybody that we’re here to make financial independence less scary, less just for somebody else, to introduce you to every money story, because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting. And now let’s bring in James Brandolino.
Mindy Jensen: James Brandolino, welcome to the BiggerPockets Money Podcast. I’m so excited to talk to you today.
James Brandolino: Very excited as well. Thanks for inviting me, Scott and Mindy.
Mindy Jensen: James, on an early day in January 2011, you walked into the Chicago Dirksen Federal Building and turned yourself in.
Scott Trench: Why?
James Brandolino: So for 8 years, I ran a Ponzi scheme as a trader at the Chicago Board of Trade running a hedge fund. And during that period, there was never more than a day or two that went by that I didn’t think I could make the money back. Well, after 8 years and $3.8 million later, the realization came. I woke up one morning and said, you know, I’m not going to make it back. So I sold my condo and I gave all my possessions away and filed for bankruptcy, found an attorney, and walked into the U.S. Attorney’s Office, like you said, and said, this is who I am, this is what I did, please arrest me.
Scott Trench: Can you define what a Ponzi scheme is, just for those who, I think most people know it’s an inappropriate activity, but they don’t know the actual definition of it.
James Brandolino: Okay, so technically a Ponzi scheme, as everybody knows it, is robbing Peter to pay Paul. So an operator will be running a seemingly legitimate business where the business plan is dictating profits that they’re making. In a Ponzi scheme, there are no profits from legitimate trading or legitimate sales or legitimate business, or maybe a small portion. The profits are coming from new investors who are investing money, and that money is used to either show a lavish lifestyle, show success, and to pay investors dividends and returns on previous investments.
Scott Trench: Yep. So you’re taking the new money from investors and using that to spend on either your lifestyle or pay back the people who invested earlier. And that’s what— that’s illegal. And this has happened many times throughout history.
James Brandolino: It happens every day.
Scott Trench: Okay, great. So we’ve defined Ponzi scheme. Let’s start from the beginning. How do we set the stage where we got either, you know, got on the path to being into a Ponzi scheme?
James Brandolino: So I would say from the very beginning, I always wanted to be a trader on one of Chicago’s futures exchanges, the Board of Trade or the Mercantile Exchange. And it really started when I was at the end of my freshman year in high school with the release of the movie Trading Places with Eddie Murphy and Dan Aykroyd. And just that wild trading scene at the end when they’re trying to corner the frozen concentrated orange juice market, that really kind of got me excited about trading. And that’s really all I ever wanted to do. I ended up running a trading desk at a now defunct firm called MF Global. And while I was there, I designed a trading program that traded Treasury bonds, bond futures, mind you. And really at the end of ’99, I had been trading this for a few years, and I decided that I wanted to go out on my own and basically started a fund and became a member of the Board of Trade. And I was going to, you know, trade money and do really, really well. So in my case, it was really simple. When I became a member of the Board of Trade, before I even started trading for the fund, I was on the floor waiting for the IT department at the Board of Trade to come in and put in my phone line and all my internet stuff at the desk. And I’m kind of walking around, and I had more than a few positions on the floor. So I knew how it worked. And although I’m trading bonds, which is slightly less volatile than, say, the Dow Jones or the S&P indices, I was just mesmerized by how the orders coming in from big firms would move the Dow Jones futures market. And I’m thinking to myself, boy, if I could just make a few adjustments to my trading models, I could raise my 6.5%, 7% returns trading bonds to 9%, 10%, 11% trading S&Ps and Dow futures, you know, I’ll be a hero. And really, in a matter of probably a couple hours, I decided to do that. I went to my models, I made some changes, I did some quick backtesting, and within a week I started trading. So my first week of actually trading for the new fund, I was down about 3%.
Scott Trench: Well, let’s back up just one second here in the story. So you left your job and set this fund up. This was in, what year?
James Brandolino: So in June of ’99, I left MF Global and I started a small independent futures brokerage firm called Lloyd Lewis, in which I would be able to solicit customers as a broker for this system, kind of like the intermediate step between leaving my brokerage firm and starting the fund. I wanted to be able to kind of test it with real customers as a broker, which means I would only be able to charge commissions. I did that until the beginning of 2003. And then in February of 2003, that’s when I became a member of the Board of Trade and started the hedge fund. And during that 3-year period, I had a positive track record, which gave me the confidence to go out and start the fund.
Scott Trench: Awesome. So that’s super helpful here. You start a fund. Who are your investors, and what is your incentive structure in this fund?
James Brandolino: The incentive structure was standard 2 and 20. So 2% management fee of all the assets every year, and then 20% of profits. And that’s really why someone would start a hedge fund, because they want a piece of the action, right? So the more profits that you make for clients, the more money that you can grab for yourself. My clients really were my brokerage firm clients that I had for 3, 4 years, family, friends, friends of family. So everybody in my fund I knew personally.
Mindy Jensen: We’re taking a quick break. And when we’re back, we’ll hear about how a career at a futures brokerage turned into a multimillion-dollar fraud scheme.
Scott Trench: And we’re back. We’re talking to James Brandolino about the worst decision he made and how it led to him running an investment fraud scheme for 8 years. Awesome. And how much did you raise?
James Brandolino: $2 million.
Scott Trench: $2 million. Okay, so 2% of $2 million is $40,000 per year. That’s kind of like a base salary, right? That’s what a lot of these private equity or whatever— it’s a very standard commission model, 2 and 20, for incentivizing folks who manage capital. And that would be, hey, that’s your salary, and then you get 20% of the profits. So if you grow the $2 million to $4 million, you would get 20% of the $2 million in profits, which is really what motivates folks in this type of model. Is that right?
James Brandolino: Absolutely. The management fees just kind of keep the lights on, and maybe you’ll pay the rent and a few of the expenses. But where the big bonuses come in is on the incentive side, when you can make a profit and grab 20% of that profit.
Scott Trench: Awesome. This is super helpful context setting, because again, legitimate trading, making a good profit, track record established. We’re raising a fund, and not even— I would say even in 2003, a particularly large fund. This is a very standard-sized fund, probably happens every day with folks here. And it’s with folks, you know, who have grown to trust you over either a lifetime or over several years in the professional field. Is that right? All correct?
James Brandolino: Correct. Absolutely.
Scott Trench: Awesome. Well, let’s keep going. So what happens next?
James Brandolino: After the first week of trading, I’m down about 3%. In my documents, I had a clause that if I was down 3% at any point in the month, I would stop trading and begin trading the next month. So I had about two and a half weeks before the statements would be prepared and mailed out by a CPA firm that I had hired. And I’m thinking, what am I going to do? Yes, I know everybody and everybody likes me, but it’s my first month, I’m down 3%. A lot of people are going to pull their money out, and then what am I going to do now, right? And I was just kind of thinking of ways of how I’m going to address my initial set of investors. And I’m sitting in an office with a colleague of mine, and he’s on the phone, and I’m paging through maybe Institutional Investor magazine, and the light bulb goes off. I see an advertisement for hedge fund accounting software, and I’m thinking, here’s the answer. Let me buy this software and put everybody’s name into it, send statements for a month or two. I’ll get them, I’ll show a gain, I’ll get the money back. I mean, I’ve been trading for a long time, right? I’ve been trading since college, so I’ve been trading for a long time. I can make 3% back, no problem at all. And that’s what I did. I sent false statements out that first month, thinking that I could make funds back. And so we’re looking at -3%, -5%, -10%, -20%, and so on. So that was really stage one of the fraud. That lasted for about a year and a half. Stage two comes in when I’m running a little bit low on money, and I’m thinking, well, I’m a sales introvert, I didn’t want to go to my clients and ask them for more money. So what do I do? I liquidate my 401(k), my insurance policy, get a home equity line of credit, and throw my personal net worth into the fund. And that lasted probably almost another year and a half. So now we’re at the 3-year mark. And up to this point, it’s civil crime — it’s making false statements, sending false statements in the mail. But I’ve not taken a penny. All of the trading was legitimate, and all the losses were legitimate. And it just happened to be, I’m really thinking of how am I going to get in front of everybody and let everybody know? And are they going to go to the authorities? And they probably will. And okay, it is what it is. And I get a phone call from a random individual who is a friend of one of my bigger clients, who wants to invest, and he decides to write a check for $500,000. And I’m thinking, well, here we go. Now I’ve got like no money to live on. Now I can at least take a small amount— illegitimately, of course— I can take money from the fund and pay business expenses. And I can also hire other people to help me fix my models and make this work. Really, from year 3 is really where the criminal side of the fraud began, from year 3 to year 8.
Scott Trench: Let me just make sure I’ve got this right. We start the fund in 2003, we immediately, first month, have a small loss, nothing that would have potentially set off any flags at all, although it’s a point of pride and ego, right? I started this thing off and couldn’t get there. Then that starts the first small lie, which compounds over the course of the next year, but the next 3 years, sorry, to this point where it’s about— we’re about to hear the next stage in the story. And during that period, looking back, was it possible? Would it have been possible for you to just have a big month that eliminated all of the problems? Would that have been— do you think a lot of that— some portion of people who start down that path get saved by that miraculous month, or was it never going to happen?
James Brandolino: Absolutely. I mean, even, you know, I had losing months that were greater than 3% when I was managing the money as a broker, right? We had 4% and 5% losing months, not many of them. And then the market would turn around, and we’d have a couple decent months, and then back to kind of normal. And we’d stay on track. So to answer your question, yes, I could have made it back. I was just so darn afraid, Scott, in terms of, what’s everybody going to say? Are they going to pull their money out? Am I going to have to close the fund? I spent at that time probably $15,000, $20,000 just on legal expenses to get all the documents done, etc. What am I going to do?
Scott Trench: Well, let’s pick it up. What happens in 2006 or thereabouts, 3 years in?
James Brandolino: So that’s really the point when I started to embezzle money to live on and to pay for business expenses. And that’s where the criminal side started. And what’s interesting, and not just in my case but in many cases of investment fraud, most cases of investment fraud don’t begin as investment fraud, right? Most people don’t wake up one day and say, you know what, I want to steal $5, $10, $20, $100 million. And they get paperwork and they start a website and they open up a bank account and they go and raise all this money. And then as soon as the phone rings or somebody knocks on the door, they’ve got the corporate jet ready to go to Brazil or wherever they’re going to go to hide from the authorities.
Scott Trench: I think what’s really interesting psychologically is, hey, the first 3% loss, it’s not acceptable, but you can empathize with, ah, I wanted, I can make it back and prove that out, right? And that lesson learned here is never go down that first step ever, because everything else is a derivative of that first month’s decision really and the path that that puts you on here. But what— you said at some point there was a clear movement into criminal with embezzlement. What psychologically kind of went through your head, or what was the moment at that point? Did you realize it and know that you were crossing that— whatever the step was here, this was way beyond the line that anyone would find acceptable? What was going on in your head at that point?
James Brandolino: Well, you know, at that point I didn’t understand probably the definition of civil and criminal, but I knew that after I deposited that $500,000 check and probably took $10,000 and moved it over to my personal account, that that was changing the game, because now there was a loss not just with trading, but there was a loss that I was actually using client funds for business and personal expenses.
Mindy Jensen: How did you cope with it personally?
James Brandolino: I think, myself personally, I compartmentalized what I was doing. And even though I absolutely knew what I was doing was wrong — I mean, there’s no doubt about it at all — I just really tried to focus on, you know, I’m making the money back. And that’s what I just kept telling myself. I can make this money back. I know I can make it back. And it never happened, but that was my mindset because we’re going into 2008, 2009, 2010.
Mindy Jensen: I mean, I remember that time period in the market, and the market just kept going down, down, down, down, down.
James Brandolino: Well, it was getting crushed. And don’t forget, December of 2008 is when the Madoff scandal broke. And I can remember sitting in the Ceres Café, which is inside the lobby of the Board of Trade, and Rick Santelli, who was the CNBC rock star commentator from the bond pit at the Board of Trade, he was holding court with a bunch of traders and just kind of went on this rant. Yeah, this is really serious, and this happened, and a lot of people lost a lot of money. But the only benefit that we’re going to see is that we’re going to learn what causes investment fraud, and the SEC and the media are going to kind of partner up and make sure this doesn’t happen again. Which, of course, unfortunately couldn’t be further from the truth. But I had clients who probably got a little bit nervous, who would call a little bit more often. Hey, can we come down and see you? Or hey, can you clarify this on your statements? And all that kind of stuff. And yeah, it was a little bit more nerve-wracking for me, but they just didn’t ask the right questions. And when they asked the right questions, they just didn’t know how to prove what I was saying, if it was right or if it was wrong. And I would say that’s probably, in terms of investors who are looking at investments, some can ask the right questions, and some will get the documents and the marketing literature and they’ll read it, but they won’t quite understand what’s there or what’s missing. And when they read it, they just have no way to align with what the company should be doing versus are they doing what they say they’re doing. And that’s the key right there.
Scott Trench: What did most of your clients think was happening during this period?
James Brandolino: I mean, they thought we were doing 1.5% to 2%, 2.5% per month trading futures.
Scott Trench: Did you ever show them a loss?
James Brandolino: I think I had probably maybe 6 or 7 losses in that 0.5% to maybe 1.25%, but nothing really major.
Mindy Jensen: So 2008, Bernie Madoff happens. Essentially, you are doing the same thing, similar thing, but on a smaller scale. You waited 3 years to turn yourself in. What made that— what led to that decision?
James Brandolino: It’s interesting, you know, I wake up one Sunday morning and I’m standing on the balcony. This is probably November of 2010, and I’m standing on my balcony looking downtown Chicago, and I’m like, you know, I’m never gonna make this back. It’s been, you know, it’s only, you know, $3.8 million. Not that that’s not a lot of money when looking at other types of fraud, but, you know, I’m not going to make it back. I’m just done. And I could have raised more money, and I just, I was just tired and just done with everything. Tired of the lying and the charades and the whole thing. I said, you know what, I’m going to turn myself in.
Mindy Jensen: Yeah. In terms of the Bernie Madoff scandal, that was $20 billion in cash losses and $65 billion in paper losses. So I can see from your point of view, oh, it’s only $3 million. It’s not nearly so bad.
James Brandolino: Right.
Scott Trench: So, but yeah, it was $3.8 million that you raised in its entirety. What did investors think the pile had grown to?
James Brandolino: That number, probably a couple hundred million with— and that’s with new money coming out as well, or new money being invested as well.
Scott Trench: So investors thought they had a couple hundred million dollars with you that you had grown over 8 years?
James Brandolino: Correct.
Scott Trench: But you had really lost most of $3.8 million or all of $3.8 million, is that right?
James Brandolino: Correct.
Scott Trench: How much did you have left in the coffers by the time you turned yourself in?
James Brandolino: $25 grand.
Scott Trench: Wow.
Scott Trench: And so what happens next? How does the— you turn yourself in, you’re charged, what judicial, civil items come up, and how does this progress from here?
James Brandolino: I hadn’t the slightest idea what to expect. And, you know, I went to an attorney, and the attorney is like, you know, don’t turn yourself in, you don’t want to do that. He really discouraged me from doing so. And I’m like, well, it’s only me. There’s no other conspirators to this crime. He goes, look, there’s no benefit to what you’re going to do here. So he goes, why don’t you just go to California, learn how to surf, and we’ll watch the federal and state internet filings. And if your name comes up, we’ll give you a call. And you won’t have to even go to court for probably 2, 3 years, maybe a little bit longer. Wow. And I’m thinking to myself, well, why the heck would I wait so long to do that? And he goes, well, do you know anybody who’s committing a crime on the floor? I go, well, of course, you know, all the floor traders and all the tricks that they do to steal money from customers. That’s really, really difficult to find. He goes, maybe we can go to the U.S. Attorney and, you know, you could be a mole. You could wear a wire and try to— he didn’t use the word entrap, but that’s basically kind of what it would be, entrapping others doing other crimes. And I’m like, you know, no, let’s just do it. So he actually went on vacation for a couple of weeks. This is getting closer to Christmas. And I really had a mental breakdown, and I decided that I was going to end it. So what I did was I went to a firearm store outside of the city of Chicago and purchased a firearm and basically attempted suicide on January 4th, 2011. And the firearm did not go off, and it locked on me. And that’s what saved my life. And then as I went back to my condo, I talked to my attorney, and he’s like, oh, I can see you’re serious. I’ll call the U.S. Attorney’s Office and try to find the best of the worst. And 2 days later, I’m sitting with the U.S. Attorney and with the FBI, and I basically tell them, this is what I did, this is how I did it, and here’s all my clients. And, you know, where do we go from here?
Mindy Jensen: Wow.
Scott Trench: This is a really, really powerful story. Thank you for sharing all of this. What happens next? You talk to the attorneys, the Attorney General, talking all this. What are the mechanics of how things transpire from there?
James Brandolino: It was one count of mail fraud, sending fictitious financial statements in the mail. With the federal system, it’s a little bit different than the state system. So in that charge, the money, it’s like a point system, right? So besides your charge, because I had over 50 victims, there was extra points for that. Because, depending upon the loss amount, you get extra points for that. So I received a sentence. My range was 8 to 10 years, and I received 9 years, a 9-year sentence. And then I am obligated to pay restitution every month that goes into a victim fund.
Scott Trench: Okay. And then how much of that sentence did you actually spend in jail before being released?
James Brandolino: I served 6 and a half years.
Scott Trench: 6 and a half years in prison before being released. And you got out at what point?
James Brandolino: I got out at the end of June of 2017.
Scott Trench: Okay. So June 2017, and I understand that you decided to start studying other fraud cases and speaking to other fraudsters in prison, and you have since made identifying, preventing, prosecuting—some combination of those things—your profession, starting in prison and then following prison. Can you tell us a little bit about that?
James Brandolino: Yeah. Well, you know, probably early on, I think everyone thinks, what am I going to do when I get out? And I had no other skill set. I didn’t know how to lay brick or pour concrete or drive a truck or anything like that. What am I going to do? And I really kind of decided, well, maybe there’s an avenue that I can take to help prevent fraud. And as I spoke to dozens and dozens of other financial fraudsters, and my family spent a lot of money sending me forensic accounting textbooks and fraud examination textbooks that I kind of devoured, the more I studied the red flags, they’re all the same. And they were the same back in the ’40s, ’50s, and ’60s as they were in the ’70s and ’80s as they were for my case in the 2000s. And nothing has really changed. So my whole mission became that I was going to tell my story, but really kind of share the dozens and dozens of red flags that are out there that fraudsters use that really hasn’t changed in a long, long time.
Mindy Jensen: All right.
Scott Trench: We’re taking a quick ad break. And when we’re back, James Brandolino will break down the telltale warning signs of fraudulent investment activity.
Mindy Jensen: Welcome back. We’re talking to James Brandolino about if and how you can prevent investment fraud from happening to you.
Scott Trench: What was the eureka moment where you kind of began settling on some of these? And can you tell us what those red flags are?
James Brandolino: Sure. So I would say, not sure if it was a eureka moment so much as just, as I was speaking to a lot of the financial fraudsters that I was incarcerated with, they’re saying all the same things. I would say probably some of the top ones are audits. So in my case, probably 3 months after I started my fund, 3 months into my fraud, so to speak, I get a phone call from one of my parents’ good friends who invested $100,000 with me. Hey Jimmy, a couple of us are looking for audited financials. Do you have those, and can you send them over? It’s like, yeah, yeah, I’ll take care of it for you, not a problem. And it was a matter of, God, what am I going to do? So I go to Google, hedge fund audit PDF, and try to find a hedge fund that was similar to mine and basically kind of copied it almost word for word and came up with a phony accounting firm. Did a website for a phony accounting firm with a New York address that nobody ever mailed anything to, or ever called the number that was listed on there. There were so many mistakes in that audit that if my investors didn’t notice it, which they probably wouldn’t, their CPAs, who I know looked at them, should have easily recognized the red flags of the mistakes I made because I wasn’t, you know, a CPA. So that would be number one. Next, 3, 4 days after the beginning of the year, starting in 2004, I get a call from one of my investors. Hey Jimmy, when is your accounting firm going to send the tax documents? We want to start doing our taxes. And I’m thinking, oh boy, this is it, I’m done, right? I mean, what am I going to do? There’s no way. I got this fraud going on, and okay, we’re a year into it, I’m maybe down, you know, 20%, 25%, whatever it was at that time, you know, I could make it back, but there’s no way I’m going to commit tax fraud, right? And what am I going to do? So I kind of just came up with this lie that, you know, well, with hedge funds, you don’t pay tax until you pull the money out. And not only did they believe it, but I had, probably over the 8 years, probably 12 to 15 conversations with their attorneys or CPAs talking about that, and nobody ever, ever, ever questioned it. I mean, I had to do a lot of dancing when I was explaining it to them, but nobody ever called one of their colleagues who worked with hedge funds to say, hey, is this right, is this true, and just never verified what I was doing. Another thing—so I was always very open and transparent about people wanting to come and visit me on the trading floor. And I had a newer client who was with me 3 months come, and he came with his CPA. And he says, you know, we’d like to see your trading for these first 3 months. I’m like, okay, no problem. So I’m thinking, well, is he gonna— is he smart enough to know the futures business? And I’ll give you an example of what happened. So I pulled the first 3 months from my file cabinet of all the trades that I did, and my office was inside of the brokerage firm, my clearing firm at the Board of Trade. We walked to the back office, and I said, hey, this is a CPA, he’s with my client here. Pull the 3 trades, or the 3 months of trading that I did, that you got from the Board of Trade. And they pulled all 3 monthly statements, and they all matched. And the CPA was like, oh yeah, this is fine. If the CPA had any knowledge of futures trading, he would have realized that the size that I was trading, or the amount of contracts that I was trading, was probably commensurate if I was trading a $10 million fund versus, you know, at that time I probably said I had a $50 million fund. So if he were to look at it, as a fraud examiner, I would have said, wow, this is— you’re not really trading very much, you’re trading really very light. But him not being familiar with the futures market and how it operates, he had no idea to say that. So it’s just amazing. And those are 3 of just the bigger ones that are out there.
Scott Trench: As a layperson coming into this, you know, things that I’ve seen from documentaries and other stuff, like, you think, okay, these guys, they show super smooth returns. Like that was one of the things in the Bernie Madoff Netflix documentary, right? Like the people were challenging him because it was like, wow, the tightness of the return relative to the risk profile of these returns, compounded over a really long period of time, is just absolutely bonkers. And nobody ever will— it’s just math, it’s almost mathematically impossible to get something that smooth. It sounds like your returns were similar to that, right? Always within a narrow band, only a few months showing losses. Is that another red flag or common theme in a lot of these?
James Brandolino: So yeah, my returns weren’t quite as streamlined as Madoff’s were, but overall they were, yes, they were definitely outside of the ordinary. And in some of the red flag reports that I do, I’ll look at a time series of all the returns that are being projected and try to find other benchmarks and just try to show that there are certain mathematical rules that will show anomalies in numbers when they are construed. Right? So if I’m picking— so every month I picked out a rate of return. So let’s say this month we’re going to make 1.24%. And next month we’re going to make 1.63%, and the next month we’re going to be down 0.74%. So when you’re picking your monthly returns that way, there are certain mathematical clues that we can pull out that will— won’t show fraud, but it’ll show they were construed, right? And I’ve done those with my numbers and with Madoff’s numbers, and it’s just amazing to see people who fudge numbers, how easy it is to see that. But yeah, you’re right. Now, there are big hedge funds out there, and I’m not going to mention names, that have been around for a long time that are doing 20%, 30%, 40% a year, and sometimes even more. But they’re going to have volatility. They’re going to have your 5%, 8% winners for the month, and then they’re going to have, you know, 5%, 8%, 10% losses monthly. So it’s going to average out. But when you don’t have that downward volatility, and, you know, it’s really like you just said, it’s risk-adjusted returns. For this return, how much risk am I taking? And when your risk that you’re taking on your numbers is so much less than which you can get anywhere else, something’s probably amiss.
Scott Trench: It also seems to me, as a layperson, that this—yeah, let me open my books to you, here’s the statements, here’s all that stuff in real time—is almost like too much. And when someone is giving you that much openness, and coming out with that, there’s like a little bit of a red flag that should be going off to some degree. Like, yeah, look, I’ll prove that I did this, you know, around that. Like, no one asked you for that. Or, if there’s something remarkable and then an over-eagerness to share in the name of transparency, it’s almost like a red flag. It comes across as disingenuous, in a few instances in my career where that’s happened, right? Let me prove I do all these things. The second is this total lack of transparency, like what I think Madoff did, where there was just nothing that they really got besides the statements. I guess that wasn’t— maybe he was more in the first category. But are those two items to look for as well? Again, I’m not an expert on this, I’m just spewing things that I’ve picked up from documentaries and stuff.
James Brandolino: So with Madoff, it’s a little bit easier only because, you know, he would never— clients would ask for an audit, and he would never show it to them. “Well, I don’t want Goldman Sachs to find out what I’m doing and reverse engineer what I’m doing.” But here’s the thing about an audit—an audit is not going to give away any trade secrets, right? And having transparency in a back office, and how you do things, and how you process trades, and how you do statements—that’s not giving any secrets away in terms of how you’re actually picking which stocks to buy or sell, right? Or which properties to buy or sell. A back office is a back office. And, you know, really in terms of audits, what we’re really looking for is to verify if the assets exist, how the assets are being valued, are the performance returns real, and are the assets being custodied correctly. And that’s just so, so important to be able to do that. And whether an investor is able to do it, or they hire someone to do it. But, you know, the second part of that—part of my business, people call me and they’ll ask, they’ll say, you know, I’ve invested in something, would you take a look at it? And I’ll have the paperwork, and, you know, they’ll usually say, well, don’t let the company know that you hired me. On the other side of it, which I much more prefer, is somebody calling me up and saying, hey, I’ve got this investment, I’ve got all the documents.
Scott Trench: I got all the paperwork.
James Brandolino: You know, the manager knows you’re going to call him, he’s expecting a call from someone, and everything is out in the open. But even with that case, Scott, I could have that audit in my hand, and it’s going to say who the CPA firm is. I’ve got to— if it’s a name that I don’t recognize, I’ve got to verify if he’s a real person, if he’s a real CPA, which is relatively easy, right? You can go to cpaverify.org. But also, has that audit been misused? Meaning, a lot of times, if I’ll call up a CPA firm and they won’t even say whether they’ve done the audit, you know, they won’t even confirm that. And it’s really difficult, because you don’t know—somebody could have done that audit, and maybe the fraudster took a page or two and just added a couple zeros in a couple different places. And yes, they did the audit, but the audit’s fake, right? So it’s so, so important, once you’ve got the audit, that you’re able to verify the authenticity of the audit.
Mindy Jensen: So how do I know that I’m getting correct information when I’m asking my hedge fund manager questions and he’s giving me plausible-sounding answers like, with hedge funds, you don’t pay taxes until you pull the money out? I mean, that sounds— if I don’t know anything about hedge funds, you just said that I don’t have to pay taxes. So how do I know? How do I get this correct information?
James Brandolino: As an investor, it’d be probably a little bit tougher, but you would go to your attorney or your CPA and they should know the answer. And if they didn’t know the answer, that would be, you know, that’s where the problem lies. I’ll give you a great little story. I’m sitting with one of my larger clients. His son, who I’ve known for years and years and years, is a CPA, has a small little firm down in Chicago. And we’re getting finished with lunch and he says, okay, so have you asked, you know, Jimmy everything? He goes, yeah, but I just can’t understand how a hedge fund could, you know, can be exempt from paying taxes unless it’s in an IRA. And I’m— and of course I’m thinking, okay, well, I’m done now. That’s it. You know, he’s figured it out. And you know why he didn’t call somebody, one of his colleagues, to ask that question? Because, I mean, look, a hedge fund, or a private equity fund, or real estate fund, all they are is either a limited partnership or an LLC, and everybody gets a K-1 at the end of the year. So it’s nothing rocket science, right? So for him not to know that or ask me that, it just— I’m just appalled, you know. And every once in a while I think about it and how I got away with this for eight years and all of the other red flags that, you know, the CPAs and attorneys didn’t recognize. I just— it never ceases to amaze me that I got away with it for as long as I did. And it’s not just me, you guys. It happens every single day.
Scott Trench: So let’s tie this in with a really uncomfortable conversation here very quickly, right? And I’m going to use the real estate syndication space, right? Which is right now, I think a lot of people raised a lot of capital to buy apartment complexes. You talked about two and twenty, where you get 2% of the profits or 2% of the capital amount raised in assets under management fees, and then you get a 20% profit interest. Syndications make that look like a weak compensation model. These guys get paid 1% to 2.5% just to buy the real estate, then they get the 2% management fee, then they get 1 to 2.5% if they refinance the property and another 1 to 2.5% if they exit the property, then they get 20 to 30% carried interest, right? So incentives are right there. A lot of investors have invested in these types of syndications over the last couple of years and they’re losing right now. Asset values have gone down dramatically. Some of them have already been exposed as Ponzi schemes or frauds at this point and you’re already seeing prosecutions in that. As an investor, how can I protect myself in the real estate syndication space through all of this? And how do I, if I’m invested in something that’s losing, determine if it was fraud, bad luck, gross negligence, some other combination of that? How can I parse that out without complete information and without being a forensic accountant who studied this as a profession like you do?
James Brandolino: Yeah, you know, the real estate field makes it a little bit more difficult sometimes to do it, only because you have to go and verify if the assets are real, and you have to see how they’re registered, and you’ve got to go to the courthouse or wherever you can go, and you can check how they’re custodied and where they’re located. You know, I think— I’m going to take a half a step back here, if you don’t mind, Scott. You know, besides crypto, I think real estate syndication, real estate, whether they’re family homes or multifamily, is probably the largest sector of fraud that I’m seeing in terms of more fraud happening. I’m investigating a case right now in Colorado. An ex-Denver Bronco invested over half a million dollars in a multifamily— well, let’s just say snafu, right? So, and the money’s pretty much gone. So I’m not sure kind of what’s going to happen there. But, you know, it’s a really bad situation. So I think one of the reasons why we’re seeing a lot more fraud in the multifamily space especially is because— and I don’t want to sound condescending at all, but, you know, you’ve got a lot of Joe Smiths in Kansas City who have bought 30, 40 doors and they’re experts in the multifamily space and want to raise money. And they raise money and the deal starts going bad. And, you know, they’ve got— say they’ve got 3 or 4 deals, capital raises they have, and, you know, 1 or 2 of the deals is not doing well and they’ve got a deal that’s doing extremely well. So they’re going to take money from one deal and put it to the other, and not disclose that. And that’s where a lot of problems are taking place. But to go back and answer your question, since most investment fraud does not start out as investment fraud, it’s really, really difficult to pinpoint it. I mean, you know, a lot of these syndications, many of them will have audited financials, and it’s a matter of going through them with a fine-tooth comb and verifying everything that’s on there, and probably even having a forensic accountant go and look at it. Even some of the stuff, some of the cases that I get hired for, you know, I’ve got a forensic accountant that will, on stuff that gets really intricate, help me with the procedures of the back office and how everything’s kind of working, because some of this stuff is just really, really in depth. But you’ve got to go through the financials, and you have to look at the books. And a lot of firms will not, especially the small ones, will not let you look at the books. And it’s a matter of, you know, if an investor’s on their own trying to do it themselves, they’ve got to say, look, either you let me look at them or I’m going to hire somebody and we’re going to charge potential fraud and we’re going to see what’s going on here, because something’s just not right.
Scott Trench: Well, James, this has been super helpful. Thank you for sharing all of this with us today. Where can people find out more about you?
James Brandolino: They can go to my website at theinvestmentfraudguy.com, and anyone can send me an email at james@theinvestmentfraudguy.com with any questions. I’d be happy to give my opinion and help you out.
Scott Trench: Well, I appreciate it and thank you for sharing your story and for the work you’re doing now to prevent and find— yeah.
Mindy Jensen: Thank you, James. This was very interesting. I learned a lot.
James Brandolino: Thank you, Scott. Thank you, Mindy.
Scott Trench: Whew.
Mindy Jensen: Wow, Scott, that was James Brandolino, the investment fraud guy. And that was a very interesting episode. I don’t know how I would have reacted if I had been investing with him because he had an answer for everything. And I mean, it really feels plausible that you don’t pay taxes until you pull the money out with a hedge fund. If you’ve never invested in a hedge fund before, it also seems completely implausible that you don’t pay taxes. Spoiler alert: the government is always going to get theirs. So I’m glad he was able to share some bits at the end about, you know, talk to your network, talk to your friends, talk to other people, and ask them these questions if it still seems a little hinky.
Scott Trench: I think today’s interview was a sobering one. It sounds like without being a forensic accountant who’s going to study this stuff for years, it’s really difficult in a practical sense to expect yourself to be able to spot fraud, right? I mean, you got to call out the audit inconsistencies on there, or, you know, go back and do the research for the audit firm. That’s great. Let’s have more people do those kinds of things and make it harder. But these fraudsters are going to be one step ahead in many of these cases, right? Some of the mistakes he made are probably ones that the next fraudster is going to be able to overcome in some of these things. It’s scary because these people don’t start out as fraudsters. I believe that, right? I believe that nobody starts out, or very few people start out, with the intent to rob people of millions of dollars in this, and that it’s more about, you know, I couldn’t deliver the returns and so I’m going to fudge them and see if I can get back. And then it becomes out of hand and it spirals from there. How many people are legitimate, or seem legitimate today, who went down that path but won and had that good month that saved them and were able to get back out of that spiral that led to James’s Ponzi scheme? You know, how many people are in the process of that right now, pretending like they have that? It took 8 years for this thing to be exposed. I mean, it’s so scary, right? People thought they were worth like a million. There was $100 million more— than there was in there. It’s just, I think the lesson is you never know, and you can’t concentrate all your bets in one area in these kind of unregulated or private syndication or hedge fund opportunities. And you always got to have in the back of your mind that no matter who you’re working with, this is a possibility, and that you’re just acknowledging that if you’re going to get into any of these private investing spaces, and try to make it as difficult as possible for someone to do that, especially if you’re with them for a long period of time and the returns seem great the entire time. Maybe that’s the lesson.
Mindy Jensen: Well, and you just said something, Scott. You said it took 8 years for it to be exposed. It wasn’t even exposed. He turned himself in. Nobody caught on to this.
Scott Trench: Absolutely.
Mindy Jensen: Well, on that note, yeah, I am very thankful that he came and shared this story with our listeners today so they can start to think about what’s going on in their investments if they have hired somebody to take care of them. So ask questions, and if you don’t like the answer, keep asking until you understand what they’re saying or until you uncover something. I hope you don’t uncover anything. Keep asking until you understand what they’re saying. That’s where I’ll stop. All right, Scott, should we get out of here?
Scott Trench: Let’s do it.
Mindy Jensen: That wraps up this episode of the BiggerPockets Money Podcast. He, of course, is Scott Trench, and I am Mindy Jensen saying toodaloo.
Scott Trench: If you enjoyed today’s episode, please give us a 5-star review on Spotify or Apple. And if you’re looking for even more money content, feel free to visit our YouTube channel at youtube.com/financialadvice. BiggerPockets Money.
Mindy Jensen: BiggerPockets Money was created by Mindy Jensen and Scott Trench, produced by Kalyn Bennett, editing by Exodus Media, copywriting by Nate Weintraub. Lastly, a big thank you to the BiggerPockets team for making this show possible.
