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Is pyramid selling endemic to the Square Mile? With the Madoff scandal in New York still unravelling, there are plenty of people asking how a $50bn pyramid-selling fraud could happen under the noses of regulators and supposedly sophisticated investors. And how someone, even a respected former stock exchange boss like Bernard Madoff, could conduct a fraud on such a scale.
But if the basic principle behind pyramid selling has been the stock in trade of many City firms, large and small, then maybe it is easier to explain how the regulators failed to see through more extreme versions. For instance, today the Liberal Democrats and Tories have called on the government to apologise to Equitable Life investors for failing to notice that this once venerable institution, a mutual of more than 200 years standing, was an accident waiting to happen – and for an eight year delay in reimbursing victims of the scandal.
Throughout the 1990s, the bosses of Equitable gained a reputation for consistent and market-beating payouts to pension savers. Much of the firm's largesse came from investments on what were then booming stock markets. But to sustain the winning formula, a good deal of it was taken from the money pouring in from new customers, keen to get the same kind of payouts when they retired. It was pyramid selling lite.
When the firm crashed at the end of the decade, plenty of investors cried foul and accused the firm of fraud. The directors were investigated and the auditors were sued. The verdict summed up the City. Judges said it was a riskier version of what passed for normal business in the rest of the insurance industry.
Only the regulators got it in the neck. Highly paid directors and auditors to Equitable walked away from the wreckage.
The Financial Services Authority promised to clean up the insurance industry and to the dismay of pension savers and investors in the firms themselves, has done a decent job. Why dismay? Because without an element of pyramid selling, insurers cannot rip off their new savers with huge upfront fees and charges. They are limited to returns from stock market investments.
And yet, the culture of the City remains spivvy. The spivs are in business because avaricious investors want them to make mega promises. When it becomes obvious there is a gap between the promise and reality, cash from new customers comes into play. The regulator may be watching, but angry investors are more frightening than a probe by the FSA.
There are plenty of lawyers signalling that Madoff's is the first of many pyramid-style selling schemes that will unravel as the downturn gets worse. Given the pressure from investors for returns that beat the average, there will always be a punter willing to buy a spiv's story, even when it sounds too good to be true.
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