Slovakia falls prey to investment scam

Slovaks have walked into a familiar financial trap

By Alexander Koliandre BBC News Online business reporter

Savers in Slovakia are learning a painful lesson in free-market economics.

Naivety multiplied by greed made the existence of such investment schemes possible in Slovakia

Tom Nicholson, Slovak Spectator

The country, part of the former Czechoslovakia and a candidate for European Union membership, is in the throes of a financial scandal, as a string of fraudulent investment companies shut their doors.

Hundreds of thousands of Slovaks, who put their money into unlicensed investment firms on the promise of unrealistically high returns, have realised that their savings have been lost, sparking panic and a growing political storm.

Slovakia is only the latest East European country to be hit by rogue investment funds - so-called "pyramid" schemes - since the collapse of communism.

Similar scandals, notably in Russia and Albania, have provoked widespread social unrest.

Pyramid power

Over the past few years, unlicensed financial institutions, known in Slovakian as "non-banks", have built up hundreds of millions of dollars in deposits,

The central bank warned savers to beware

It is still unknown exactly how much was deposited in these funds, or how many clients they had; the "non-banks" were not obliged to unveil their books and were reluctant to show any figures or investment plans.

But the nature of the companies' activity is clear: in the manner of classic pyramid schemes, the money was never invested anywhere - depositors instead relying on a steady flow of new clients for the fund to keep afloat.

Last week, BMG Invest became the first such "non-bank" to stop paying money back.

AGW, BDV Drukos and several others soon followed suit.

Others have slapped limits on withdrawals, in the hope of preventing savers taking out their money in panic.

Pyramid power

Events in Slovakia are eerily reminiscent of the wave of "pyramid scandals" that swept post-communist Europe in the 1990s.

With poverty widespread, get-rich-quick schemes are tempting

Such schemes preyed on the financial naivety of East Europeans, who were unused to the sophistications of the investment business.

Pyramid schemes typically spend huge amounts on advertising and promotion, kitting out luxurious offices, and in some cases currying favour with influential officials.

As these schemes grow, paying huge returns to early investors is easy.

These returns then draw in further investors, but since the money evaporates, the inevitable result is eventual collapse.

Government under fire

In many cases, the fall-out of a financial pyramid caused mass rallies, strikes, and in Albania something close to civil war.

The Russian pyramid scheme MMM issued its own"bonds"

Few expect similar disruption in Slovakia, which is among the most advanced countries in the region.

Fitch, the international credit rating agency, has said there should be little overall economic impact.

But with elections due in two months, the opposition parties are trying to make hay.

The populist Slovak National Party, which enjoys the support of some elements in the media, has urged the government to make good the losses, and save the investors.

Ministers have stood firm, fearing the impact on Slovakia's fragile state budget.

The government argues that, as long as the "non-banks" were unlicensed by the state, and bearing in mind warnings from the central bank, it bears no responsibility whatsoever for the collapse of the "pyramids".

Why so late?

What seems strange is that Slovakia has been hit so late, more than a decade after free-market reforms were launched.

In Albania, the fall of the "pyramid" companies caused violent clashes

Michal Vasecka, a sociologist from Bratislava, partly blames the government, which failed to introduce proper legislation to prevent such "pyramids" emerging.

But he points out that pyramid schemes focused on more vulnerable and uneducated sectors of society, where people were more likely to be fooled.

"The vast majority of investors were from rural underdeveloped areas of Eastern Slovakia; they were mostly over 60 years old and poorly educated," he told BBC News Online.

During the years of high inflation in the 1990s, a 30% return on investment did not look suspicious, says Tom Nicholson, editor-in-chief of the Slovak Spectator newspaper.

"People get used to high rates and believed that the government would save them if anything happens, as it has done in the past," he says.

"But the law applies only to licensed banks, which people failed to realise."

Greed and naivety

"Naivety multiplied by greed made the existence of such investment schemes possible in Slovakia," says Mr Nicholson.

The majority of the clients came from rural and underdeveloped areas

The government says it is ready to punish the founders of the "non-banks".

On Friday, police said two senior managers of the firms Horizont and BMG Invest had been detained in Croatia on an international arrest warrant.

The interior ministry said the two men, and a third suspect still at large, faced charges of fraud and illegal business activities in Slovakia.

The Pravda daily reports that the police have strong evidence that two of the failed "non-banks" transferred millions of dollars abroad through dubious payments for "consulting services".

Criminal investigations on similar cases are still running in many East European countries, and hundreds of thousands - if not millions - of people are still waiting to get their money back.

For many of these people, the real culprit is capitalism itself.