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>> Madoff—A 21st Century Ponzi Scheme
The Ponzi scheme is a house-of-cards swindle in which high returns are paid to initial investors out of the funds of later investors, who end up losing all or most of their money to the promoter. Fueled by the often bewildering variety of new investment opportunities, the renaissance of the Ponzi scheme has ranged from well-known national cases to local cases.
Some examples follow below:
>> In Massachusetts, a former investment adviser was sentenced in 2008 to 18 years in prison for his role in a Ponzi scheme that took in more than $20 million from more than 250 unsuspecting investors.
>> In British Columbia, securities regulators in 2008 ordered three men to pay $12.7 million to the courts for operating a Ponzi scheme that bilked nearly 90 investors out of at least $23.3 million by promising a return of 6 percent per month through an "asset growth program." No such program existed, regulators found.
>> In Florida, an entertainment impresario who helped 'N Sync and the Backstreet Boys rise to fame faces 25 years in prison after pleading guilty in 2008 to a series of charges stemming from state and federal investigations that he bilked investors and banks out of more than $300 million in part through what Florida officials compared to a Ponzi scheme in which initial investors are lured with guarantees of lucrative returns but money from later investors is used to pay dividends.
>> In Maryland, securities regulators launched an investigation into a Ponzi scheme that bilked 900 investors throughout the United States, including victims of Hurricane Katrina, out of $8 million. The man behind the Ponzi, which involved a fraudulent real estate scheme, pleaded guilty in 2008 to 27 counts of wire and mail fraud and faces a maximum sentence of 20 years in prison and a $1 million fine.
ORIGINS OF THE PONZI SCHEME
The story of the Ponzi scam begins with its namesake, Charles Ponzi, an Italian immigrant who moved to Boston in 1919 after brief imprisonment in Canada for minor fraud schemes. Ponzi struck on the idea of profiting on the widely-varying currency exchange rates for International Postal Reply Coupons (IPRCs), which were redeemed for stamps. Ponzi calculated that he could pay a pittance for IPRCs in a weak-currency country, like Spain, and then turn around and redeem them at a substantial profit in the United States.
In the early 1920’s, Ponzi solicited funds with the promise that investors would get a 40 percent return in just 90 days at a time when interest rates stood at just 5 percent. As interest in the scheme escalated, Ponzi upped his guaranteed returns on 45-day notes to 50 percent. For those who would turn over their funds for 90 days, he was now offering a whopping 100 percent return.
Early investors were paid off as promised--a classic earmark of a Ponzi scheme. The word spread, and investment came in at an ever-increasing rate. Ponzi hired agents and paid them generous commissions for every dollar they brought in.
But Ponzi’s scheme was eventually exposed by Boston newspapers and law enforcement officers, who pointed out that there were not enough IPRCs in circulation to support Ponzi’s scheme. Undaunted, the promoter claimed that he was actually using another – and even more – arcane means to earn tremendous returns for investors. Money continued to pour in to Ponzi’s office for a while, but eventually fell off when Ponzi was unable to keep up the rapidly-expanding swindle. Though he promised to make good with a $100 million global investment syndicate, Ponzi eventually was imprisoned in Massachusetts and deported to Italy. He died years later in a Rio de Janeiro charity ward.
Charles Ponzi’s con game fleeced uncounted numbers of Boston investors of $10 million, a staggering sum in those days. State investigators later learned that Ponzi had only engaged in token IPRC transactions totaling about $30 in the first weeks of the scam.
THE CLASSIC PONZI SCHEME
The Ponzi scam amounts to little more than robbing an army of Peters to pay a handful of Pauls. As the number of initial investors (the Pauls) grows and the supply of potential new investors (the Peters) dwindles, the Ponzi bubble bursts under the pressure of meeting the promised returns. While some initial payments are made to drum up new recruits, the vast majority of investors in a Ponzi scheme end up losing all or most of their money. As in the case of simple pyramid recruitment frauds, a point is inevitably reached where the con man simply cannot keep up with the required payments.
The good news for investors is that the Ponzi scheme can be one of the easiest swindles to detect and avoid. The facts, however, indicate that even extremely sophisticated investors are falling victim to Ponzi promoters.
BEHIND THE RETURN OF THE PONZI SCAM
Variety and Confusion
Though the Ponzi scheme has been around for 89 years, it is more prevalent today than ever before. The driving force behind this renaissance of the Ponzi swindle is the recent explosion of financial services and often bewildering new investments available to the public. In this crowded and fast-changing marketplace, Ponzi promoters have an increasing number of “costumes” at their disposal with which to dress up their schemes and thwart detection. Ponzi scams can involve almost any type of deal – generic drugs, clothing brokerages, hydroponics, windmills, gold mines, diamonds, precious metals, foreign currency transactions, commodities, high-tech stocks or speculative real estate
Greed
The Ponzi scheme thrives on greed, which appears to explain why there always seems to be a ready supply of investors eager to turn over their life savings. Rather than investing for the future, victims are urged to cash in on a quick speculative scheme. Conservative, straight as an arrow investors sometimes get caught up in Ponzi schemes after promoters dangle high rates of return such as 18-20 percent over their heads.
A “Surefire Scheme”
The bottom line of the Ponzi scheme is always the same: the attractive above-market rate of return on your investment is guaranteed. Investors are lulled by the nonsensical proposition that their investment is not at risk.
The Herd Instinct
Frequently, Ponzi scam promoters rely completely on word of mouth to line up new investors. To get this process going, the con operators often concentrate their initial efforts on specific cities, types of investors, family members, church groups, professionals and social acquaintances. This initial stage of the scheme has zeroed in on members of specific pro football teams, Air Force bases and even law offices. This concentration on close knit groups often yields the desired result: Initial victims unwittingly aid the swindler by lining up their closest friends, relatives and professional associates as new victims.
The Appearance of Success
Some initial investors in Ponzi scams are paid off handsomely, and often with returns considerably higher than those originally promised. Frequently, this is the “hard” proof that skeptical investors insist on seeing before they will jump in with both feet.
Fear
Even as a Ponzi scheme starts to collapse, investors are slow to admit that they’ve been swindled. Frequently, there is the fear that public exposure will create a crisis of confidence that could create a run on the promoter and make things worse. There is also the fear of looking foolish for being blinded by greed. The investor may fear that if his suspicions are wrong, he will be drummed out of the high-interest scheme. And since the Ponzi scheme relies on a sense of community, there is the fear that the first investor who breaks ranks will be blackballed in his professional or social circles.
The Tooth Fairy Syndrome
Investors in Ponzi schemes frequently cling to even the faintest of hopes that everything will work out for the better. Even after Charles Ponzi was exposed, for example, investors continued to press their funds on him, believing that his new global investment syndicate would set everything straight. As one recent Ponzi scheme victim explained, “It was like believing in the tooth fairy. I didn’t want to give up on the whole deal.” This brand of thinking has resulted in investors attacking government officials and defending Ponzi promoters as heroes, saints and misunderstood financial geniuses with basically good intentions. Frequently, an exposed Ponzi operator will capitalize on these sentiments by stating that he got in over his head, telling investors that he meant well, but that things just got out of hand. Or the Ponzi promoter may vow to make good in one last venture, which may turn out to be nothing more than yet another Ponzi scheme.
AVOIDING PONZI SCAMS
Here are basic rules to follow in steering clear of Ponzi schemes:
Beware promises of high, guaranteed profits. This is perhaps the easiest way to spot a Ponzi scam. Any legitimate investment involves a degree of risk that makes it impossible to flatly promise profits, much less astronomical returns.
Avoid promoters who fail to provide clear and detailed explanations. Don’t listen to promoters who tell you that it is impossible to explain their deal in layman’s terms. Many investors fail to seek even the most rudimentary basic understanding of the investment they are making.
Check out the promoter’s background. Check with your state, provincial, or territorial securities office for licensing/registration of the individuals selling the investment. Remember, anyone selling a security must have a license. If the promoter says he’s exempt, follow-up with your regulator to confirm the claim.
Get information from your state or provincial securities regulator. Since most Ponzi schemes involve investment contracts, they should be registered as securities offerings with your state, provincial, or territorial securities division. If the promotion appears to be in violation of state securities law, turn over all information on the case in your possession to securities regulators.
Ask for detailed information in writing. Any investor is within his rights when insisting on detailed information from a promoter seeking large sums of money. Ask for information on the company, its officers and financial track record. If a product is involved in the deal, ask for documentation on its cost, fair market value, and existing and potential markets. Frequently, Ponzi promoters rely on nothing more than fast talk and official-looking promissory notes when investors sign over their funds. Reluctance to provide detailed information should be regarded as a red flag of a potential Ponzi scheme.
Verify the promoter’s claims. Remember that seeing is believing. Be skeptical of deals that can’t be checked out in person. When it comes to checking on details of your investment, be particularly leery of claims that all banking transactions and bookkeeping are handled in remote cities or other countries. Searching the internet is another way to verify the investment deal. If you do not have a home computer, your local library has internet access available to the public. Investors are sometimes told that certain information is being kept “secret” for security purposes.
Resist pressure to reinvest without seeing your “profits.” Ponzi schemes often are kept going for substantial periods of time by promoters who convince even initial investors to roll-over their “profits” for even greater returns. While it frequently makes sense to stay with a legitimate investment over time, be suspicious of promoters who are reluctant to let you cash in your gains.
Look for unbusiness-like conduct or disruption of services. Reluctant to have their schemes exposed, few Ponzi operators enlist much, if any, office help, and may even go to the extreme of answering the phone and opening all the mail themselves. This has the effect of hastening the collapse of the Ponzi scheme, since it makes it even more difficult for one person to keep up with all the required payments and investor contacts. And when the Ponzi bubble is about to burst, promoters typically become extremely difficult to reach.
WHERE TO TURN FOR HELP
The securities administrator in the state, province or territory is responsible for protection of investors. If you have any questions about an investment, contact your securities administrator. You can locate your securities administrator by clicking here. Remember, it is a good idea to contact your securities regulator before you invest. | 
