What is a Ponzi Scheme?

A Ponzi scheme is a fraudulent investment that is designed to deceive investors and ultimately make the originator very wealthy.  Most follow a similar design:

1. Promise extraordinary returns
2. Show historical returns and potential for profit
3. Build credibility with testimonials
4. Leave with investors’ money

While it’s simple in concept, some Ponzi schemes may be difficult to spot.  One of the most recent and largest Ponzi schemes in history, run by Bernie Madoff, went unnoticed for years.  Madoff promised excellent market returns and proved ‘credible’ to investors because his history with the NASDAQ and the high net worth investor profiles he managed.  In 2008, Madoff was unable to keep up with the sequence of paying old investors with new investor dollars, and was found guilty of fraud in the form of a Ponzi scheme.  It’s estimated that $30- $50 billion was lost by investors associated with the Madoff ponzi scheme.

Why is it called a “Ponzi” Scheme?

In the early 1900s, an Italian immigrant named Charles Ponzi ran an investment opportunity that promised investors a 50% return in 45 days.  The claim was that an investor could make large amounts of money because his company “Security Exchange Company” (not to be confused with the Security Exchange Commission) would purchase IRCs from one country (a type of prepaid envelope of sorts) and cash it in at a premium in other countries.

Investors flocked to Charles Ponzi’s incredible offer and thousands of people put their life savings with Ponzi.  For a while, Ponzi was brining in $250,000 a day as investors tried to get rich quick.  Many people received a high rate of return, but opted to reinvest, building the scheme even larger.

Ponzi’s fraudulent history led to the end of his scheme in the 1920’s and thousands of people lost their life savings.

Are Ponzi Schemes Common Today?

In 2010, the SEC filed 47 ‘enforcement actions’ that were considered to be a Ponzi scheme or a similar fraudulent investment operations.

If an investment seems too good to be true, and claims to provide high returns for very little risk, make sure you do your homework before investing.  The SEC provides some red flags that can help you determine if an investment operation is a Ponzi scheme or not.

The following is cited from the SEC Website:

Many Ponzi schemes share common characteristics. Look for these warning signs:

• High investment returns with little or no risk. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk. Be highly suspicious of any “guaranteed” investment opportunity.
• Overly consistent returns. Investments tend to go up and down over time, especially those seeking high returns. Be suspect of an investment that continues to generate regular, positive returns regardless of overall market conditions.
• Unregistered investments. Ponzi schemes typically involve investments that have not been registered with the SEC or with state regulators. Registration is important because it provides investors with access to key information about the company’s management, products, services, and finances.
• Unlicensed sellers. Federal and state securities laws require investment professionals and their firms to be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
• Secretive and/or complex strategies. Avoiding investments you don’t understand or for which you can’t get complete information is a good rule of thumb.
• Issues with paperwork. Ignore excuses regarding why you can’t review information about an investment in writing, and always read an investment’s prospectus or disclosure statement carefully before you invest. Also, account statement errors may be a sign that funds are not being invested as promised.
• Difficulty receiving payments. Be suspicious if you don’t receive a payment or have difficulty cashing out your investment. Keep in mind that Ponzi scheme promoters sometimes encourage participants to “roll over” promised payments by offering even higher investment returns.

If you are aware of an investment opportunity that might be a Ponzi scheme, contact the SEC by phone at (800) 732-0330 or online at http://www.sec.gov/complaint.shtml.

Have you or someone you’ve know been affected by a Ponzi scheme?