Ponzi Schemes
Most people associate Ponzi schemes with Bernie Madoff, the mastermind behind the largest ($64.8 Billion) investment fraud operation in US history.
Key Takeaways
A scam in which victims are coerced into investing in an entity that doesn't exist is usually set up to play out as a Ponzi Scheme.
This practice is also known as “robbing Peter to pay Paul” and self-sustains until there aren't enough new investors or until enough of the victims asked for their money back.
What is a Ponzi Scheme?
In short, a Ponzi scheme is a scam in which victims are coerced into investing in an entity that doesn't exist. Ponzi scheme operators recruit unsuspecting individuals by promising that they'll get rich quick by putting money in a promising business or exclusive investment portfolio. However, this money is never actually invested and instead ends up as profit for the fraudsters for small payments for early investors to provide the illusion of stock growth.
This practice is also known as “robbing Peter to pay Paul” and self sustains until there aren't enough new investors or until enough of the victims asked for their money back. When the scheme eventually unravels, hedge fund managers profit off whatever money is left.
How the term “Ponzi” came to be.
The term Ponzi Scheme was coined in 1920. After Italian American businessmen Charles Ponzi gained notoriety for his investment fraud operation, which cost US clients an estimated $20 million. Ponzi’s front company promised investors huge returns by purchasing cheap postal reply coupons from overseas and redeeming them for US postage stamps, which is the most 1920s Prime ever.
Today, most people associate Ponzi schemes with Bernie Madoff, the mastermind behind the largest investment fraud operation in US history. For decades, Madoff used his credentials as a well known NASDAQ chairman and Wall Street bigwig to coerce investors into his investment firm. This scheme robbed billions from wealthy individuals, as well as charitable organizations, universities, and publicly traded banks.
In 2009. He was sentenced to 150 years in prison. Ponzi schemes are often confused with pyramid schemes. As both are get rich quick schemes fueled by fraudulent investments.
Warning Signs and Characteristics of a Ponzi Scheme
According to investor.org, here are some warning signs and shared common characteristics of a Ponzi Scheme:
High 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. Be skeptical about an investment that regularly generates positive returns regardless of overall market conditions.
Unregistered investments. Ponzi schemes typically involve investments that are not registered with the SEC or with state regulators. Registration is important because it provides investors with access to information about the company’s management, products, services, and finances.
Unlicensed sellers. Federal and state securities laws require investment professionals and firms to be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
Secretive, complex strategies. Avoid investments if you don’t understand them or can’t get complete information about them.
Issues with paperwork. 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. Ponzi scheme promoters sometimes try to prevent participants from cashing out by offering even higher returns for staying put.