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What is a Ponzi scheme? -

A Ponzi scheme is first and foremost a scam. It's an investment scam that pays early investors with money that is later taken from subsequent investors and creates an illusion of big profits. This type of scheme promises a high return rate with little risk to the investor. 

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Word-of-mouth referrals -

New investors will hear about the large returns that earlier investors have made and enter the scheme unknowingly. With time, the scheme will collapse as the flow of new money slows thereby making it impossible to keep up with the payments of the alleged profits.

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Are Ponzi schemes illegal? -

Yes, Ponzi schemes are illegal and there are two main reasons. The first is that the perpetrator is deceiving investors into supporting something that doesn't actually exist.

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Fake enterprises -

The second is that the criminal has to make their fake enterprise look real and legitimate so they aren't immediately caught. Forging and falsifying documents is absolutely a crime.

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Origins of the Ponzi scheme -

This scheme is named after the swindler who started it—Charles Ponzi. In 1920, he became a millionaire by promoting a nonexistent opportunity to invest.

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Earlier schemes -

Ponzi wasn't the first person to imagine this type of fraud. In the 19th century, Charles Dickens dramatized the methods in two novels, 'The Life and Adventures of Martin Chuzzlewit' and 'Little Dorrit.'

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International mail -

In 1919, Ponzi's original scheme focused on the US Postal Service and international mail.

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Differences in prices -

Ponzi noticed that international postage reply coupons could be bought cheaply in Spain due to currency exchange rates and redeemed in the US for a higher value. Scaling this arbitrage concept, he saw a profit potential, which was legal at its core.

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The end -

August of 1920 saw the end of the Ponzi Scheme after the Boston Post began investigating Ponzi's securities exchange company, which was promising a 50% return in 90 days and subsequently, only 45 days.

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Following his release -

On August 12, 1920, Ponzi was arrested and charged with counts of mail fraud. He served time in federal prison. Later, he was tried and convicted in a Massachusetts state court. He initially ran from the law before being arrested in other states and eventually imprisoned in Massachusetts. After state prison, he was deported back to Italy.

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Ponzi scheme red flags -

If you are approached with the promise of a large return with little to no risk, that's a huge red flag. No investment is risk-free.

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Unusually consistent returns -

It may be too good to be true, if, despite market conditions and fluctuations, you are continually receiving profits from an investment. 

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Unregistered and/or unlicensed -

A legitimate stockbroker and company that offers stocks are required by law to register with the regional and/or federal regulators (such as the SEC in the US). If a broker or business is involved in a Ponzi scheme then they likely won't be registered.

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Secretive or overly complex investment strategies -

If your investment broker is reluctant to share anything about how their "investments" work or what they are, you may be involved in a Ponzi scheme.

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Suspicious paperwork -

If the money isn't adding up on account statements, or you aren't allowed to see them at all, then you should be worried.

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Receiving or divesting money is difficult -

If you're expecting an investment payment to come and it doesn't, this can be a sign. A Ponzi scheme leader may try and dissuade you from divesting by saying that bigger and better returns are coming soon.

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Is a Ponzi scheme a pyramid scheme? -

A Ponzi scheme is different from a Pyramid scheme. There are similarities in that they both rely on new investors' funds to pay back earlier investors. However, they differ in their structure and their approach to attracting new participants. 

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How pyramid schemes work -

Pyramid schemes lure participants with promises of lucrative business opportunities that require an initial investment. The primary focus shifts from selling a product or service to recruiting new members.

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Examples of a Pyramid scheme: Burn Lounge -

The Burn Lounge was an online music store that brought in people who paid for the right to sell music while earning awards for recruiting others into this "business." The Federal Trade Commission (FTC) ended up winning a US$17 million judgment. 

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Top Ponzi schemes: Charles Ponzi -

According to Smithsonian Magazine, Ponzi made an estimated US$15 million in just eight months.

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Tom Petters -

Tom Petters was accused and sentenced to 50 years in prison for stealing money from "hedge funds, missionaries, and pastors alike," according to the New York Times. He originally promised investors that if they invested in his organization they were funding the purchase of retail merchandise that would subsequently be sold for a profit.

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Bernie Madoff -

Bernie Madoff's Ponzi scheme is the largest in history and may date back to the 1960s. He conned thousands of investors out of US$20 billion in principal funds until his arrest in 2008. He was later sentenced to 150 years in prison where he died on April 14, 2021.

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The psychological impact on victims -

Falling victim to a scam such as a Ponzi scheme can cause feelings of shame, guilt, and even embarrassment alongside the financial loss.

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The role of regulation and enforcement -

Regulatory bodies like the SEC in the US play an important role in detecting and preventing Ponzi schemes.

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The rise of crypto-related Ponzi schemes -

As cryptocurrencies multiply and grow in value, Ponzi schemes are adapted to take advantage of the digital sphere. Investors should be extremely vigilant and exercise a lot of caution in general, but especially in the crypto space.

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The importance of investor education -

If you are taking the time to invest your money, you should take the time to make an educated decision. Education can empower you to make better, more informed choices and remain hyper-vigilant about risky, fraud-like "opportunities." 

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The ethical considerations for financial professionals -

Financial professionals have an ethical responsibility to act in the best interest of their clients, which includes a duty to identify and prevent Ponzi schemes.

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What to do if you suspect a Ponzi scheme -

If you suspect a Ponzi scheme, stop investing immediately, gather evidence (documents, communications), and report it to authorities like the SEC, FINRA, or your country’s financial regulator. Additionally, consult a lawyer or financial advisor to protect your interests and avoid recovery scams.

Sources: (Investopedia) (Constantine Cannon) (CNN business) (Unit21)

See also: How to spot a pyramid scheme

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