Anatomy of a “Ponzi” Scheme
Anatomy of a “Ponzi” Scheme:
Contributed by: Lucas Trevant-Global Advocates
It seems most people are familiar with the phrase “Ponzi Scheme” especially after 2008 when Bernard Madoff and his investment firm, Bernard L. Madoff Investment Securities LLC, were charged by the SEC with securities fraud for a multi-billion dollar Ponzi scheme perpetuated on his firm’s clients for many years.
In Madoff’s case he appeared to be a successful securities investor. He had been a prominent member of the securities industry throughout his career. He served as vice-chairman of the NASD, he was a member of its board of governors, and chairman of the New York region. He was also a member of the NASDAQ Stock Market’s board of governors and it executive committee and served as chairman of its trading commission. Over a period of 48 years he established a significant reputation in securities trading and his clients trusted him.
What is a Ponzi scheme?
A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.
Why do Ponzi schemes collapse?
With little or no legitimate earnings, the schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out.
How did Ponzi schemes get their name?
The schemes are named after Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. At a time when the annual interest rate for bank accounts was five percent, Ponzi promised investors that he could provide a 50% return in just 90 days. Ponzi initially brought and traded a small number of international mail coupons in support of his scheme, but quickly switched to using incoming to pay off earlier investors.
What are some Ponzi scheme “red flags”?
Many Ponzi schemes share common characteristics. Look for these warning signs:
- High investment returns with 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 do not understand or for which you cannot 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.
What steps can I take to avoid Ponzi schemes and other investment frauds?
Whether you’re a first-time investor or have been investing for many years, there are some basic questions you should always as before you commit your hard-earned money to an investment. The SEC sees too many investors who might have avoided trouble and losses if they had asked question from the start and verified the answers with information from independent sources.
When you consider your next investment opportunity, start with these five questions:
- Is the seller licensed?
- Is the investment registered?
- How do the risks compare with potential rewards?
- Do I understand the investment?
- Where can I turn for help?
For more information, we suggest you read;
If you have been a victim of fraudulent scheme, anywhere in the world then it’s time to real justice and recover your losses.
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