What is a Ponzi Scheme?

Feb 10
08:39

2012

Steven Hart

Steven Hart

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A Ponzi scheme is an investment scam in which the fraudster uses money collected from a new crop of suckers to pay off earlier investors. The idea is to create the illusion that the scheme is making money when all that is going on is that money is being shuffled around.

 

Any enterprise in which returns or profits are being paid with funds collected from investors can be considered a Ponzi scheme. This includes Pyramid schemes which can be considered a variety of Ponzi. The difference between a Ponzi and a pyramid is that in a pyramid the victim usually has to join some sort of organization and recruit others to do so. In a Ponzi all that happens is that the con artist takes your money,What is a Ponzi Scheme? Articles pockets most of it and uses part of it to pay off earlier victims.

 

Why they are Called Ponzi Schemes

This kind of con game is called a Ponzi scheme because of the activities of Charles or Carlo Ponzi. Contrary to popular belief, Ponzi did not invent the scam that bears his name. Instead he popularized it by swindling thousands of people in Boston with the scheme in the early 1920s.

 

Ponzi’s racket worked just like similar swindles today. He claimed that he could make fantastic profits by investing in an obscure financial instrument called a postal reply coupon. Like similar predators today, Ponzi told investors that they could make 100% profit within 90 days. The scam was wildly successful and at its height Ponzi was raking in as much a $250,000 a day in the 1920s. The money went not to buy the coupons but to pay off investors and finance Ponzi’s lavish lifestyle.

 

Unfortunately, Ponzi had to pay all or most of the money out to keep up his illusion of profit. Eventually the scam got so big that it threatened to bring down Boston’s banking system. It collapsed when The Boston Globe newspaper ran a story that revealed Ponzi was an ex convict who had served prison time for check fraud in Canada. Ponzi was eventually convicted of mail fraud, served time in prison and deported from the United States.

 

How to Spot a Ponzi Scheme

Most of the investment scams around today are some variation of the Ponzi scheme. Even though they may look very different on the outside, such scams usually share certain characteristics. Some classic features of this kind of swindle include:

 

Promises of fantastically high investment returns often as high as 50% or even 100%. This is possible because the fraudster is paying people off with other people’s money. Promises of a risk free investment and constant returns this is impossible there is no such thing as a risk free investment. Fast pay out of returns particularly to people who ask questions is another sign of a Ponzi.

 

Exotic investments, Ponzi artists like to promote obscure or unusual investments such as derivatives, accounts receivables, gold, overseas banking and promissory notes. Fraudsters like the exotic because it confuses investors. Beware of any investment based on something you have never heard of or can find no information about.

 

Unregistered investments and unlicensed promoters, not surprisingly scam artists usually don’t register investments with the SEC. Another sure sign is investments sold through nontraditional channels such as social networks. Many con artists use ethnic or religious ties or community relationships to target people with little or no knowledge of investment.

 

A lack of paperwork and information, in many cases there will be little or no documentation about the investments. Always get suspicious when somebody cannot produce any evidence of claims or records of their investment’s performance. Instead of documentation the conman will claim to have inside or special information that enables him to make a lot of money.

 

How it Collapses

Ponzi schemes gets exposed and people start pulling out their funds. That is what happened to Charles Ponzi himself when his criminal record was exposed people pulled out their money. Ponzi owed investors $7 million yet he was $2 million in debt. Most schemes collapse when the con artist runs out of suckers and additional income.

 

Everybody should beware of Ponzis because the predators that run them are becoming more sophisticated. A growing problem is that brokers and financial advisors will act as fronts for such a scheme then divert investors’ money into one. If you become aware of such a fraud you should report it to the Securities and Exchange Commission or SEC, a federal agency that has the power to shut such scams down.