Ponzi frauds are a type of illegal pyramid scheme named after Charles Ponzi, a 1920s con man who duped thousands of New England residents into investing in a postage stamp speculation scheme. According to the Securities and Exchange Commission (SEC), Ponzi’s scheme centered on taking advantage of the price differences between U.S. and foreign currencies that were used to buy and sell international mail coupons. His pitch to potential investors included a 40% return in just 90 days compared with 5% for bank savings accounts.
Ponzi’s marketing ploy attracted a long list of eager investors. During one three-hour period in 1921, Ponzi reportedly took in $1 million. Ultimately, Ponzi’s con game collapsed but not before investors had lost $10 million.
Decades later, Ponzi schemes continue to dupe investors out of billions of dollars via a “rob-Peter-to-pay-Paul” investing principle. The concept itself creates the illusion of solvency, using money from new investors to pay off earlier ones. As long as new investors are found, the scheme can often continue uninterrupted. It’s when current investors decide to pull out their money or new investors are no longer willing to invest that the scheme typically collapses.
The North American Securities Administrators Association offers the following suggestions to help investors avoid Ponzi schemes:
- Beware of individuals offering high, guaranteed profits. Any legitimate investment involves a degree of risk, which makes it impossible to promise profits, much less astronomical returns. In the Madoff and Gieseker cases, both individuals promised big profits to their victims. Madoff touted consistent annual returns of 10% or more to investors. Gieseker promised local farmers that she could sell their grain at prices higher than the going rate because of supposed contracts she had secured.
- Steer clear of individuals who cannot or are unwilling to provide clear and detailed explanations of their investment strategies.
- Ask for credentials and licenses. Check with national organizations that issue financial and securities-related credentials to ensure the person selling an investment is legitimate. These organizations include the National Association of Personal Financial Advisers, the Financial Planning Association, and the Certified Financial Board of Standards.
- Also, visit the Web site of the Financial Industry Regulatory Authority (FINRA), which provides a FINRA BrokerCheck tool to help investors verify the professional background of current and former FINRA-registered securities firms and brokers.
- Ask for detailed information regarding any investment in writing. Every investor has the right to insist on explicit information from someone who is seeking large sums of money. Ask for information on the company, its officers and financial track record. Reluctance to provide this information is a red flag of a potential problem.
- Look for unusual business conduct or disruption of services of the person marketing and selling the investments. Ponzi operators rarely enlist much, if any, office help, and may even go to the extreme of answering the phone and opening all the mail themselves.