The very mention of Ponzi scheme reminds you of the famous Madoff scam.
The scare factor is that the investors call it as ‘get rich quick’ scheme.
However, in reality, a Ponzi scheme refers to any kind of fraudulent investment operation.
The sole purpose of these schemes is to fleece investors of their money.
The only person who makes money in these schemes is the owner of the Ponzi.
Therefore, it is needless to mention that there is nothing legitimate about this business.
The bases of the foundation of this type of scheme are false promises.
Invariably gullible investors fall for these traps and lose a lot of money.
But the Ponzi schemes are nothing new.
They have been operational since the early 20th century.
Basically, it is an effort to capitalize on human greed.
Almost everyone wants to be rich and very quickly.
In many ways, these Ponzi schemes try to take advantage of this human urge.
They promise to make you rich quickly.
They promise fantastic returns, many times higher than your regular savings tool.
But the problem is often investors understand this after they are trapped.
At that stage, they tend to continue with the hope they will be able to recover at least some bit.
Moreover, these are pyramid schemes.
So they tend to believe that if they can recruit some people, they may recover the cost.
But sadly a Ponzi scheme is invariably a lose all deal.
The only people who make money are the owners or the older members.
Operators often use the short-term returns bait to attract new customers.
But have you wondered why the name Ponzi?
History of Ponzi Scheme
The Ponzi schemes are named after Charles Ponzi.
This is after Charles Ponzi who was responsible for a notorious fraudulent scheme.
His scheme was centered around the then prevalent postal service.
The postal service used a certain international coupon.
Senders had an option of buying these postage stamps in bulk.
The receivers had the option to exchange these for priority airmail postage stamps.
These are used to send replies.
Now the price of these stamps tends to fluctuate.
The rates are different in different countries.
Now Charles Ponzi hired some agents to buy these stamps cheap internationally.
After that, Ponzi would exchange these coupons for expensive ones.
The difference was the profit that he pocketed.
Now you may feel this is merely an arbitrage; there is nothing wrong with it.
But Charles Ponzi did not stop at that.
He decided to increase his profits further.
He created a company, Securities Exchange Company.
The operation model was based on phenomenal returns within a short time.
He offered unbelievable returns like 50% in 45 days or even 100% in 90 days.
Investors never doubted these claims.
This is because he had already established a certain degree of credibility with stamps.
But in this case, Ponzi hardly invested anything on his own.
He simply redistributed it to investors and convinced them that they earned profits.
This scheme lasted for close to a year and then the US SEC launched a probe.
But even then, this concept was tried and tested earlier.
Some of Dickens’ novels between 1840-1860 mention such schemes.
How Does a Ponzi Scheme Work?
So the question is how does a Ponzi scheme work?
Well, inevitably a Ponzi scheme is an absolutely fraudulent operation.
Almost inevitably you have no product in this case.
Investors are promised huge profit in return for some basic investment.
But the reality is that old investors are paid with the money earned from new investors.
As the pyramid gets bigger, new investors keep putting in money.
Only those who are at the very top of these pyramids get to make money.
The way a Ponzi grows is by each member adding a number of new members.
The problem with this type of business theme is there is no meaningful expansion.
The business is based purely on greed.
It expands on the basis of each person luring a few more to join the business.
However, at some point of time, this pyramid gets saturated.
It means no more new members are added.
This also inevitably coincides with the time when the creator of the Ponzi decides to escape.
The result, the key founder or a group of them run away with your hard earned money.
You are fleeced off your savings.
Someone makes a lot of money at your expense.
Most times gullible low-income people are the easy targets for these Ponzi.
They want to get rich quickly.
Many of these people are not very educated, and they fall in the Ponzi trap.
Seeking any help tends to become difficult.
Why Does a Ponzi Work?
If you ever want to understand why a Ponzi works, there are two reasons.
Primarily human greed and secondly the lure of making easy money.
Yes, invariably these Ponzi schemes promise a huge return in a short time.
Moreover, investors have to do nothing to get it.
At least that is how they are lured into this trap.
Information about any Ponzi scheme is invariably vague.
The problem is most times investors also don’t dig any deeper.
The promise of huge returns just buoys them.
They don’t try and explore how and why they are going to get it.
That, in many ways, becomes the undoing of the Ponzi investor.
Another interesting element of a Ponzi scheme is they target some basic genre.
Almost invariably the sector or the kind of business they target look inconsequential.
Most times, investors miss the warning signs and tend to concentrate on the profit.
Whoever is trying to lure them towards the Ponzi will try every trick to get maximum profit.
The result is unsuspecting investors get trapped in this cycle and lose their money.
Remember the old saying; there is any no free lunch.
Sometimes investors tend to forget this basic truth.
Key Features of a Ponzi Scheme
As a result, every Ponzi Scheme has a set of features.
It is common across the board irrespective of the scale.
Some of the key features include
- A pre-decided sum that becomes initial investment
- Promise of huge returns
- Vague description of growth and expansion plans
- Take advantage of lack of investor understanding.
- Sometimes employing a secret investment strategy to make money
- Avoid any kind of information dissipation about the scheme
- Initially pay investors huge return and lure them into investing further
But the problem is every pyramid faces the same type of cascading effect.
Moreover, the initial high returns convince investors to not claim their returns.
Instead, they plough it back into the system.
As a result, the promoter effectively pays nothing to a large number of people.
Most times investors get a statement about their earnings.
This is undeniably one of the most convincing ploys to maintain the deception.
Sometimes even if investors smell something wrong, getting their money out is difficult.
Most times promoters have a strategy to work around this as well.
They try and introduce new plans in a way that reduces withdrawals.
The investor’s attention is invariably distracted by how much profit they can earn.
They are slowly and systematically weaned away from claiming that profit.
Also, if you have a group of investors wishing to withdraw money, it is tackled strategically.
No one is denied withdrawal outrightly.
Instead, some of the withdrawals are processed immediately.
This helps them maintain the illusion that this is a genuine business model.
Often Ponzi schemes take the cover of legitimate business.
This enables them to deceive people in a convincing manner.
Different types of mediums are used to win investor trust.
Allen Stanford even used fraudulent bank CDs for his scheme.
The Madoff Ponzi Scheme
It was one of the major scams in the stock market in recent times.
This scam was discovered in 2008 after officials were alerted by Madoff’s son.
Madoff was previously a chairman of Nasdaq and admitted to creating an elaborate Ponzi.
This fake firm was started in 1960 and continued operations for almost 40 years.
Madoff even admitted to paying people with money that was not there.
Eventually, when the Ponzi scam was unraveled, Madoff had pled guilty to 11 federal crimes.
In June 2009, he sentenced to 150 years in prison.
The liabilities of his firm were close to $50 billion.
The size of the fraud was close to $64.8 billion.
Madoff had over 4800 clients by the time this scam was highlighted in 2008-end.
When he got arrested, regulatory papers showed he was a hedge fund money manager.
There were also a large number of fictitious tax filings.
All of these were created to continue with the deception about the Ponzi.
This is how Madoff continued this scheme for this long.
Learn more about the Madoff Ponzi Scheme here.
What Are Red Flags in Ponzi Scheme?
So the question is how you will identify a Ponzi scheme?
Well, one of the first questions that you must ask is what is the business model?
Verify the source of earning at the very behest.
So do not get buoyed by fantastic returns right away.
Always question the source of such returns.
That will help you gauge the kind of business.
This will also help you understand the kind of interest that you can get from such schemes.
If you ever heard of knowledge is power, this is the best time to use it.
Often this can be the litmus test that helps you identify a fraudulent scheme and an actual one.
Also, ask for details of investment strategy.
Don’t invest money in any scheme without understanding the business model.
This will invariably throw important light on the source of income.
In many ways, you can then assess the veracity of the huge claims.
You can take a fair call about the possibility of getting the promised earnings at all.
Are the returns consistent irrespective of market moves?
Well, that is surely a cause for concern.
No investment strategy, however unique it is, can maintain such consistency.
That should be proof in itself of the false claims that a company makes.
Also, another clue is, are you having any trouble withdrawing the money?
Because if you face difficulty in doing that you can be very sure.
So try and talk to existing investors.
Gauge the ease with which anyone is withdrawing funds from the scheme.
Is the money getting redeployed on some excuse or the other?
Well, if that is the case, you have enough reasons to be aware.
You can easily smell trouble on the basis of that fact.
What Should You Do If You Get Trapped?
But the question is what if you get trapped in a scheme like this despite your best effort?
How can you escape or rather what should be your strategy?
Well, if you think you have got trapped by a Ponzi scheme, look for available documents.
Collect all of these.
These could range from offer documents to a myriad income statement.
Collect all of these and bund them up.
Next look out for potential organizations that you can address your grievance.
Almost invariably, you can contact the FSA with your complaints.
They have a specially created customer service cell.
But before that, you must break off ties with the scammers.
If you have active contacts with them, gradually make yourself unavailable.
This also means that you must stop investing any further money in it.
Also, try to gather written documents that can work as evidence against the Ponzi scammers.
But going forward you also need to be careful about not getting trapped in any other fraud.
Often companies may try to fraud you from multiple IDs.
Also, contact lawmakers at the earliest.
Even if you pay some fees, you can hope to recover at least some amount of the money.
Also, remember anyone who you take to the task will not let you go scot free.
So you must be very concise about your whereabouts.
The first rule of the game is to not be buoyed by any sweet talk.
Also, don’t part with evidence that can help to expose these scammers.
Ask for the real veracity of anyone posing to be legal enforcement officers.
Do not part with key documents without being very sure.
Your carelessness can work against you at times.
So be aware of every single development.
How Do Ponzi Schemes Unravel?
So the question is how do these scams unravel?
Most times, Ponzi scams unravel after someone alerts officials about these.
Invariably someone outside or an existing member goes about alerting.
But even if that does not happen, a Ponzi scheme can still fall apart.
There are many reasons for this.
The most important one is, of course, that the pyramid reaches a saturation point.
This means that no new investors are putting their money in it.
Almost invariably the money source starts to dry up.
So Ponzi reaches its eventual end.
When the founder understands this, they mostly run away with the money.
Moreover, when the money source dries up, promoter will have a problem in paying returns.
As a result, investors start getting worried.
Like any other conventional scheme, a liquidity crisis is one of the biggest panic factors.
Buoyed by one, there will be ten others trying to recover for money.
When multiple people start asking for money, chaos reigns.
Invariably then the Ponzi scheme comes to a standstill.
Global economic factors or market condition can also trigger a closure of a Ponzi.
Especially if the Ponzi scheme is in the financial sector, this is a sure trigger.
The Biggest Ponzi Schemes by the Biggest Scams
The human greed knows no bounds.
Therefore, it is needless to mention that there have been many kinds of Ponzi schemes that have unraveled over the centuries across the world.
We decided to list out some of the biggest Ponzi schemes in history and the way they conned people.
These famous Ponzi schemes were striking not just because of the kind of money they swindled, but also the way they swindled it.
1. Bernie Madoff
Madoff swindled well over $65 billion. They sentenced him to 150 years of imprisonment and charged with 11 counts of fraud, felonies.
His strategy was a consistent return of 10% in return for handing over the investor’s savings to him.
The scheme began to flounder when the payout went as high as $7 billion, and Madoff had less than $300 million for it.
The most interesting aspect is the way this scheme continued right under the nose of the regulatory authorities.
Being a respected financial market advisor, Bernie knew exactly how to play his card. Finally, he pleaded guilty and is now serving his prison term.
Bernie Madoff Ponzi Scheme was really huge the that even it has made some people to make an HBO movie on Bernard Madoff.
The movie is now known as Bernie Madoff movie among people.
2. Tom Petters
His scheme was well over $3.50 billion, and in this case, investors funded a practically non-existent electronic goods establishment.
A successful and extremely legitimate businessman, Tom Petters was the creator of several large and successful businesses like Polaroid and Fingerhut.
This also created a whole aura of legitimacy and convinced his clients about the merit of investing with him.
Finally, the Ponzi collapsed, and on December 2009, he was sentenced to 50-year prison.
The 20 counts charged against him included mail fraud, wire fraud and money laundering.
3. Lou Pearlman
One of the most famous music producers in 90s, this former boy band kingpin was indicted on several counts of fraud, money laundering and theft.
He swindled close to $500 million over 20 years and eventually sentenced to 25 years of imprisonment.
For over 2 decades, Lou Pearlman effortlessly convinced people to invest in two fake companies.
He even created fake statements detailing the financials to get bank loans.
Finally, in 2008, the fraud got highlighted, and he was sentenced after he pleaded guilty.
4. Reed Slatkin
Also, the co-founder of a technology firm, Earthlink, Slatkin’s Ponzi scheme promised nearly 24% returns using an unlicensed investment club as his platform to further the Ponzi.
He defrauded nearly 800 people and swindled close to $600 million.
Some of his more famous victims included Pearl Harbor producer, Armyan Bernstein and news anchor, Greta Van Sustern.
A good chunk of his victims were Scientologists.
5. Adriaan Nieuwoudt
In fact, what Nieuwoudt did was just sell the dried activator kits instead of the actual milk cultures.
The culture was then grown back and sold off to the company, which the company claimed was made to use the beauty product.
The fact was this product was hardly brought back, and the beauty product was actually non-existent.
Finally, he had to stop operation when the South African government claimed that it was illegitimate lottery business.
6. Gary Gauthier
He swindled nearly $6 million from over 38 senior citizens.
The return that he promised his clients ranged from 8-40% and claimed that it was based on return on investments in real estate.
The way that he lured his investors was by making them listen to his show, and then convincing them to call him.
He would after that setup meetings, and the scheme lasted almost 5 years.
He often used the radio show to add legitimacy to the whole scheme.
The eventual charges that were levied against him ranged from security fraud to absolute racketeering.
7. Gerald Payne
In the mid 90s, this Pastor actually ran one of the most talked about Ponzi scheme; he swindled nearly 18,000 people and committed a fraud amounting to $20 million.
He convinced the church goers to hand over their cash, and he would double the entire amount.
For a while, Payne went ahead with the whole scheme by managing to encash checks below $10,000.
The revenue department caught the crime finally after they traced back the operations to his wife’s account.
Finally, he was sentenced to 27 years of imprisonment.
His wife too was charged with 13 years imprisonment.
One of the biggest factors that led to the success of this scheme was the fact that he was a church pastor and people inevitably took his genuineness for granted.
There was an ingrained trust factor that went with this whole scheme and people did not doubt the claims that he made.
They assumed a pastor would only have their good in consideration.
These were undoubtedly some of the biggest ponzi schemes and were made famous by virtue of the sheer amount they swindled.
Moreover, most of these schemes were connected by the common theme of trust and a huge breach of that.
Whether you consider the massive Madoff scheme or the rather petty Payne scheme, people and their blind faith were taken for granted and absolutely deceived.
Most of these victims are still reeling under the impact of these scams and were not able to recuperate from the massive losses they incurred.
Therefore, we can conclude that a Ponzi scheme is inevitably all about a well-executed fraud.
There is never any business or source of income.
Money is just moved around creating an illusion of income.
This forms the crux of any long-standing Ponzi.
The biggest factor here is taking advantage of people’s ignorance.
Needless to mention that human greed also plays a crucial role in it.
It works on two fronts.
On the one side is the whole thrust to create instant returns.
On the other hand, it is also an effort to fool people and lure them into parting with their money.
Moreover, a Ponzi scheme is a celebration of blind faith.
Remember in terms of financial savings and investment, this is never a good approach.
It is the best way to avoid getting entrapped in a Ponzi scheme.