In the headlines due to the high-profile conviction last year of $65 billion fraudster Bernie Madoff in the largest scam of its type, Ponzi schemes date back to the 1920s to a con run by namesake – Charles Ponzi. eZonomics outlines the characteristics of these schemes – and give tips on how to spot one and avoid being duped.
Ponzi schemes try to suck in new victims to survive
A Ponzi scheme is like a giant balancing act – but with nothing holding it up. Eventually the schemes fall down (or they are closed after the scam is uncovered) and investors lose out. The investment fraud works by paying those who “invest” in it early with money put in by “investors” who join later on – rather than sourcing returns from actual profits. The scam is also known as a pyramid scheme because income from new joiners pays the people a tier above.
The structure means that the schemes require a continuous flow of investors putting money in, otherwise the returns being paid out will cease. Ponzi schemes often offer conspicuously high returns – which are genuinely too good to be true – to attract new followers. Those running the schemes have also encouraged those involved to tell their friends and families, with the word of mouth affect seeing families and pockets of communities hit hard by the frauds.
Ponzi schemes have conned the rich and poor around the globe
Ponzi schemes are more common than you might think and many people – not only the wealthy – have been conned. Just last month, the BBC reported a conman had been convicted after running a £34 million Ponzi scheme targeting small valley communities in South Wales in the United Kingdom. It said the personal and financial toll on those involved was high, with marriages collapsing and other longtime friendships ending. In the US this month, CNN reported Tom Petters was jailed for 50 years for orchestrating a $3.65 billion Ponzi scheme. And in Albania in the mid-1990s the banking system was devastated after the fall of communism by a widespread Ponzi scheme detailed by the World Bank.
Watch out for unrealistic performances and other signs of potential trouble
Writer and investment advisor Bonnie Kirchner had her own life ripped apart when it emerged in 2004 that her husband Brad Bleidt had been running a Ponzi scheme. Kirchner divorced Bleidt, who was jailed, and put the findings of her investigation into how even the most intelligent people can be victimised by financial scammers in her new book Who Can You Trust With Your Money?. In the book, published by FT Press last month, Kirchner points to three warning signs that it seemed in hindsight Bleidt’s clients missed:
- Unrealistic monthly performance statements: Monthly performance statements made Bleidt appear to be delivering consistent, reasonable returns — even when the market was not performing well.
- Lack of trading confirmations: “As far as I know, Brad’s clients did not receive trading confirmations showing how many shares were bought or sold, their prices, and commissions or fees,” she writes.
- Direct payments: She says Bleidt had customers make cheques payable to his own firm rather than a custodial firm that provides Securities Investor Protection Corporation (SIPC) insurance (and that work to help protect customers’ money).
She urges people who spot such warnings signs to investigate, to ask for proof of trades and to check the credentials of the custodian of their investments.