Ponzi Schemes
Ponzi scheme named after Charles Ponzi is an investment scam; it is a fraudulent investment scam whereby the managers of a fund or an investment vehicle promise high rates of return with little or no risk to the principal invested. Ponzi schemes may last for a short while before they are discovered, they may even last for decades before they are brought to the awareness of the public. How is this possible you may ask. Let us analyze how a Ponzi scheme may be sustained for such a long period of time.
Ponzi schemes usually are pools of fund, they might be mutual funds, or any other type of fund. They collect money in the form of investments from an investor. They promise heaven on earth and tell the investors that they can invest the money and make returns that are high and unreasonable. The truth of the matter is that while investors think that it is a legitimate investment fund, the managers are busy focused on attracting new investors and using the money for their personal use. They do not invest the money, but instead they announce unbelievable returns to shareholders, and then use the money gotten from new subscriptions to their fund to pay older investors this return.
The life of a Ponzi scheme is determined by how well the scheme can cajole new investors to invest in order to pay up the returns they promised older investors.
Characteristics of Ponzi schemes
- Ponzi schemes promise high investment returns with little or no risk: We all know that in investment, the higher the expected return, the higher the risk to the investment. An investment scheme which promises returns with little or no risk should be closely scrutinized as it might be a Ponzi scheme.
- Ponzi schemes promise overly consistent returns: It is natural for investment returns to flunctuate depending on the state of the economy. When an investment vehicle promises to generate consistent returns regardless of overall market conditions, that is a red flag and you should be careful not to invest in such investments as it might just be a Ponzi scheme.
- Ponzi schemes are usually not registered: Investment in securities in the united states remains subject to the jurisdiction of the securities and exchange commission. Such securities must be registered with the securities and exchange commission. Ponzi schemes generally avoid registering with the SEC.
- Returns promised but payments yet to be received: Ponzi schemes promise consistent returns, but it is all a faux. The truth is that they are waiting for cash from new investors to finance payment of returns to older investors. As a result, Ponzi schemes regularly default in payments as a result of no new investor. When that happens, they may be try to cajole you into rolling over promised payments by offering higher investment returns.
- Unlicensed sellers: Federal and state securities law require certain investment professionals and firms to be licensed or registered. Many Ponzi schemes avoid this because their activities would be closely monitored thereby making it almost impossible to scam investors.
The biggest Ponzi scheme in USA is by Bernie Madoff, who was a former stockbroker, investment advisor and financier. Madoff founded the Wall Street firm Bernard L Madoff Investment securities LLC in 1960. He was the company’s chairman, with close family members taking up key positions in the company. In 2008, Madoff confessed to his sons that the wealth management unit of his company was a big lie. His sons in return informed the authorities of their Father’s confession.
Madoff confessed that the Ponzi scheme had started in the early 90’s, although through investigations it is believed to have started as far back as the 70’s . That is almost 38years of defrauding innocent investors. The amount missing from clients accounts including fabricated gains was almost $65billion. The SIPC (Securities investor protection corporation) trustee estimated actual losses to investors of $18 billion. Madoff was later sentenced to 150 years in prison on June 29, 2009.
So people, before keeping your money in a new investment, ensure you carry out a thorough due diligence inorder to ascertain if it is a Ponzi scheme or not
Recommended Reading
Mitchell Zuckoff., Ponzi Schemes: The True Story of a Financial Legend
This is an eye opener. Most times focus shouldn’t be based on what we can get from an investment as returns but the credibility of the organisation being invested into, and thus goodwill either inherent or purchased can be a key factor here. Also we should shift our gaze to how efficient the business will make use of the amount being invested too. Not forgetting also that knowledge about the market is key, if you want to invest and have little or no knowledge about the market even though you know the organisation quite well, get an expert who can. Ponzi scheme is real.
Thank you Mayowa for your insightful comment, i am glad you like the post.