With Ponzi schemes, the investments are opaque, or there is no complete information on file with regulatory agencies. Image: artichoke studio/Shutterstock.com
By: John GrobeA Ponzi scheme is a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors. It was named after Charles Ponzi, a businessman whose scheme garnered considerable press coverage both in the United States and internationally. Ponzi’s name was even mentioned in the popular series Downton Abbey, when Robert Crawley suggests that they raise capital through investment and mentions that “a chap in America named Charles Ponzi offers a huge return after 90 days”.
A recent well-known Ponzi scheme was run by the late Bernie Madoff and victimized wealthy investors.
Even federal employees were victimized by a Ponzi schemer. Wayne McLeod, owner of Federal Employees Benefits Group, bilked feds of $34 million dollars before he killed himself on June 22, 2010. The Securities and Exchange Commission (SEC) became aware of his fraud, and he killed himself a mere 10 minutes before he was to meet with their attorneys.
What are common characteristics of Ponzi schemes?
They will claim to “consistently beat the market”. Studies have shown (see Burton Malkiel’s A Random Walk Down Wall Street) that the market usually comes out ahead of actively managed investments.
The returns they offer are overly consistent. The value of legitimate investments tend to fluctuate over time.
They pay off current investors with the money received from new investors, not from legitimate profits.
Often, the investments cannot be easily understood by the investor, or there is no complete information on file with regulatory agencies.
They are often marketed as “special opportunities” available only to select investors and often for only a short period of time.
Operators will try to limit withdrawals by encouraging current investors to leave their money in the scheme. Sometimes they actively discourage cashing out.
Ponzi schemes are frequently stopped by the authorities, just like the SEC stepped in in McLeod’s case. They can also be derailed by economic crises. The Madoff scheme came apart in the financial crises of 2008. During a crisis, investors might, when trying to take their money out, find out that there is no actual money.
What can we do to avoid being victimized by a Ponzi scheme?
• We can realize that no investment will consistently beat the market.
• We can be leery of any special opportunities we are offered.
• We can remember the old saying that “If it sounds too good to be true, it probably is.”
• We can seek out financial advisors who are fiduciaries.
• We can deal with reputable companies and investments.
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