In short, a Ponzi Scheme is a well-known form of white collar crime. White collar crime is a broad term that describes any crime committed through deception, intended to increase financial gains. The Ponzi Scheme was named after Charles Ponzi in 1919, who was the first person to develop an orchestrate such a scheme. Charles hired people to buy cheap stamps overseas and ship them to the United Sates, where he would exchange them for more expensive ones to sell at a profit. Here’s where the illegal activity came in: Ponzi started promising quick returns, and shifted investor money around to pay out — rather than actually investing it.
More specifically, a Ponzi Scheme is a fraudulent investing scam that typically occurs when someone guarantees high returns on a investment. Rather than actually investing this money, the orchestrater of the Ponzi Scheme uses new investments to pay returns to old investors. This cycle continues — collecting new investments to pay to earlier investors as alleged returns. However, at some point, there will be no new investors to add money into the cycle. At this point, the Ponzi Scheme will collapse, leaving all the latest investors with none of their original money or any returns.
Perhaps most infamous for running a Ponzi Scheme is Bernie Madoff. In 2008, he was convicted of falsifying trading reports to pretend he was making a profit for his clients. In reality, he was using money from new investors to pay out returns to older investors. Unfortunately, by the time Madoff’s Ponzi Scheme was caught, many people had fallen victim to it and lost money. Nearly $65 billion had been defrauded from his investors over at least 17 years. He is now serving a 150 year prison sentence.
Fortunately, most Ponzi Schemes share some common characteristics. These allow potential investors and the SEC to identify them, stay far away, and press charges. Below are some tips to identify and avoid getting roped up in a Ponzi Scheme.
- Be wary of guaranteed high returns
- Be wary of investments with little risk
- Avoid investments that are not registered with the SEC
- Make sure you can easily remove your money
- Make sure you can view investment paperwork
If you do research on your investment, and make sure it doesn’t have any of these red flag characteristics, you should be able to avoid falling victim to a Ponzi Scheme. If any friend or family is getting involved with such an investment, it is important to strongly advise them to steer clear.