Ponzi Schemes Remain a Threat to Investors
While investors generally understand that high yield means high risk, many are taken in by the promise of high yields with low risk, particularly if the broker offering the investment appears to have good credentials, claims to be part of a reputable firm, or uses testimonials to show that the investment has enjoyed some success. Scammers may start off by paying out quickly and handsomely to initial investors, encouraging them to invite others to invest. The new money coming in is then used to pay earlier investors, as well as the scammer running the scheme. But sooner or later the scheme collapses, leaving the most recent investors out of pocket, sometimes seriously so.
Ponzi schemes are named after Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi (1882-1949), more commonly known as Charles Ponzi, an Italian con artist who operated in the United States and Canada in the early 1920s. His scheme promised clients a 50% return on investment within 45 days, or 100% in 90 days. The ‘investment’ involved purchasing discounted postal reply coupons in foreign countries and redeeming them in the United States at face value as a form of arbitrage, taking advantage of the price difference between the two markets. However, Ponzi used the money from later investors to pay initial investors and, primarily through word of mouth, the scheme gained momentum and continued for more than a year before collapsing, costing investors $20 million at that time, more than $225 million today.
The Securities and Exchange Commission lists the following ‘red flags’ for identifying Ponzi schemes: High investment returns with little or no risk; overly consistent returns; unregistered investments; unlicensed sellers; secretive and/or complex strategies; issues with paperwork; and difficulty receiving payments or cashing out of the investment. One of the ways investors can avoid becoming victims of Ponzi schemes is insist on complete transparency and clear-cut answers to any questions they may have. Take a tip from history’s Ponzi king, Bernie Madoff, who noted that he only turned potential investors away when they asked too many questions.