What is a Ponzi Scheme?

Ponzi schemes are a specific type of investment fraud, where criminals will take money from unsuspecting victims, promising to handle their victim’s money and get great returns. In reality, they are using money from newer victims whose money they have also taken to pay back original victims. Schemers will usually offer great returns on initial investments for no risk to the investor.  Ponzi schemes can be summed up in an infamous quote by Charles Ponzi, the man that ponzi schemes are named after, “the old game of robbing Peter to pay Paul”.

Ponzi schemes usually end in three ways:

  • Scheme creator runs off with money
  • No new investors, leading to a collapse of the scheme
  • Too many investors will ask for their return, leading to a collapse of the scheme

There are six warning signs or “red flags” the SEC, U.S. Securities and Exchange Commission, warns to look out for in order to identify a potential ponzi scheme:

  • No risk guaranteed returns
  • Suspiciously consistent returns that completely disregard changes in the market or stock values
  • Unlicensed / unregistered sellers or firms
  • Creators are shady, not open about strategies
  • Paperwork has numerous errors on it, like an unbalanced balance sheet
  • Difficulty getting money back

Development / Timeline

Ponzi schemes have been created ever since people needed money and have been created around the world, some notable ones are:

1880 – Sarah Howe’s “Ladies Deposits”

1920 – Charles Ponzi’s Stamp Scheme

1997 – Albania’s government backed ponzi schemes

2000 – Reed Slatkin’s Scientology Scheme

2001 – Haiti’s government advertised ponzi schemes

2007 – Lou Pearlman’s Investment schemes

2008 – Bernard Madoff, the biggest ponzi scheme in recorded history

*Through Madoff’s ponzi scheme, which went on for over 20 years, investors lost nearly 65 billion dollars, he is currently serving a 150 year jail sentence

The Impact

Accountants have failed to discover these frauds in timely manners, earning them bad reputations. An example would be that auditing firms and government checkers failed to notice Madoff’s scheme for nearly 20 years. The general population seems to think that “money managers [are] turning into money makers”.  Auditors and even government officials are constantly criticized for their inability to catch ponzi schemes and bring the creators to justice quickly enough.

The Future Outlook

Ponzi schemes will probably never stop, as long as people need money and they are smart enough and desperate enough, they will find a way to get money, whether it is through legal means or illegal ones, like creating a massive ponzi scheme. Even when a ponzi scheme is busted, the court procedures are very long and daunting, Bernard Madoff’s case is still being looked at today by the SEC, meaning less time can be spent on finding undiscovered ponzi schemes. People looking to invest their money must be cautious and learn from the past, being careful of where they place their money, if everyone is careful enough with their money, perhaps the impact of ponzi schemes can begin to decrease.

Video

An FBI video, with testimonies from victims of ponzi schemes, and advice from FBI agents can be watched here:

Frauds and How to Spot Trouble

Works Cited

Gandel, Stephen. “The Madoff Fraud: How Culpable Were the Auditors?”. Time. 17 December 2008. 7 April 2011 <http://www.time.com/time/business/article/0,8599,1867092,00.html&gt;

Margolick, David. “His Last Name Is Scheme”. The New York Times. 10 April 2005. 7 April 2011 <http://www.nytimes.com/2005/04/10/books/review/10MARGOLI.html?_r=1&ref=ponzischemes&gt;

Nasaw, Daniel. “Timeline: Key dates in the Bernard Madoff case”. Guardian.co.uk. 16 February 2011. 7 April 2011 <http://www.guardian.co.uk/business/2009/mar/12/bernard-madoff-timeline-fraud&gt;

Washington, Rudy. “Bernard L. Madoff”. The New York Times. 16 February 2011. 7 April 2011 <http://topics.nytimes.com/top/reference/timestopics/people/m/bernard_l_madoff/index.html?inline=nyt-per&gt;

“The First Ponzi Scheme”. The Washington Post. 17 December 2008. 7 April 2011 <http://voices.washingtonpost.com/washingtonpostinvestigations/2008/12/the_first_ponzi_scheme.html&gt;

“The 10 Nastiest Ponzi Schemes Ever”. Business Pundit. 15 December 2008. 7 April 2011 <http://www.businesspundit.com/the-10-nastiest-ponzi-schemes-ever/&gt;

“Ponzi Schemes”. The New York Times. 7 April 2011 <http://topics.nytimes.com/top/reference/timestopics/subjects/f/frauds_and_swindling/ponzi_schemes/index.html?scp=1-spot&sq=ponzi&st=cse&gt;

“Ponzi Schemes and Forensic Accountants”. Bella Online. 7 April 2011. <http://www.bellaonline.com/articles/art49196.asp&gt;

United States. US Securities and Exchange Commission. Ponzi Schemes – Frequently Asked Questions. 7 April 2011 <http://www.sec.gov/answers/ponzi.htm&gt;