Ponzi Schemes

A Ponzi scheme is fraudulent business operation that promises investors high returns on investment with little risk. Projected returns are often offered at higher-than-market rates, sometimes in excess of 50%, in order to entice an individual to invest. Investors in a Ponzi scheme are led to believe their money will be invested in a legitimate business operation and they will receive regular cash returns on their investment. However, in reality, their money is used to pay returns to earlier investors, and their returns, if any, will come from funds collected from new investors. This type of scheme is dependent upon the ability to attract new and more investors because without these additional investments, there would be an inability to pay the existing investors. 

The first Ponzi scheme was orchestrated by an Italian immigrant named Charles Ponzi in 1919. At the time, it was typical for a government to allow individuals to redeem postal stamps for local currency. Ponzi intended to capitalize on this system by purchasing postal stamps from a foreign country and holding them until the currency’s value increased. Friends and family of Ponzi joined this venture by providing the necessary money to invest in the operation. Ponzi promised a 10% return each month, which created buzz for his venture because banks were only offering a 5% return per year. Ponzi was entrusted with approximately $15 million dollars from investors. He used ‘new’ money to provide fake returns to ‘old’ investors. When it was discovered that Ponzi was becoming bankrupt, investors demanded their money back, and Ponzi’s scheme was finally uncovered. Ponzi pleaded guilty to mail fraud and spent time in federal and state prison before he was deported to Italy. 

A key aspect for a Ponzi scheme to succeed is the promise of high returns with minimal risk providing a mechanism for the perpetrator to draw the required attention and obtain investors. These individuals lure investors with unheard of profits; however, many investors tend to question the high rates of return and therefore, the perpetrator of the scheme must have a believable story. This story must provide investors with something reasonable, which can range from anything involving banks to mortgages to international manufacturing companies. The key to making this story believable is the use of diverse, complex, and unique situations. 

Once an investor has been drawn into a scheme, the individual conducting the operation must work to gain investor trust and conceal the truth for as long as possible. Once the trust of investors has been fully gained, the perpetrator must meet this trust with the promised payments. These payments must be made on time in order to verify the initial story and not create cause for concern. This keeps investors content and keeps them from questioning the operation, since they are receiving returns on their investments. 

Because the money received from investors is not actually being invested but it is rather going to pay the supposed returns of other investors, the operation will eventually collapse when there is a lack of new investors. Therefore,  the cycle must be sustained in order for the perpetrator’s work to go unnoticed by investors.  This is why it is so important to attract new investors with the high rate of return with low risk and with believable yet attractive stories. 

There are countless examples of Ponzi schemes occurring around the world each year, but perhaps the most notorious scheme was discovered in 2008 and involved prominent businessman Bernie Madoff. Madoff was able to convince affluent businesspeople and even companies to invest in his strategy of “absolute returns.” Individuals trusted him and did not question his methods even though he was very secretive about what he was doing with their money. An important element to note is how investors saw it as a privilege to be able to trust Madoff with their money. It has been said that individuals were asking his current investors to pull strings for them to be able to give Madoff their money. Madoff’s operation was discovered when he was unable to keep up with investors requesting repayment -- just as every other Ponzi scheme is eventually crumbles. Madoff’s investors ultimately lost approximately $20 billion throughout the duration of his scheme. 

Ponzi schemes continue to evolve with changing technology especially through the introduction of virtual currencies. Virtual currencies, such as Bitcoin, may be attractive for the perpetrator of a fraud since these currencies offer privacy and have less regulatory oversight than conventional currencies. Even though cryptocurrency is a relatively new development in the financial industry, there have already been numerous Ponzi schemes and other frauds involving it. It has been reported that one in four of the Ponzi schemes uncovered in 2022 involved cryptocurrency. A recent example of a Ponzi scheme involving cryptocurrency would be OneCoin, which began in 2014.  The scheme involved a multilevel marketing structure where commissions were paid to members who sold crypto packages to others and was marketed as being similar to Bitcoin; however, OneCoin was not a legitimate cryptocurrency and had no actual value from the start. The OneCoin cryptocurrency scheme collected more than $4 billion from at least 3.5 million individuals between 2014 and 2016. In September 2023, a co-founder of OneCoin, Karl Greenwood, was sentenced to 20 years in prison after he pled guilty to wire fraud and money laundering charges.  

During the “Madoff era”, the average size Ponzi scheme involved approximately $98 million. This amount is dramatically increasing through the use of cryptocurrency, which is demonstrated by the OneCoin scheme. According to data published by the Federal Trade Commission (“FTC”), consumers reported losing approximately $8.8 billion to fraud in 2022, with investment scams making up more than $3.8 billion. This data published by the FTC indicates consumers lost 30% more due to fraud in 2022 than in 2021. These statistics highlight why individuals need to be vigilant. 

If you think you may be a victim of a Ponzi scheme you should contact law enforcement, legal counsel and a forensic accountant.