Even in the wake of the “Bernie” Madoff scandal, investors continue to lose billions of dollars in Ponzi schemes. Stripped to its bare bones, a Ponzi scheme is a ploy where a promoter pays one set of investors with money raised from other investors.
Ponzi promoters promise investors high returns but offer few details, except to indicate that they have found a way of generating high profits by making highly secure investments in assets such as foreign currency transactions, European “prime note” deals, diamonds, gold, complex stock trading strategies, or real estate. The pitch for a Ponzi almost always promises high returns and little risk. The potential investor is told that the exact mechanics for doing this are secret. Many Ponzi promoters gain credibility by actually paying their customers high returns for months, even years.
The ploy is that the Ponzi promoter pays early investors their “returns” with money raised from subsequent investors. Along the way, the promoter buys himself a Rolls Royce, yacht, and a luxury penthouse or two (or four).
As happened with Bernie Madoff, Ponzi schemes inevitably fall apart when too many investors start asking for their money back and the supply of new investors declines to the point where there are not enough Peters to pay Paul.
The North American Securities Administrators Association (NASAA) has offered the following seven rules for avoiding Ponzi schemes:
- Beware promises of high, guaranteed profits. This is perhaps the easiest way to spot a Ponzi scam. Any legitimate investment involves a degree of risk that makes it impossible to flatly promise profits, much less astronomical returns.
- Avoid promoters who fail to provide clear and detailed explanations. Don’t listen to promoters who tell you that it is impossible to explain their deal in layman’s terms. Many investors fail to seek even the most rudimentary basic understanding of the investment they are making.
- Check out the promoter’s background. Check with your state, provincial, or territorial securities office for licensing/registration of the individuals selling the investment. Remember, anyone selling a security must have a license. If the promoter says he’s exempt, follow-up with your regulator to confirm the claim.
- Get information from your state or provincial securities regulator. Since most Ponzi schemes involve investment contracts, they should be registered as securities offerings with your state, provincial, or territorial securities division. If the promotion appears to be in violation of state securities law, turn over all information on the case in your possession to securities regulators.
- Ask for detailed information in writing. Any investor is within his rights when insisting on detailed information from a promoter seeking large sums of money. Ask for information on the company, its officers and financial track record. If a product is involved in the deal, ask for documentation on its cost, fair market value, and existing and potential markets. Frequently, Ponzi promoters rely on nothing more than fast talk and official-looking promissory notes when investors sign over their funds. Reluctance to provide detailed information should be regarded as a red flag of a potential Ponzi scheme.
- Verify the promoter’s claims. Remember that seeing is believing. Be skeptical of deals that can’t be checked out in person. When it comes to checking on details of your investment, be particularly leery of claims that all banking transactions and bookkeeping are handled in remote cities or other countries. Searching the internet is another way to verify the investment deal. If you do not have a home computer, your local library has internet access available to the public. Investors are sometimes told that certain information is being kept “secret” for security purposes.
- Resist pressure to reinvest without seeing your “profits.” Ponzi schemes often are kept going for substantial periods of time by promoters who convince even initial investors to roll-over their “profits” for even greater returns. While it frequently makes sense to stay with a legitimate investment over time, be suspicious of promoters who are reluctant to let you cash in your gains.
- Look for unbusiness-like conduct or disruption of services. Reluctant to have their schemes exposed, few Ponzi operators enlist much, if any, office help, and may even go to the extreme of answering the phone and opening all the mail themselves. This has the effect of hastening the collapse of the Ponzi scheme, since it makes it even more difficult for one person to keep up with all the required payments and investor contacts. And when the Ponzi bubble is about to burst, promoters typically become extremely difficult to reach.
Ponzi schemes are illegal and can result in criminal prosecution of the promoters. Others who help out promoters by recruiting more investors (for a fee) may themselves be engaged in prosecutable activity. But the prosecutions seldom result in a recovery of enough money to benefit defrauded investors.
When Ponzi schemes collapse—and they always do—there is typically a scramble for assets. Sometimes, investors who thought they were being paid actual returns on their investments find themselves on the wrong side of suits by bankruptcy trustees seeking to recover proceeds that actually came from later investors.
Investors who have lost money in Ponzi schemes may wonder if it is possible to recover their losses. The good news is that, in many instances, the Ponzi operator may be registered as a representative of a legitimate investment firm. In such cases, the firm may be liable for its employee’s fraudulent conduct, even if the firm was not aware of his actions.
Through the years, we have successfully represented investors who have suffered losses as a result of Ponzi schemes. In many instances, we have been able to recover their losses. If you believe that you have lost money as a result of a Ponzi scheme, please contact us so that we can discuss your rights.