Ponzi Schemes: The Pyramid Tumbles Down
By: Source: AARP.org Date Posted: 2006-04-09 11:57:00-04:00
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When Joan, a retiree living in Santa Fe, heard from a financially successful friend that an investment he'd made was getting interest rates of over 20%, she gave the broker a call. She wasn't sure she completely understood details of the "foreign currency hedge fund" he was urging her to invest in, but it was hard to argue with the results it was producing. In fact, it looked like such a good deal that she convinced her father-in-law and sister-in-law to invest as well. Over the next few months, statements from the investment company arrived regularly, and the results were just as had been promised. So Joan eagerly reinvested her returns in the scam.
But after awhile, the statements and the payments stopped coming. Her calls to the broker weren't answered. And then it all came tumbling down – she read in the newspaper that the broker wasn't really a broker at all, and that she and many others had been snared by a scam – a "Ponzi scheme." All of the $80,000 she'd invested was gone.
Ponzi schemes can be well-disguised and enticing, but they tend to share some common characteristics. If you know what to look out for, you can avoid them.
How Ponzi Schemes Work
The con artists who run Ponzi schemes constantly come up with new bait. In Joan's case it was a foreign currency hedge fund, but it could be an ATM franchise, stocks, certificates of deposit, anything that might sound promising. The pitch is often elaborate and inventive; the promise is very high returns over a very short time.
For example, the Securities and Exchange Commission (SEC) recently shut down an Internet Ponzi scheme in which people were told that if they paid money to a certain company and then viewed ads that came up automatically on their web browsers, they would receive money from ad revenues. They were promised a return of 44% in just 12 days. In reality, some early participants were paid money invested by later participants. Most investors simply lost their money. According to the SEC, 300,000 people worldwide were bilked out of more than $50 million in this scam.
Ponzi schemes, named for a 1920s con artist, are a kind of pyramid scheme. Investors are lured with promises of unique opportunities producing high returns, and for awhile they may get those returns. But what they don't know is that their money is not really being invested in anything at all. The interest they receive is money being paid in by later investors. As long as more investors sign on, which they will because of word-of-mouth advertising about the "great returns," everything seems fine. But since no real investments are being made, it can't last long. Because the promoter is only collecting money from new participants to pay off earlier investors, the scheme will inevitably fail. After a time, the con artists pocket investors' money and disappear.
As with other scams, the con artists running Ponzi schemes may try to find their marks over the telephone, through the mail, with advertisements, or in face-to-face meetings (perhaps arranged through friends or relatives who have been taken in). And of course, the Internet provides fertile ground for all kinds of fraudulent investment promotions.
Red Flags
Although the product and approach may vary, there are warning signs that many Ponzi schemes and other investment scams have in common. Look out for:
- Unexpected telephone calls, letters, emails or even personal visits from strangers-or even friends – who offer quick profit schemes requiring an immediate investment from you.
- Promises that you can double your money within a short time.
- Irregular interest payments.
- Stalling by the seller when you ask to withdraw your investment.
How to Do Your Research
People offering honest investments welcome questions, and will give you the time to do some research.
- Check the product. Before sinking your money into any investment – no matter how promising the returns, make sure the offering is registered with your state securities regulator.
- Check the person. People selling most investments must be licensed by state regulators.
- Watch for very high returns over a very short term. When Ponzi schemes get started, the returns can be great. The word gets out about the high returns, drawing more people in, just as Joan convinced her family to invest. But actually money is just being transferred from new investors to old investors.
- Read everything you can. Get on your computer or go to the library and look up articles about the product being offered and the person offering it.
- Don't be pressured to act quickly. Be ready to say, "I'm not making a decision today."
AARP Resources
AARP on Investment Frauds
| Because your Money Matters, get more tips and action steps on Ponzi Schemes - PDF file |
AARP Message Board
Has anyone ever approached you or a friend with what you thought was an investment scam? Ever been scammed? Share your experiences with investment scams.
Other Resources
"Pyramid Schemes"
The Securities and Exchange Commission shows how the pyramid scheme builds and then folds, taking investors for a fall.
"Bubble and Ponzi Schemes Used in Investment Fraud"
It is not the investment, but rather the process that makes the Ponzi investment scheme a fraud.
State Securities Regulators
You can find your state securities regulator by going to the Financial Industry Regulatory Agency website and clicking "Contact Your Regulator."
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