Ponzi Schemes

A Brief History

The Ponzi scheme has existed in varied forms for many centuries and takes its name from Charles Ponzi who in 1920 committed a multimillion dollar investment fraud involving the sale of foreign postal coupons. Ponzi was able to solicit funds from investors by promising a 50% return on their investment within 90 days. In total, Ponzi took more than $10 million from thousands of individuals who were hoping to see a significant return on their invested funds. However, instead of investing the funds as promised, Ponzi pocketed a large portion of the funds, while using the remaining to pay “returns” to investors. Ultimately, his scheme collapsed, and Ponzi was convicted of fraud and sentenced to jail. The investors never saw their money again. While this crime has existed for many years, the basic operation of the fraud, as well as the means used to obtain new investors, are the same today. What have changed over the years are the techniques used to perpetrate this offence; these have adapted to technological advancements and prevention efforts.

How Ponzi Schemes Work

Ponzi schemes are typically perpetrated by either a single individual or a small group (two to three) of individuals working collaboratively. Contrary to popular opinion, all Ponzi schemes do not develop as outright frauds. In many cases, Ponzi schemes are initiated by well-intentioned individuals seeking to secure funding for a business or other legitimate financial opportunity. However, these individuals may quickly find that their initial financing plans were either inadequate or severely anorexic. As a result, these initially well-intentioned individuals have found themselves within the realm of pure fraudsters and criminal opportunists.

Regardless of whether the Ponzi scheme initiator has legitimate or deviant intentions, all Ponzi schemes begin at the same point: the offering of a high-value investment opportunity. Potential investors are enticed to make a stake in the scheme because of the promise of high net returns on their investment and the understanding that the investment itself is a solid opportunity. Up to this point, Ponzi schemes operate like any other type of investment where individuals seek to make financial gains on the funds they have invested. In legitimate investment opportunities, investors receive some stated rate of return on their investment, which typically is proportionate to the risk associated with the investment. However, in a Ponzi scheme, investors are not paid returns based on the performance of some financial instrument. Instead, investors continue to receive funds from their investment so long as the scheme initiator is able to secure new investors.

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