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What is a Ponzi scheme and what can you do to avoid them?

Ponzi scheme is a phrase you may have come across in the press recently as it seems to be a constant reference point used by those journalists committed to exposing the latest digital frauds.  However, do you know what a Ponzi scheme is?

A Ponzi scheme is an investment fraud that promises to pay its existing investors by using the additional funds raised from new investors who have been persuaded to join the scheme with promises of higher than usual levels of return for a minimal risk.

While the schemes can raise a lot of money very quickly for the organisers, it is far from a robust model.  In order to work the schemes need a constant flow of new investors and the majority of schemes will collapse when they can no longer find the new recruits required to provide that flow of new funds.

The schemes take their name from Charles Ponzi, a fraudster who, in the 1920s, cheated thousands of New England residents of their savings by launching a postage stamp scam that promised investors a 50% return in just 90 days.  When the scam launched Ponzi did buy a few international mail coupons but, once the scam was up and running, he ignored the postal element and just used the incoming funds to pay off the earlier investors.

If postage stamps and the 1920s all seem a long way off, we can assure you Ponzi schemes are very much a 21st century problem. 

In 2008 the US’s Securities and Exchange Commission (SEC) charged Bernard Madoff and his investment firm, Bernard L. Madoff Investment Securities LLC, over the multi-billion dollar Ponzi scheme he’d used to defraud his advisory clients over a period of many years.  The SEC was able to freeze his assets and return some of the invested monies back to the clients investors involved.  He also received a 150 year prison sentence.

The Madoff case is interesting for 2 reasons. 

The first is Bernard Madoff does not fit into any traditional criminal mould.  He was a well-known figure in the securities industry, even serving as vice chairman of the NASD and chairman of the NASDAQ Stock Market’s trading committee.

The second reason is that Madoff didn’t make the usual promises about huge and unmissable returns.   Instead he provided his clients with falsified statements showing modest but consistent gains, a reward many were willing to accept and even appreciate during a difficult time for the markets.

Both of these points go to show that the organisers behind these schemes are getting more cunning and are even prepared to use professional respectability to gain the confidence of their victims.  This means that as a potential investor you have to remain on your guard at all times.

We would suggest that if you are approached by any scheme that could fit the Ponzi mould you must:

  • Be suspicious of any scheme that promises high returns with little or no risk because every investment carries some risk and usually the higher the return, the greater the risk will be.
  • Be suspicious of any scheme that promises a consistent level of return returns as the unpredictable nature of the markets dictates that all investments will go up and down over time.
  • Be suspicious of any unregistered investments because the regulators’ involvement will provide you with the information about the company’s management, history and finances you will need for your due diligence.
  • Be suspicious of unlicensed sellers simply because legitimate firms will be licenced while those involved in Ponzi schemes tend not to be.
  • Be suspicious of secretive or overly complicated models, especially if you can’t get a better explanation as the chances are, the organisers will be trying to hide something.
  • Be suspicious if there are any issues with paperwork as again a refusal to provide the paperwork you want could be a warning that the organisers are trying to hide something. Similarly any obvious errors in the statements you receive could also be a warning things are not as they should be.
  • Be suspicious if you are not receiving the payments you should be and if payments aren’t forthcoming and never accept an offer to reinvest the payments your owed to generate even higher returns.

As an extra layer of insulation, we would also suggest you ask the scheme’s managers:

  • If they are licensed and if they are, by whom
  • If the scheme is investment registered and if it is, by whom
  • How does the level of risks correlates with the level of return
  • What options you have should the scheme not deliver the promised returns

If you have been the victim of any type of a Ponzi scheme or any other type of fraud and want to discuss how best to recoup the money you have lost, call us today on 020 7792 5649 or email us at This email address is being protected from spambots. You need JavaScript enabled to view it.. 


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