How To Spot A Ponzi Scheme or Don’t Be Duped Into Allowing Strangers To Steal All Of Your Money

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Since the dawn of civilization, there have been scams and con artists. Con artists are that special class of person whose sole job in life is devoted to stealing anything and everything of commercial value from you without you realizing you are being robbed. These folks will take all of your money, property, possessions or anything and everything of value that can be converted into cash or some other form of easily convertible asset. It’s an unfortunate state of affairs that these people even exist in this world, but that’s just the way it is. To add insult to injury, this kind of robbery is almost always done with your unwitting cooperation. These kinds of scams are in fact so common today that almost everyone, regardless of income or education level, has been a victim of them at one time or another. People of means are especially vulnerable to this kind of fraud. But there are things that can be done to minimize the risk to you, which we will explore here. One of the most popular of these scams, and arguably the hardest one to spot and protect yourself from is the Ponzi Scheme. There are, however, ways you can expose them for what they are that we will explore here but the first thing we need to understand is how this type of scheme works.

Before we get into the mechanics of this particular fraud, it’s best to begin with why the Ponzi Scheme has worked so well for so long. The major reason for this is that the mechanics of the fraud are actually triggered by the victim’s own emotional buttons. Once you are familiar with how these buttons are used by the perpetrator of the fraud to spring the trap, you will understand two things, why most people are so easily duped and why you won’t be. But first things first, how did this scheme start and how does it work?
The Ponzi Scheme started in Boston, Massachusetts in the early 1900s by the scams namesake Charles Ponzi, an ambitious Italian immigrant. Although this type of fraud had been around for hundreds of years, and was in fact detailed in a novel by Charles Dickens titled “Little Dorrit”, what set Ponzi and his version of the swindle apart from all the other bit players and crooks who had used it in Boston and elsewhere was the absolute enormity of the crime. His scheme literally robbed thousands of people out of millions of dollars seemingly overnight. When he was finally arrested and prosecuted he had stolen over $7,000,000.00 all in the space of 8 short months. This crime and the amount of money stolen at the time was almost unfathomable. In today’s dollars, it would be the equivalent of a theft of approximately 84 million dollars all done in less than a year. The other element of the crime that was initially baffling to authorities was the fact that all the victims willingly gave Ponzi their money. This theft was unique not only in the amount of money stolen from investors and the unsuspecting public but also because of the ease and speed by which it was done. Charles Ponzi’s scheme was so notable that it still stands today as the single most significant example of fraud in America. However, with the dawn of the internet age, the dollar amount stolen by Ponzi has been eclipsed by more than one criminal mastermind. The most notable of these crimes was orchestrated by the infamous Bernie Madoff, whose 65 billion dollar Ponzi Scheme was given months of worldwide television and press attention. As a side note, it took Bernie over 20 years to pull off his scam before he was caught.

The Man

Charles Ponzi started out life in America dirt poor. He was broke but he never gave up on wanting to become wealthy. He worked at this goal diligently for years but was never really successful. His life completely changed, however, when he stumbled on what would become the scheme to end all schemes. It came about this way. It was a common practice among immigrants and others in the early years of the twentieth century to mail letters to family and friends with a prepaid international reply coupon (IRC) enclosed in the letter. This was done to make it convenient for the recipient to mail a reply back. Once the letter was received in Europe or America the enclosed prepaid IRC could be exchanged by the recipient for the proper return postage at a local post office.

Ponzi learned about the IRC coupons when he received an international letter from Spain with a prepaid return coupon enclosed in it. When he carefully examined the price of the return coupon he received compared to the actual price of the return stamps he noticed a large difference. He immediately recognized that if this difference in price was consistent enough it could be the basis for a fantastic and seemingly foolproof business opportunity that could make him extremely wealthy. But first he had to determine what caused this price difference. He concluded that it depended in large part on where the coupons were purchased and if the currency of the issuing country was fluctuating in the open market or possibly depressed. He immediately saw that if he bought and sold these instruments methodically this price spread or arbitrage could make him a very, very rich man. He also recognized and that if he could hire outside agents to help him he could buy huge quantities of these instruments, retain complete control of the scheme and make a fortune. His mind raced with the possibilities.

To initiate this plan, Ponzi would have to hire agents in overseas countries to buy the local reply coupons for him. After they purchased the IRCs they would then mail them back to him in the United States. Hiring the agents, he reasoned, would be fairly easy as there was a large pool of immigrants in Boston for him to connect with. Once an overseas agent was in his employ he would then send them money to purchase the return coupons locally. Once purchased, the agent would then mail the coupons to Ponzi in the United States where he would exchange them for the more expensive return postage stamps. Once he exchanged them for the return stamps he would immediately sell them. The sales would, of course, reap huge profits. He then concluded that the more agents he had the more sales he could turn and the more money he could make. The initial coupon transactions he used to test this theory worked out so well it was reported that he made a 400% return.
However, in practice, he found that the scheme was not at all viable. In reality, it proved extremely difficult to hire overseas agents, the transaction costs involved were more than expected, and the time delay in communicating with any overseas agents made the prospect of paying investors regularly problematic at best. But these initial difficulties didn’t deter him. He decided to sell the scheme to those he knew locally in the immigrant community and others anyway. To get around the lack of legitimate profits, he decided he would pay investors back with money he got from new investors. He could still get rich he thought and not get caught.

The Scheme

On December 26th, 1919, he established a firm called “The Security Exchange Company” on State Street in Boston to be the front for his new business. Much to his surprise when all the elements were put into place, everything worked and he started making money, lots of money. Before he knew it his success was so large that he began to gain the attention of the local press. Rather than sate his greed, these successes only encouraged him to become bolder and enlarge the scam to make even more money. It was even reported at the time that he was making as much as $250,000 a day buying and selling coupons and stamps. Of course, nothing of the sort was happening. He was, however, taking in so much cash that he bought himself an air-conditioned mansion with a heated pool in Lexington Massachusetts along with a chauffeured limousine to drive himself and his guests around in style. As another extravagance, he brought his mother to America by first class ocean liner to show off his good fortune to her.

To enlarge his fraud even further Ponzi began to seek more and more investors from his pool of immigrant contacts in Boston and the general public. He was also inadvertently helped in this by glowing articles in the local press about his company’s miraculous financial success. These articles literally had the effect on the general public of causing investors to line up outside of his offices on State Street clutching fistfuls of dollars waiting for Ponzi to show up so they could give their money to him. His main weapon though was his personal pitch to investors and word of mouth. In his personal pitch, he guaranteed huge amounts of interest in return for investor money. In most instances he promised a 50% return in 45 days to investors who purchased an investment voucher. These were the largest returns anyone had ever heard off and if asked about the safety of their money he always had a ready and easily believable explanation available. As unrealistic as it was it all worked because people wanted to believe it and they wanted to believe him.

For a short time, everything worked like magic and Ponzi was on top of the world. However, as more and more people began talking about his rags to riches success more and more attention was drawn to Ponzi, his company, and the returns. This ultimately set the stage for the total collapse of the fraud. In early August of 1920, the Boston Post began to investigate Charles Ponzi, The Security Exchange Company, and its reported investment returns. What the Post uncovered in their investigation was what was later reported as a web of lies, deceit, and broken promises. When the article appeared in the paper on August the 12th, 1920 there was a run on The Exchange Company’s assets by frantic investors. Panicked people rushed to State Street headquarters to cash in their investment vouchers. When the run ended Ponzi’s company was bankrupt and no one was surprised when shortly afterward Charles Ponzi was arrested and prosecuted for multiple counts of mail fraud. He was subsequently convicted of all charges against him and spent 14 years in prison.

What This All Means To You

The main thing to understand about yourself and the Ponzi scheme is that you are not immune. The fact that you are an investor of means actually paints a huge target on your chest. To illustrate this, most of the victims that were skinned by Bernie Madoff were not your average mom and pop investor they were, in fact, wealthy. Some of Madoff’s victims were even considered very sophisticated investors. Regardless, he swindled them all anyway. He also swindled scores of banks, hedge funds, retirement funds, accredited investors of all persuasions and both public and private banks. How did he do it? The same way Charles Ponzi did it. He used the victim’s emotional triggers to spring the trap and suck them into the scam.

How The Trap Is Set

A common tactic used by the Ponzi scammer is to quietly let the word out to a small group of new marks and their friends that the investment success of their friend was due to the scammers vast knowledge, inside information, or some other special insight that no one else had. This would inevitably trigger the curiosity of those victims. When questioned by a new mark the scammer would usually feign indifference unless pressed. At this point, it is common to get what is called the anti-close from the scammer. The scammer is absolutely not interested in new clients, there’s just not enough time, there are too many clients already or some other plausible reason. There are many variations of the anti-close but one or more are generally used at this point in setting the trap. At this point in the scam, there is normally a plea by the mark to make an exception because you are a good friend with so and so. The scammer will then seem to relent somewhat. Once the scammer is sure you have taken the bait he will usually always have a change of complete change of heart and begin to reel you in. Once reeled in the scammer will then dictate the terms of his special “Deal” to you. The “Terms” usually involve you giving the scammer all of or most of your money. That’s the way Ponzi did it and that’s also the way Madoff did it and it always works. The surprising fact is the victims do it to themselves.

How To Recognize This Scam And Not Become Its Next Victim

Why does it always work? Because people want to believe it. It’s that simple. Investing is hard, getting good returns is hard, and many people are looking for an easy answer to these problems. This is why people will suspend their doubts and put their intellect on hold because of two critical things provided by the Ponzi scammer: 1) Trust. Your good friend Bill, who you trust, has made a fortune by taking the advice of this guy you don’t know and, 2) Faith. You want to believe it’s true because Bill is your friend and you have faith in him. To make sure this never happens to you all you have to do is remember this fact and simply act on it. If it sounds too good to be true it isn’t. The other thing to remember is that all the losses of all the people who have ever been scammed out of their money happened because they were greedy. There’s an old saying you should memorize about greed that goes like this, “Pigs get fat and hogs get slaughtered.” Nobody wants to be the hog, do they? Do you? Of course not.

Although the prior scenario is standard there are sometimes variations on it. Bernie Madoff’s Ponzi scheme used one of these. His investment record was very long. It spanned decades. Yet through all the good times and bad times his returns were always consistently good, too good. They were, in fact, unnatural. But even so, people suspended their disbelief because of the same old reasons. See number and one and two above. Don’t forget the role greed plays in this and review that old saying again. Enough said.
One last red flag to be aware of is a lack of details. All registered investments are required by law to have certain documents on file with the SEC. There are exceptions to this rule and there are instances where registration is not always required but you should always ask for an explanation if there is a lack of written information. When you ask that question and you don’t receive a clear answer call someone not associated with the investment company and ask them. Better yet call the Securities and Exchange Commission. They are actually there to help you. The bottom line on this one is if you get an explanation to any question you ask about an investment that doesn’t make sense grab your wallet and leave. While you are leaving remember that old Will Rogers adage “I’m more interested in the return of my money than the return on my money.”

P.S. As a postscript to this piece if you go to the SEC website and click on Ponzi Schemes, which you will find on the first page of their website, you will pull up all the current Ponzi Schemes that are either being investigated or prosecuted by the government. The number of these scams is absolutely astounding considering the history of this crime. They also stand as a testament to Charles Ponzi and his fraud to end all frauds.


© Richard Woodling 2014