PONZI SCHEMES: AN OVERVIEW - Part 1

The words “Ponzi scheme” can be found quite easily throughout the world of media these days. What exactly is a Ponzi scheme though? It’s something to be forewarned about so that you don’t fall into its deadly trap.


DEFINITION

First things first, according to the American Bar Association, a Ponzi scheme is:

“…a type of securities fraud where the promoter makes some sort of false or misleading statement about an investment (often including a guaranteed high rate of return) and pays off older investors with newer investor’s monies. Eventually, when the promoter can’t find any new investors, the scheme collapses.”

The difference between a Ponzi scheme and a pyramid scheme is that a Ponzi scheme the promoter handles the new recruits and the new money. Within a pyramid scheme, people within the scam recruit new participants. In both of these traps, the early investors receive an income from the subsequent individuals taking part in the scam; however, only in a Ponzi scheme does the organizer handle all of the recruitment.

COINING THE TERM

Charles Ponzi came to the United States at the turn of the century from Italy. He was an Italian swindler that went by many different aliases to con his prey and had been jailed many times. In 1918, he began offering his investors a choice between receiving a fifty percent return on a simple forty-five day investment and receiving one hundred percent return on a ninety day investment. Ponzi promoted that this was a possibility due to a special circumstance with the international postal reply coupon system. Back then, due to an international agreement, postal reply coupons were accepted by all countries despite the fact there were varying cost from country to country (depending on their economy).

As legal as Ponzi’s idea was (the cost for an IPRC in the US could have been a dime while a nickel in Germany), he full well knew that his idea would not be a success. It was impossible due to importation restrictions. The idea was too tempting though and Ponzi pushed it well.

Unfortunately for Ponzi, suspicions grew when investors would not receive the interest on their investments. The scheme had no underlying business so it couldn’t possibly generate any revenue! In 1920, Ponzi’s brilliant idea came crashing around when investors began requesting their money be returned during a growing governmental inquest into his company.