Ponzi schemes, such as those perpetrated by Bernie Madoff and Allen Stanford, have raised
awareness of such operations among the general public. But smaller, less
notorious Ponzi schemes are carried out on a regular basis. Investors
must be vigilant when selecting their investment advisors and investments,
to protect their assets from such unscrupulous schemes.
What is a Ponzi scheme?
A Ponzi scheme is a fraudulent investment system where funds from new investors
are paid to earlier investors as returns on their "investment."
The organizers of a Ponzi scheme often solicit new investors by promising
investment opportunities that generate
high returns with little or no risk. In many Ponzi schemes, the perpetrators focus
on attracting new money to make promised payments or "returns"
to the earlier investors and to use for personal expenses. There is often
little to no legitimate investment activity actually taking place.
Why do Ponzi schemes collapse?
With little or no legitimate investments to produce earnings, Ponzi schemes
require a consistent flow of new investor money to continue operating.
The schemes often collapse when it becomes difficult to attract this new
money, or when a large number of the earlier investors ask to cash out.
How to protect yourself and your investments?
Before handing over your life savings to an investment advisor, there are
several steps you should take to help safeguard your investments.
First, for brokers, always check and make sure the person is licensed and
registered with a broker-dealer. This information can be obtained through
FINRA's BrokerCheck or by contacting your state's securities division.
Do not be afraid to ask the person if they are licensed and with what
broker-dealer they are registered. Take time to ask these questions from
the start and verify their answers with information from readily available
independent sources. Running such a check will also reveal whether the
firm or individual has a history of investor complaints or problems with
federal or state regulators. If a person is not a registered broker, they
might be registered as an investment advisor. Information on registered
investment advisors can be obtained from the SEC or your state securities division.
Second, consider these "red flags" that are common to Ponzi schemes:
Promised high returns with little or no risk.
Investments always carry some degree of risk, and those promising higher
returns typically involve more risk. Be highly wary of promises of "guarantees"
- such as guaranteed returns or a guarantee of principal protection.
Accessing all available sources of funds.
Ponzi scheme operators are often overly zealous and want to tap into all
of your available sources of funds for investment. Be especially suspicious
if they urge you to surrender life insurance policies, cash out IRAs,
401(k)'s, or pensions, or suggest you could refinance your home and
pull out home equity for investment. Ponzi scheme promoters also tend
to encourage you to spread the word about the great investment returns
you are receiving in an attempt to draw your family and friends into the scheme.
Overly consistent returns.
Most investments tend to vary over time, especially those seeking high
returns. Investments that generate regular, positive returns despite prevailing
market conditions are suspect.
Ponzi schemes typically involve investment opportunities that are not
registered with the SEC or state regulators. Registration is important
because it provides a public record which investors can access to gain
important information about the investment opportunity.
Investment professionals and their firms are required to be licensed or
registered by law. Most Ponzi schemes are perpetrated by individuals who
are unlicensed or working with an unregistered firm.
Secretive or overly complex investments.
Make sure you understand how the investment will work and where your investment
dollars are going. If you do not understand an investment strategy, seek
out a second opinion. If the person is less than forthcoming about the
investment opportunity, this should be a cause for concern. Avoiding investments
you do not understand, or for which you cannot get complete information,
is a good rule of thumb.
Lack of paperwork.
Generally, Ponzi scheme operators will provide no monthly statements,
provide bare bones, incomplete statements, or provide statements containing
errors and discrepancies. Be wary if the person is unwilling or unable
to provide you information about an investment in writing.
Trouble receiving payments.
Be suspicious if you do not receive a payment, a payment is late, or are
have difficulty cashing out your investment. Ponzi scheme operators often
will attempt to persuade investors to "roll over" or "reinvest"
the promised dividends and principal into new investments by offering
even higher investment returns. Trouble receiving payments is a warning
sign that the Ponzi scheme may be on the verge of collapse.
What to do if you are involved in a Ponzi scheme?
If you suspect you are involved in a Ponzi scheme, seek assistance of counsel.
Also, do not be afraid to contact the SEC or your state securities regulator
to file a complaint.