How Does a Ponzi Scheme Work?

We've been hearing a lot about Ponzi schemes in the news in the last few years. Although most people understand that Ponzi schemes are a type of investment fraud, not many really understand exactly how these investment scams work. It is precisely because so few people understand the inner workings of a Ponzi scheme that so many investors are bilked out of their cash. Understanding how a Ponzi scheme works will help you recognize the scheme at work and avoid being taken in.

The Ponzi scheme is named after Charles Ponzi, who pulled off his namesake pyramid scam in the 1920's. He promised investors a 40 pence return on mail coupons over three months, compared with the five pence that could be earned in a savings account. Unfortunately, Mr. Ponzi only actually purchased about $30 worth of mail coupons, although he took in over a million dollars from investors. The structure of the scam was not a new one, but Mr. Ponzi's scheme was on such a large scale and took in so much cash that it has since been named after him.

How Does a Fraudster Pull Off a Ponzi Scheme?

The steps seem simple enough:

• Come up with an enticing investment premise that offers great imaginary returns.
• Convince a few investors to put money on it.
• Hold on to the money for a period of time.
• Return that money to the investors as the promised "returns."
• Convince your original investors to reinvest since they "made money" the first time.
• Entice new investors with the same promises and point to prior investors as "proof" of returns.
• Use some of the new investors' cash to continue to pay off other investors.
• Profit.
• Repeat for several years.
• Stop returning phone calls and disappear with the cash...preferably somewhere sunny.

It's scary how simple it is...and how often it works. Ultimately, though, a Ponzi scheme is doomed to fail when it can no longer support the ruse, and there are big consequences for the fraudster and the victims. Although some Ponzi schemes do stretch over ten years or more, they ALWAYS collapse eventually because the number of new investors needed to support it becomes a mathematical impossibility. By the time the investors find out, however, the fraudster is usually long gone and has cut off all communication.

If you have been the victim of a Ponzi scheme, you need an experienced investment fraud lawyer to walk you through your options for FINRA arbitration or potential mediation or litigation to potentially recover your losses. We have over 50 years of collective experience recovering losses for our clients and will give your case the personal, knowledgeable attention it deserves. Contact us today at 1-866-8-BROKER (866-827-6537) and also request a copy of our free book, 5 Signs of Investment Fraud... And What to Do if it's Happened to You.