We've been hearing a lot about Ponzi schemes 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 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.
Learn more about the aftermath of a Ponzi scheme by reading David Meyer's post for the American Bar Association.
Charles Ponzi: 1920’s Pyramid Scammer
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 3 months, compared with the 5 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 Ponzi Scheme Work?
A Ponzi scheme is a fraudulent investment operation that pays returns to investors from their own money or money paid by later investors rather than from actual earned revenue. These types of schemes are illegal and continue to operate on the "rob-Peter-to-pay-Paul" principle, as money from new investors is used to pay off the previous investors in a continuous and destructive cycle until the whole scheme eventually falls apart when not enough new investors can be found.
The investment opportunity may have been a genuine opportunity that did not work out as the promoter had planned or the entire operation may have been a fraud from the start. This uncertainty, coupled with the fact that many initial investors are paid "returns" at the beginning, makes it difficult for investors to realize the scheme for what it is until it is too late.
A pyramid scheme can be similar to a Ponzi scheme, relying as it does on a mistaken belief in a nonexistent financial reality, including the hope of a high rate of return. However, a distinguishing characteristic is that in a Ponzi scheme, the schemer acts as a "hub" for victims, interacting with them directly. In a pyramid scheme, those who recruit additional participants benefit directly.
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"
- Use some of the new investors' cash to continue to pay off other investors
- Profit and 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, it 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 10 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.
How to Avoid Ponzi Schemes & Other Scams
We have seen just about every trick in the investment scam book. Learning to recognize the way fraudsters operate can be a big step toward avoiding Ponzi schemes and other scams.
Take a look at some of the claims you might hear when you're being sold a "lemon":
High returns. Higher returns are better returns—and it's easy to be dazzled by claims of 600% annually. Don't be fooled. High returns come with high risks, and it's very unusual for the private investor to see returns greater than 25%.
Out-of-date information. Bending the truth about investment performance can mean easy money. A fraudster may try to reel you in by publishing old information that makes an investment look like it's doing well, even though current performance is lackluster.
Tricky math. Reporting averages, ignoring compounding, or otherwise "cherry picking" numbers is a subtle scam, and it is very effective. Make sure you understand how your returns are calculated and pay attention to how it matches up with your statements.
Know When to Make the Call
The first step in getting your money back is partnering with an experienced attorney who is willing to fight for you. You will know that the time is right to call an investment fraud lawyer when:
- You recognize the warning signs of a real estate Ponzi scheme.
- You discover you have lost money in a real estate Ponzi scheme.
- You are contacted by another victim or victim's attorney.
You can also learn more about recovering losses after a Ponzi scheme by watching Attorney Dave Meyer's video below:
How Can an Investment Fraud Attorney Help Me?
Investment scam attorneys practice a narrow and specialized field of law. Not every lawyer has the experience necessary to help you recover damages in a real estate investment fraud case.
In deciding which law firm to hire, and to help you recover the money that has been wrongfully taken from you, it is important to consider the following:
- The firm's experience with real estate Ponzi scheme cases.
- The firm's available resources to help you win your case.
- The reputation of the firm.
For Ponzi scheme victims, an experienced investment fraud lawyer is able to:
- Investigate your account activity for signs of a scam
- Detect and identify the investment scam
- Determine the parties who may be held responsible for the scam
- Access your advisor's complaint history and background
- Understand FINRA rules and walk you through the arbitration process
Are You a Victim? Call Meyer Wilson to Find Out!
As the catastrophic losses suffered by the varied investors defrauded in the recent Bernie Madoff Ponzi scheme illustrate, victims can include anyone—including the following:
- Individual Investors
- Small Businesses
- Pension Funds
- Institutional Investors
Get Started with a Free Consultation Today
If you believe that you fell victim to a Ponzi or pyramid scheme, trust a "Lawyer of the Year" to handle your case. David P. Meyer was selected as the best lawyer in his region in the practice area of professional malpractice. With more than 50 years of combined legal experience, and having successfully represented approximately 1,000 investors, Meyer Wilson has the expertise, experience and resources necessary to review, investigate, and aggressively pursue investor claims.
When you hire Meyer Wilson, you can rest assured that we:
- Are devoted solely to investor claims and class actions
- Are nationally recognized for our work with investors
- Only earn a fee if your losses are recovered
- Will assign two lawyers to your securities fraud case
- Employ a full-time investigator
Regardless of whether the promoter meant to defraud from the beginning, unsuspecting investors who invest in Ponzi and pyramid schemes often suffer massive financial losses when the pyramid collapses. When this happens, Meyer Wilson can step in and hold financial advisors accountable. When choosing a securities litigation attorney, results matter. Our firm recovered more than $350 million. View other case results.
For assistance with your securities fraud claim, call us for a free case evaluation.