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How to Recognize a Ponzi Scheme

The Ponzi scheme is a notorious type of securities fraud, and for good reason. Because it functions by paying off newer investors with money from previous investors while little to no actual investing is going on, everything looks to be on the up and up. Although eventually every Ponzi scheme will run out of new investors to dupe, many of these scams can run for a long time.

So what is a wise investor supposed to do? If a Ponzi scheme is so undetectable that newer investors are being paid and previous investors are able to say they've received the "promised" returns, how can an average investor sniff out a fishy deal? As securities fraud attorneys, we'd like to say that, luckily, with a little education, any investor can be wise to the biggest red flags.

What Is a Ponzi Scheme?

Before you are able to recognize the warning signs of a Ponzi scheme, it is important that you understand what this type of fraud entails. Charles Ponzi was one of the most notorious people who participated in this type of scam, which is why it was named after him. Basically, he collected money from people who wanted to invest in his business and then paid investors large interest payments from the money he obtained from the new investors. While Ponzi didn’t create this form of investment fraud, his operation was the first to become known in the United States.

Ponzi schemes can be difficult to identify. One of the most recent examples involved a man from Santa Ana, CA, who allegedly used money received from new investors to make payments for principal and interest to previous investors. The earlier investors believed that they were receiving returns on their investments. This scam reportedly cost investors $14.5 million. Unfortunately, this case is not isolated, as there are regularly reports of Ponzi schemes resulting in financial loss.

Red Flags of a Ponzi Scheme

When you are looking into a new investment opportunity, it's important to take the time to check out both the person offering the investment and the investment itself. Verifying that both the promoter and the opportunity are legitimate can save you a lot of time, money, and heartache.

Any person offering an investment should:

  • Be registered to sell investments in your state
  • Have a history that is clear of any disciplinary action or a pattern of complaints
  • Be able to explain his or her investment model to you in terms you understand
  • Be willing and able to provide all of the documents and information you need

Beyond checking out the person offering the investment, you should also look into the actual opportunity itself. If an opportunity features the following, it could be a Ponzi scheme:

  • "Guaranteed" High Returns
    Any investment with “guaranteed” high returns should be carefully examined.

  • Hidden Information
    Excuses about missing paperwork, errors, or secretive strategies are red flags.

  • Consistent High Returns
    Be cautious of investments that generate high returns unaffected by the market

  • Unregistered Investments
    Most cases of investment fraud involve investments that have not been registered.

  • Unlicensed Sellers
    Many Ponzi schemes involve unregistered firms and/or unlicensed individuals.

  • Pressure to Reinvest
    Ponzi schemes collapse without regular income or when too many investors cash out.

Steps to Avoid a Ponzi Scheme

  • Check out the credentials and background of the person who has approached you about the investment. You can check the company out with the BBB. If the person is a broker, you can use his or her CRD number to gain more insight into the broker’s record.

  • Have an attorney review any contracts that you are given. Don’t send any money until you have had the contracts analyzed by a lawyer that you can trust.

  • Be cautious if a money manager wants to be your custodian. A custodian is a broker-dealer that maintains investment accounts. If a money manager asks you to write a check directly to them, it is a red flag. It would be better to write the check to the custodial firm.

  • Make sure you understand your investment. If the investment appears complicated or if it cannot be properly explained, you may not want to hand over your money.

  • Trust your instincts. There are times when your instincts will tell you something is wrong. If you don’t feel comfortable about an investment, walk away.

Take Action to Protect Your Rights

The first step you should take if you suspect a Ponzi scheme is to contact an experienced investment fraud attorney. Failure to do so may result in evidence becoming too obscured to properly establish your case. An attorney will take the time to go through your options and determine the best course of action. Choosing the right legal representative is not easy. However, it is absolutely critical in establishing an effective legal strategy.

The right law firm should possess the following qualities:

  • Established, recognized experts in investment fraud cases
  • Track record of successful outcomes in investment claims

If you believe that you may have been the victim of a real estate Ponzi scheme then it is important to contact an experienced investment fraud attorney. Meyer Wilson has successfully represented more than 800 investors in stockbroker mediation, arbitration, and litigation claims.

For more information, call us or fill out our online form.

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  • Recovered for Elderly Ponzi Scheme Victim $3.2 Million
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