Edit filter log

'{{for|schemes where people are told that it is based on enrolling ever larger numbers of people|Pyramid scheme}} {{short description|Type of financial fraud}} {{Use dmy dates|date=February 2013}} [[File:Charles Ponzi.jpg|thumb|1920 photo of [[Charles Ponzi]], the namesake of the scheme, while still working as a businessman in his office in Boston]] A '''Ponzi scheme''' ({{IPAc-en|ˈ|p|ɒ|n|z|i}}, {{IPA-it|ˈpontsi|lang}}; also a '''Ponzi game''')<ref>{{cite web|title=Ponzi|url=http://www.dictionary.com/browse/ponzi|website=Dictionary.com|accessdate=17 May 2016}}</ref> is a form of [[fraud]] that lures [[Investor|investors]] and pays [[Profit (accounting)|profits]] to earlier investors with [[Funding|funds]] from more recent investors.<ref>{{cite web|url=https://www.sec.gov/fast-answers/answersponzihtm.html|title=Ponzi Schemes|website=www.sec.gov}}</ref> The scheme leads victims to believe that profits are coming from product sales or other means, and they remain unaware that other investors are the source of funds. A Ponzi scheme can maintain the illusion of a sustainable [[business]] as long as new investors contribute new funds, and as long as most of the investors do not demand full repayment and still believe in the non-existent assets they are purported to own. The scheme is named after [[Charles Ponzi]]<ref>{{cite web |url=https://web.archive.org/web/20041001-20051231re_/http://www.ssa.gov/history/ponzi.html |title=Ponzi Schemes |publisher=US Social Security Administration |accessdate=24 December 2008 }}</ref> who became notorious for using the technique in the 1920s.<ref>{{citation | last=Peck | first=Sarah | year=2010 | title=Investment Ethics | publisher=John Wiley and Sons | isbn=978-0-470-43453-6 | url=https://books.google.com/books?id=EiIMJ83qRCIC&pg=PA5 | page=5 }}</ref> The idea had already been carried out by [[Sarah Howe (fraudster)|Sarah Howe]] in Boston in the 1880s through the "Ladies Deposit". Howe offered a solely female clientele an eight-percent monthly interest rate, and then stole the money that the women had invested. She was eventually discovered and served three years in prison.<ref name="zuckoff2005">Zuckoff, Mitchell. ''Ponzi's Scheme: The True Story of a Financial Legend''. Random House: New York, 2005. ({{ISBN|1-4000-6039-7}})</ref> The Ponzi scheme was also previously described in novels; [[Charles Dickens]]' 1844 novel ''[[Martin Chuzzlewit]]'' and his 1857 novel ''[[Little Dorrit]]'' both feature such a scheme.<ref>{{citation | last1=Markopolos | first1=Harry | year=2010 | title=No One Would Listen: A True Financial Thriller | last2=Casey | first2=Frank | publisher=John Wiley and Sons | isbn=978-0-470-55373-2 | url=https://books.google.com/books?id=7NeZeQ6qHq4C&pg=PA50 | page=50 }}</ref> Ponzi carried out this scheme and became well known throughout the United States because of the huge amount of money that he took in. His original scheme was based on the legitimate arbitrage of [[international reply coupon]]s for postage stamps, but he soon began diverting new investors' money to make payments to earlier investors and to himself.<ref name="ponzi">{{cite web |url=https://www.sec.gov/answers/ponzi.htm |title=Ponzi Schemes – Frequently Asked Questions|publisher=U.S Securities and Exchange Commission|work=U.S Securities and Exchange Commission|accessdate=23 June 2012}}</ref> == Characteristics == Typically, Ponzi schemes require an initial investment and promise above average returns.<ref>{{cite web|title=What is a Ponzi scheme?|url=http://www.mijiki.com/what-is-a-ponzi-scheme.html|work=Mijiki|publisher=Mijiki.com|accessdate=23 June 2012}}</ref> They use vague verbal guises such as "[[Hedge (finance)|hedge]] [[Futures contract|futures trading]]", "[[high-yield investment program]]s", or "offshore investment" to describe their income strategy. It is common for the operator to take advantage of a lack of investor knowledge or competence, or sometimes claim to use a proprietary, secret investment strategy to avoid giving information about the scheme. The basic premise of a Ponzi scheme is "''To rob Peter to pay Paul''". Initially, the operator pays high returns to attract investors and entice current investors to invest more money. When other investors begin to participate, a cascade effect begins. The schemer pays a "return" to initial investors from the investments of new participants, rather than from genuine profits. Often, high returns encourage investors to leave their money in the scheme, so that the operator does not actually have to pay very much to investors. The operator simply sends statements showing how much they have earned, which maintains the deception that the scheme is an investment with high returns. Investors within a Ponzi scheme may even face difficulties when trying to get their money out of the investment. Operators also try to minimize withdrawals by offering new plans to investors where money cannot be withdrawn for a certain period of time in exchange for higher returns. The operator sees new cash flows as investors cannot transfer money. If a few investors do wish to withdraw their money in accordance with the terms allowed, their requests are usually promptly processed, which gives the illusion to all other investors that the fund is solvent and financially sound. Ponzi schemes sometimes begin as legitimate investment vehicles, such as hedge funds that can easily degenerate into a Ponzi-type scheme if they unexpectedly lose money or fail to legitimately earn the returns expected. The operators fabricate false returns or produce fraudulent audit reports instead of admitting their failure to meet expectations, and the operation is then considered a Ponzi scheme. A wide variety of investment vehicles and strategies, typically legitimate, have become the basis of Ponzi schemes. For instance, [[Allen Stanford]] used bank certificates of deposit to defraud tens of thousands of people. Certificates of deposit are usually low-risk and insured instruments, but the Stanford CDs were fraudulent.<ref>{{citation | last=Kurdas | first=Chidem | year=2012 | title=Political Sticky Wicket: The Untouchable Ponzi Scheme of Allen Stanford | url=https://www.amazon.com/Political-Sticky-Wicket-Untouchable-Stanford/dp/1479257583/ref=sr_1_2?s=books&ie=UTF8&qid=1348001922&sr=1-2|website=Amazon.com|accessdate=19 January 2018}}</ref> == Red flags == According to the United States Securities and Exchange Commission (SEC), many Ponzi schemes share similar characteristics that should be "red flags" for investors.<ref name="sec.gov">{{cite web|url=https://www.sec.gov/fast-answers/answersponzihtm.html#RedFlags|title=Ponzi Schemes - Red Flags|website=www.sec.gov}}</ref> The warnings signs include:<ref name="sec.gov"/> '''High investment returns with little or no risk'''. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk. Be highly suspicious of any "guaranteed" investment opportunity. '''Overly consistent returns'''. Investment values tend to go up and down over time, especially those offering potentially high returns. Be suspicious of an investment that continues to generate regular positive returns regardless of overall market conditions. '''Unregistered investments'''. Ponzi schemes typically involve investments that have not been registered with the SEC or with state regulators. Registration is important because it provides investors with access to key information about the company's management, products, services, and finances. '''Unlicensed sellers'''. Federal and state securities laws require that investment professionals and their firms be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms. '''Secretive or complex strategies'''. Avoid investments that you do not understand or for which you cannot get complete information. '''Issues with paperwork'''. Do not accept excuses regarding why you cannot review information in writing about an investment. Also, account statement errors and inconsistencies may be signs that funds are not being invested as promised. '''Difficulty receiving payments'''. Be suspicious if you do not receive a payment or have difficulty cashing out your investment. Keep in mind that Ponzi scheme promoters routinely encourage participants to "roll over" investments and sometimes promise even higher returns on the amount rolled over. == Unraveling of a Ponzi scheme == If a Ponzi scheme is not stopped by authorities, it usually falls apart quickly for one of the following reasons:<ref name="ponzi" /> # The operator vanishes, taking all the remaining investment money. # Since the scheme requires a continual stream of investments to fund higher returns, if the number of new investors slows down, the scheme collapses as the operator starts having problems paying the promised returns (the higher the returns, the greater the risk of the Ponzi scheme collapsing). Such [[Liquidity crisis|liquidity crises]] often trigger panics, as more people start asking for their money, similar to a [[bank run]]. # External market forces, such as a sharp decline in the economy (for example, the [[Madoff investment scandal]] during the [[Global financial crisis of 2008|market downturn of 2008]]), cause many investors to withdraw part or all of their funds. Actual losses are extremely difficult to calculate. The amounts that investors thought they had, were never attainable in the first place. On the other hand, they could have invested differently without being scammed. The wide gap between "money in" and "fictitious gains" make it virtually impossible to know how much was lost in any Ponzi scheme. == Similar schemes == A [[pyramid scheme]] is a form of fraud similar in some ways to a Ponzi scheme, relying as it does on a mistaken belief in a nonexistent financial reality, including the hope of an extremely high rate of return. However, several characteristics distinguish these schemes from Ponzi schemes:<ref name="ponzi" /> * In a Ponzi scheme, the schemer acts as a "hub" for the victims, interacting with all of them directly. In a pyramid scheme, those who recruit additional participants benefit directly. (In fact, failure to recruit typically means ''no'' investment return.) * A Ponzi scheme claims to rely on some esoteric investment approach, and often attracts well-to-do investors, whereas pyramid schemes explicitly claim that ''new money'' will be the source of payout for the initial investments.<ref name="zuckoff2005"/> * A pyramid scheme typically collapses much faster because it requires exponential increases in participants to sustain it. By contrast, Ponzi schemes can survive simply by persuading most existing participants to reinvest their money, with a relatively small number of new participants.<ref name="olsson">{{cite web|title=Ponzi's Scheme: The True Story of a Financial Legend|url=https://www.c-span.org/video/?186251-1/ponzis-scheme-true-story-financial-legend|publisher=C-SPAN|date=Apr 7, 2005|accessdate=Sep 29, 2018|author=Zuckoff}}</ref> [[Cryptocurrency|Cryptocurrencies]] have been employed by scammers attempting a new generation of Ponzi schemes. For example, misuse of [[initial coin offering]]s, or "ICOs," on the [[Ethereum]] blockchain platform have been one such method,<ref name=cryptoatlantic>{{Cite news|url=https://www.theatlantic.com/technology/archive/2017/05/cryptocurrency-ponzi-schemes/528624/|title=The Rise of Cryptocurrency Ponzi Schemes|last=Morris|first=David Z.|work=The Atlantic|access-date=2017-06-28|language=en-US}}</ref> known as "''smart Ponzis''" per the ''[[Financial Times]]''.<ref name=cryptoft>{{cite web|url=https://ftalphaville.ft.com/2017/06/01/2189634/its-not-just-a-ponzi-its-a-smart-ponzi/|title=It’s not just a Ponzi, it’s a ‘smart’ Ponzi|first1=Izabella|last1=Kaminska|date=2017-06-01|website=[[FT Alphaville]]|language=en|access-date=2017-07-20}}</ref> The novelty of ICOs means that there is currently a lack of regulatory clarity on the classification of these financial devices, allowing scammers wide leeway to develop Ponzi schemes using these assets.<ref>{{Cite news|url=http://www.coindesk.com/sec-petition-calls-for-blockchain-token-rules/|title=SEC Petition Calls for Blockchain Token Rules - CoinDesk|date=2017-05-16|website=CoinDesk.com|access-date=2017-06-28|language=en-US}}</ref>{{Clarify|reason=What is this leeway? What is vague? What is novel?|date=February 2019}} [[Economic bubble]]s are also similar to a Ponzi scheme in that one participant gets paid by contributions from a subsequent participant (until inevitable collapse). A bubble involves ever-rising prices in an open market (for example [[stock bubble|stock]], [[real estate bubble|housing]], [[cryptocurrency]],<ref>{{cite web|url=https://www.counterpunch.org/2017/12/14/is-the-bitcoin-bubble-the-new-subprime-mortgage-bomb/|title=Is the Bitcoin Bubble the New ‘Subprime Mortgage’ Bomb?|website=Counterpunch.org|accessdate=19 January 2018}}</ref>{{Unreliable source?|date=February 2019}}<ref>{{cite news|url=https://www.ft.com/content/1877c388-8797-11e5-90de-f44762bf9896|title=Subscribe to read|newspaper=[[Financial Times]]|accessdate=19 January 2018}}{{Clarify|date=June 2018}}</ref>{{Subscription required}} or [[Tulip mania|tulip bulbs]]) where prices rise because buyers bid more, and buyers bid more because prices are rising. Bubbles are often said to be based on the [[Greater fool theory|"greater fool" theory]]. As with the Ponzi scheme, the price exceeds the [[Intrinsic value (finance)|intrinsic value]] of the item, but unlike the Ponzi scheme: * In most economic bubbles, there is no single person or group misrepresenting the intrinsic value. A common exception is a [[pump and dump]] scheme (typically involving buyers and holders of thinly-traded stocks), which has much more in common with a Ponzi scheme compared to other types of bubbles. * Ponzi schemes typically result in criminal charges when authorities discover them—but other than pump and dump schemes, economic bubbles do not typically involve unlawful activity, or even [[bad faith]] on the part of any participant. Laws are only broken if someone perpetuates the bubble by knowingly and deliberately misrepresenting facts to inflate the value of an item (as with a pump and dump scheme). Even when this occurs, wrongdoing (and especially criminal activity) is often much more difficult to prove in court compared to a Ponzi scheme. Therefore, the collapse of an economic bubble rarely results in criminal charges (which require proof [[beyond a reasonable doubt]] to secure a conviction) and, even when charges are pursued, they are often against corporations, which can be easier to pursue in court compared to charges against people but also can only result in fines as opposed to jail time. The more commonly-pursued legal recourse in situations where someone suspects an economic bubble is the result of nefarious activity is to sue for damages in [[civil court]], where the standard of proof is only [[balance of probabilities]] and where the plaintiff need not demonstrate ''[[mens rea]]''. * In some jurisdictions, following the collapse of a Ponzi scheme, even the "innocent" beneficiaries (including anyone who unwittingly profited without being aware of the fraudulent nature of the scheme, as well as the recipients of charitable donations from the perpetrators while the scheme was in operation) are liable to repay any such profits or donations for distribution to the victims. This typically does not happen in the case of an economic bubble, especially if nobody can prove the bubble was caused by anyone acting in bad faith. * Items traded in an economic bubble are much more likely to have an intrinsic value that is worth a substantial proportion of the market price. Therefore, following collapse of an economic bubble (especially one in a commodity such as real estate) the items affected will often retain some value, whereas an investment that is part of a Ponzi scheme will typically be worthless (or very close to worthless). On the other hand, it is much easier to obtain financing for many items that are the frequent subject of bubbles. If an investor trading on [[margin (finance)|margin]] or borrowing to finance investments becomes the victim of a bubble, he or she can still lose all (or a very substantial portion) of his or her investment capital, or even be liable for losses in excess of the original capital investment. == Society and culture == * Weightlifters frequently use the term Ponzi in reference to a scheme of strength training in which athletes perform exercises with progressively less weight (also known as drop-sets) to maximize muscle tension. Such exercises are intended to invoke imagery of a pyramid, as the weightlifter gradually reduces the size of their weight stack in the same way that a pyramid grows upwards. This usage of Ponzi consists of erroneous reference to the [[pyramid scheme#Relation to Ponzi schemes|pyramid scheme]], a similar form of fraud that is often mistaken for a Ponzi scheme.<ref>{{cite journal|last1=Garcia-Pallares|first1=Jesus|last2=Izquierdo|first2=Mikel|title=Strategies to optimize concurrent training of strength and aerobic fitness for rowing and canoeing.|journal=Sports Medicine|date=April 2011|volume=41|issue=4|page=329|doi=10.2165/11539690-000000000-00000}}</ref> == See also == * [[Adele Spitzeder]] * [[Black Friday (1869)]], also referred to as the ''Gold Panic of 1869'' * [[Bucket shop (stock market)]] * [[Chain letter]] * [[Get-rich-quick scheme]] * [[List of Ponzi schemes]] * [[Matrix scheme]] * [[Pump and dump]] * [[Tulip mania]] * [[White-collar crime]] * [[Hustle (TV series)|''Hustle'' (TV series)]] * [[United States Postal Inspection Service]] == References == {{Reflist}} == Further reading == * {{cite book |title=Ponzi: The Incredible True Story of the King of Financial Cons (Library of Larceny) (Paperback) |last=Dunn |first=Donald |year=2004 |publisher=Broadway |location=New York |isbn=0-7679-1499-6}} * {{cite book |title= The Ponzi Scheme Puzzle: A History and Analysis of Con Artists and Victims |last=Frankel |first=Tamar |year=2012 |publisher=Oxford University Press |location=USA |isbn= 0199926611}} * {{cite book|authors=[[Leila Schneps|Schneps, Leila]] & [[Coralie Colmez|Colmez, Coralie]]|title=Math on trial. How numbers get used and abused in the courtroom|publisher= Basic Books|date= 2013|isbn= 978-0-465-03292-1}} (Eighth chapter: "Math error number 8: underestimation. The case of Charles Ponzi: American dream, American scheme"). * {{cite book |title=Ponzi’s Scheme: The True Story of a Financial Legend |last=Zuckoff |first=Mitchell |year=2005 |publisher=Random House |location=New York |isbn=1-4000-6039-7}} == External links == * [https://www.sec.gov/answers/ponzi.htm Ponzi Schemes FAQ] Information and advice from the US Securities and Exchange Commission * [http://www.cftc.gov/ConsumerProtection/FraudAwarenessPrevention/index.htm Fraud Awareness and Prevention] Information about spotting fraud from the US Commodities Futures Trading Commission * [http://bookstore.gpo.gov/marketplace/39527 Ponzimonium] Free e-book about Ponzi schemes from the US Commodity Futures Trading Commission {{Scams and confidence tricks}} [[Category:Confidence tricks]] [[Category:Pyramid and Ponzi schemes| ]]'