From 1919 to 1920, Charles Ponzi, a charismatic Italian immigrant, was able to sweet-talk thousands of individuals into shelling out millions of dollars to buy postage stamps using international reply coupons. Ponzi promised potential investors high returns for their investment, since they can purchase postage at European currencies’ lower fixed rates and then redeem these in U.S dollars at higher values. The real issue, however, was the fact that Ponzi diverted investors’ money to make payments to earlier investors and himself and, when the time came when he could no longer rustle up enough fresh investments to keep up with the money going out the door, his scheme was discovered, landing him in jail.
Now known as the Ponzi scheme, this fraudulent investment operation involves an individual or an organization luring people to invest in a non-existent business with the promise of high return. The fact, however, is scammers pay returns to investors using their own money or money paid in by subsequent investors. Since there is no legitimate business, there are also no legitimate earnings, thus Ponzi schemes require a steady flow of money from new investors to continue. If becomes difficult to recruit new investors or when a large number of investors ask to cash out, it will mean this scheme’s collapse.
Ponzi schemes are quite difficult to spot, – the reason why many people still get drawn into it. There are signs, though, that may be indicative that the investment opportunity you have gotten into is a Ponzi scheme. These signs or red flags include:
- High returns with no risk. If a fund is promising its investors a high return on their investment with little or no risk, be highly suspicious. Legitimate “high yield” investments are generally risky, and the law requires financial advisors to disclose those risks.
- Unusual consistency in returns. The values of legitimate investments fluctuate; they go up and down along with the market. This is particularly true of investments that offer high returns. You should approach any investment opportunity that consistently provides high returns to its investors, even in an unstable market, with extreme caution.
- No registrations or licenses. Most Ponzi investments aren’t registered with state regulators or the SEC. Registration provides investors with crucial information about a company’s inner workings to help them make informed decisions, so be skeptical of unregistered investments. Likewise, both federal and state laws require investment professionals and companies to be licensed, so use caution if an investment opportunity involves an unlicensed firm or individual.
- Secrets and unnecessary complexity. Ponzi scheme managers find they can dupe inexperienced investors by hiding behind “company secrets” and complex or highly technical language. If a firm seems to be holding back information or providing you with documents you can’t understand, avoid investing there.
- Paperwork problems. As an investor, you should always be able to review information about your investments in writing. Be alert for any reluctance on the part of a firm to provide you with paperwork, as well as errors or inconsistencies that can point to mismanagement of funds.
- Trouble with payments. Ponzi schemes rely on continued cash flow from investors to keep running. They’ll often encourage you to roll over your investment, promising an even higher return, rather than paying out as promised. This should be a big red flag.
The funds that a Ponzi scheme generates are usually used to enrich the manager of the scheme. Thus, by the time a Ponzi scheme collapses or when investors discover the scheme, it can be difficult or impossible for them to get their money back. This is why it is highly necessary to get in touch with an attorney right away as investors may be able to hold legally liable their financial advisor or the brokerage firm where this advisor or broker is employed.