Ponzi scheme: what this form of fraud is (and how to detect it)

The Ponzi scheme is one of the most common types of fraud; let's see what its characteristics are.

We all know, even if only by hearsay, some investment proposal that promised a great return under a dubious methodology.

It was probably a case of a Ponzi scheme. We are going to discover what exactly this type of scam consists of, what it owes its name to and some of the most well-known cases in which this system has been applied, with a promise impossible to fulfill.

What is the Ponzi scheme?

The Ponzi scheme is a type of fraud based on a pyramid-type investment. This implies that each person who joins the system has to recruit new members in order to keep the methodology working.. Obviously, at each level this becomes more complicated, since the progression of people needed in each jump makes it practically impossible to comply at a certain point, so the system collapses.

In the case of the Ponzi scheme, what the swindler proposes to the first participants is that they deposit a certain amount of money and in exchange he will pay them month after month another smaller amount, but which in sum will be greater than the initial investment.

But it does not end there, as we already anticipated, being a pyramidal system also requires that the participants look for new ones. They will also see their investment recovered whenever they find new referrals, thus creating a never-ending system.What is the obvious problem here? The money is not being invested anywhere, it is simply redistributed to the top of the pyramid, where the scammer is ultimately located. As long as participants keep coming in, he can use that money to pay the payments he promised.

However, when it is no longer possible for new referrals to join the pyramid, However, when it is no longer possible for new referrals to join the Ponzi scheme, there will be no way to deliver the benefits that were that had been guaranteed in the first place, because the amount of money is exactly the same as at the beginning, it has not been invested in any kind of activity that has made the amount grow. This will cause the pyramid to collapse and most of the lower levels will lose their money.

Why is this form of fraud so called?

The Ponzi scheme takes its name from Carlo Ponzi, an expert swindler who was known for his crimes and who developed the system we are concerned with here in 1920. Ponzi was a recently arrived immigrant to the United States and of limited means, but with a sharp mind and few scruples. He soon realized that he could make a great business, selling postal coupons that were supposedly more expensive to buy in the U.S. than in other countries.

He began to look for investors for his business, who he paid promptly, so the rumor quickly spread and within months there was a real hysteria of people wanting to join the Ponzi scheme, even mortgaging their homes to do so. Of course, Ponzi did not buy or sell coupons, he simply paid the investors, knowing that this trust was generating many more participants.

In less than a year, Carlo Ponzi had become rich, lived a life of luxury and even took control of a small bank. However, he was closely followed by government agencies and his company was finally taken over. But Ponzi still had time for one last maneuver, paying out investments to anyone who demanded them.. This restored his confidence and won the support of the people.

But it was clear that the scheme could not succeed and eventually went bankrupt, causing most investors to lose all their money. He was imprisoned, but managed to post bail and was eventually deported to Italy, his native country, where some people even received him with the honors befitting a philanthropist.

Warning signs to help you recognize a Ponzi scheme

The danger of a Ponzi scheme is that it is a scam that can be very a scam that can be very attractive to some people with very basic financial knowledge, who would not notice it.The danger of the Ponzi scheme is that it is a scam that can be very attractive to some people with very basic financial knowledge, who would not realize the risk involved in investing. That is why we are now going to see what are the most important indicators to detect this type of scams.

1. Low investment, high profit

Probably the main characteristic of a Ponzi scheme scam, and precisely what makes it so attractive to the unwary, is that it it proposes an investment that is a priori very low compared to the return it will theoretically generate, and it will do so in a short period of time.. Little investment, much profit and all this in record time. Who would not want to make such an investment?

The problem is that the financial world is much more complex than this. If an investment promises a large profit in such a short time, it either carries a very high risk, or it is a scam, as in this case.

2. Regularity of performance

Another red light that should make the potential investor think twice is promises of a very specific return on a very regular basis. Any legal investment is subject to multiple market variables that mean that they are not always exactly the same and can be modified in different periods. and can be modified in different periods.

This indicator is especially important if, in addition to this regularity, a very high return is promised, as we saw in the previous point. In that case, it is better to stay away from the wonderful product that is being offered.

3. Lack of records

On the other hand, when it comes to investments involving a Ponzi scheme, these do not respond to any type of official organization or registry, which should make us suspicious.This should already make the investor suspicious about the reliability of this operation.

Of course, no scam is going to have the guarantee of a prestigious organization behind it, so if a person decides to invest his money in a fraudulent system like this, he will not be able to check the status of the operation in any index.

4. There are no sales licenses

Just as there are no records to check the investments (they are not shares that one can check on the stock exchange), there are no licenses to sell the proceeds of the Ponzi scheme.How could there be a license to defraud?

Therefore, if the investor asks for official accreditations from the seller and the seller is not able to provide such documents, this is another sign that the product is most likely not to be trusted.

5. Opacity of information

Ponzi scheme operations operate in dark areas, outside the official channels. This means that information is conspicuous by its absence. The scammer always gives vague information, explains the operation in a very superficial way or does it in a totally incomprehensible manner.. He cannot explain it in detail because if he did so, a slightly awake investor would realize that something is wrong.

If the information is not abundant, it is not absolutely clear and the promoter of the idea does not respond in an understandable way to any kind of doubt about it, we should turn on another red light and abandon our idea of investing in this type of product, because the probabilities of it being a scam will increase considerably.

6. Lack of documentation

If we saw that there is hardly any information, much less will there be any documentation on the operations. If the investor asks to check the papers and documents, he will surely always come across all sorts of excuses that will ultimately prevent you from checking the reliability of the investment..

The objective is clear, you cannot let the investor check that you are not actually doing with his money what you promised you were going to do. Another clear indicator that this is a Ponzi scheme and therefore, without a doubt, a scam.

7. Delays in payments

An investor has only one objective: to receive a profit for the money contributed. The problem is that in a scam there are no profits. In reality there are, but obviously they are for the scammer, not for the investor. So the last and surely the clearest sign that will alert us of the type of fraudulent business we are facing, is the problem to receive the payment.

The fraudster will allege a whole series of problems and incidents to try to delay the payment of the benefits for as long as possible.. In some cases, the investor will eventually receive it, but the further down the pyramid, the more likely the Ponzi scheme will collapse before the investor can see a dime.

Bibliographical references:

• Benson, S.S. (2009). Recognizing the red flags of a Ponzi scheme. The CPA Journal.
• Frankel, T. (2012). The Ponzi scheme puzzle: A history and analysis of con artists and victims. Oxford University Press.
• Mayorga-Zambrano, J. (2011). A mathematical model for Ponzi-type pyramid schemes. National Institute of Statistics and Census.
• Zuckoff, M. (2005). Ponzi's Scheme: The True Story of a Financial Legend. Random House: New York.