How not to fall foul to the Ponzi scheme...

Across previous posts were described "what is" a Ponzi scheme and how it "operates", moreover some important cases were presented, among them extreme cases as the Madoff  or the Albanian case, all with the aim to present an insight to the Ponzi scheme and its various mechanisms.

Now it's finally time to see how best the investors can protect their investments from such a fraudulent scheme. In this context the FBI.Gov and the SEC (US securities exchange commision) through out their websites  both provide the following excellent suggestions to follow when engaging in any investment activity and in particular in order to avoid falling foul to a fraudulent enterprise:

1. Be careful of any investment opportunity that makes exaggerated earnings claims.
2. Exercise due diligence in selecting investments and the people with whom you invest - in other words, do your homework.
3. Consult an unbiased third party - like an unconnected broker or licensed financial adviser - before investing.

In addition to these useful pointers, I would add that investors in investing should be extremely cautious, always remember that risk and reward always go together, that is, investments yielding higher returns typically involves more risks and  - although is a simple concept - that if an investment sounds too good to be true it usually is, as the the examples in the previous posts reveals.

 

                                         

Ref: http://www.fbi.gov/scams-safety/fraud
      http://www.sec.gov/answers/ponzi.htm

Breaking news: Bernie Madoff Ponzi scheme (2009)

Indeed Bernie Madoff was sentenced to serve 150 years in prison plus the order to forfeit $170 billion.

http://www.cbc.ca/news/business/story/2009/06/29/madoff-ponzi-fraud-sentence564.html

Bernie Madoff: “it’s all just one big lie”

Bernie Madoff, 2009

These were the words used by Bernie Madoff back in 2008 to describe his operations across almost 20 years, from the early 1990’s till 2008, when what nowadays has become known as “the largest financial fraud in U.S history” emerged.

Bernie Madoff - the mind behind it - is a former American businessman, stockbroker, investment adviser, financier and former non-executive chairman of the NASDAQ stock market. In the early 1960’s he founded the Wall Street firm Bernard L. Madoff Investment Securities LLC, but it was during the late 1990’s that he became renowned as one of the top traders in US securities on the wave of his achievements.

Attracted by Madoff track of records of regular double digits returns (10-12% per annum), more than 5000 investors decided to invest approximately $17.3 billion in Madoff’s securities across virtually the past two decades (among the investors hedge funds, charities, universities, wealthy individuals and banks such as Banco Santander, Bank Medici, Royal Bank of Scotland Group and BNP Paribas). 

Unfortunately for them, things didn't work as they might expected to, given the fact that, as Madoff in his guilty plea admitted, there was no actual trade or investment since already the mid-1990s, and  all of his returns since then had been fictitious,  just “one big lie” or a “giant Ponzi scheme” where the money invested by newer investors was simply used to pay the returns to older investors.

In December 2008, when the general market downturn (sub prime crisis) accelerated, the first signals of imminent collapse started to emerge. Investors in need of liquidity tried to withdraw $7 billion from the firm, money that obviously Madoff didn’t and couldn’t have (despite the desperate research for new investors which never arrived) and which made him unable to keep up with the avalanche of withdrawals.

This signed the end of Madoff's epic Ponzi scheme.

Thereafter Madoff had no choice but to confess the criminal and fraudulent nature of his activities. By consequence was soon charged with one count of securities fraud from the FBI, (which soon became 11). At the end of the trial Madoff was plead guilty to federal crimes and in June 29, 2009, he was sentenced to 150 years in prison with restitution of $170 billion.

In terms of size of the losses, the amounts owed to clients - including fictional gains - were approximately $64 billion, of which however “only” $17.3 billion were truly initially invested by the customers. Out of the $17.3 billion initially invested, so far only $7.6 billion have been recuperated and even if all the recovered funds will be returned to the involved victims, their net loss would still be of $10 billion, making it “the largest financial fraud in U.S history” and the biggest Ponzi scheme ever made.

When things fall apart: Albania 1997

Uprising in Albania, 1997

 One of the main characteristics which distinguish a Ponzi scheme from any other investment activity is its inevitable and systemic collapse, and some times, when things fall apart, the consequences can be dramatic.

A clear example of this  is what happened in Albania in 1997, where the magnitude of the man-made disaster caused by the multiple collapse of the Ponzi schemes perpetrated across the country was unprecedented and the political, social and economic repercussion as a result of them were profound if not devastating.

It all initiated in the mid 1990's when Albania started its transition from a central planning to a market economy. Soon, and for different reasons - such as banks unable to satisfy private sector demand for credit with consequent growth of the informal credit market, an inadequate regulatory framework (was not clear who had responsibility for supervising the informal market) and Albanians' unfamiliarity with financial markets - the Albanian 1990's rudimentary financial system became dominated by Ponzi schemes.

When in 1997 the schemes inevitably collapsed involving approximately two-thirds of the population, the total losses amounted for $ 1.2 Billion. As a consequence people took their protest in the streets culminated in what has become known in history as the Albanian 1997 rebellion or Anarchy in Albania.
For ten days from the 1st of march 1997 until the 9th of march 1997 Albania descended into anarchy and violence in which the Government felled and more than 2,000 people were killed whilst more than 3,700 suffered physical injury.

In addition to these dramatic social and political repercussions must be added the economic damage caused by the collapse of the Ponzi schemes in Albania.
Although the short term impact on the economy are principally related to the civil war rather than from the Ponzi scheme itself, it is interesting to see which were these consequences.
A fall in output by 7% of the GDP, an increase in inflation by 40% (due to a depreciation of the local currency) and a decline in both capital inflows and imports.

Fortunately, tragic events due to Ponzi schemes such the one just described are not frequent, specially in terms of its scale relative to the size of the economy, but still - as the Albanian case demonstrates - possible.

Sergey Mavrodi is back...

...the convicted criminal behind the Russian MMM Ponzi scheme (see previous post for detail) of the 1990s who taught millions of Russians one of the hardest financial lessons of their lives created a brand new Ponzi scheme called MMM-2011.

Was the lesson really learnt? Well, sad to say, it doesn't seems so, in fact according to RT.com (http://rt.com/news/pyramid-scheme-finance-mavrodi-049): "As at 20 December 2011 MMM-2011 works for 10 months, with over 1.5 mln. participants (organiser claims there are more than 10 mln. participants)"

Ponzi scheme....similar to the Phoenix.

It's not a case that this blog is named as it is, in fact "the never ending Ponzi schemes" refers to the ability of this fraudulent investment activity to exponentially replicate itself over the years despite the fact that has become a well known fraudulent activity and that at this stage, investors should be well aware of it.
This particular characteristic, which makes a Ponzi scheme similar to a Phoenix - that is, from the ashes of one scheme immediately a new and stronger one arises as the mythical fire bird - has drawn my attention and leaded me to willing to provide an overview of it, with the hope that by providing information of it, future investors will may be more cautious in engaging in their investment activities.

In order to gain a better understanding of how disruptive can be a Ponzi scheme for both an economy as a whole (e.g Albania 1997) and private investors (e.g.Mardof 2008), it is necessary and interesting to observe some of the most important Ponzi schemes perpetrated over both the past and the current century.

Although there are numerous cases to be reported and discussed of, only the most relevant will be presented as examples; while the two cases known as the "Albanian Ponzi scheme" and the "Madof Ponzi scheme" will be discussed in detail in future posts, given the fact that for different reasons they both clearly show the disruptive and serious consequences that a Ponzi scheme can cause both to a financial sector of an economy in the Madof case and to a whole nation in the Albanian case.

Here are listed six important cases of Ponzi schemes occurred across Europe, Russia and USA:

1. Portugal 1970/1984 - Dona Branca maintained a scheme that paid 10% monthly interest. She had received the equivalent of €85 million before being arrested and sentenced 10 years in prison.
2. МММ is a Russian company which during the 1990's implemented one of the world's largest Ponzi schemes of all time. Has been estimated that  between 5 and 40 million people lost up to 10 billion dollar. 
3. The European Kings Club collaps occurred in Switzerland (1994), caused losses of about 1.1 billion dollar.
4. In Romania, between 1991 and 1994, the Ponzi scheme run by the "Caritas" company from Cluj, guaranteed to investors eight times the money invested in six months. It attracted more than 400,000 depositors who invested about 1 billion dollars before it finally went bankrupt in 1994,  with debts accounting for 450 million dollar.
5. In 2003, the U.S. Securities and Exchange Commission closed a 1 billion dollar scheme by Mutual Benefits Company in Florida, run by Peter Lombardi, affecting more than 28,000 investors.
6. USA 2008 Tom Petters was accused by the Federal government as the criminal mind behind a 3.65 billion dollar Ponzi scheme that attracted investors for more than 13 years.

The Ponzi scheme... "too good to be true".

The mind behind the Ponzi scheme: Charles Ponzi

Charles Ponzi in 1920

 Carlo Ponzi, (March 3, 1882- January 18, 1949), commonly known as Charles Ponzi, was a businessman and con artist in the U.S. and Canada. Born in Italy, he became known as a swindler in North America for his money making scheme.

Charles Ponzi promised clients a 50% (compared to the just 5% p.a. guaranteed by the banks at the time) profit within 45 days, or 100% profit within 90 days, by buying discounted postal reply coupons in other countries and redeeming them at face value in the United States as a form of arbitrage, however, he soon diverted investors' money to make payments to earlier investors and himself.

Ponzi opened for business in December 1919, and soon the first few customers began trickling in. There was no need for advertising; word of mouth sufficed, (as on the next posts will be demonstrated, is a typicall characteristic of these scheme). In February 1920, he took in $5,290; in April, more than $140,000; in May, more than $440,000; in June, more than $2.5 million; and in July, nearly $6.5 million -- this at a time when the president of Harvard earned $6,000 a year. In seven months, 30,000 people had entrusted Ponzi with almost $10 million of their money.

Only a year later, in 1920,  his investors found themselves practically wiped out, receiving less than 30 cents on the dollar, loosing about 20 million in 1920 dollars (225 million in 2011 dollars); while ponzi was convicted of a variety of federal and state offenses. After several years in prison, he was deported to Italy in 1934.

A brief intro...

A Ponzi scheme is a fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from any actual profit earned by the individual or organization running the operation.

In order to attract potential investors, extraordinary returns are promised on the investment, and vague verbal constructions such as "hedge futures trading," "high-yield investment programs" or "offshore investment" are  used in order to take advantage of a lack of investor knowledge or competence.

Initially the promoter will pay out high returns to attract more investors, and to lure current investors into putting in additional money. Soon, attracted by the high returns, other investors begin to participate, leading to a cascade effect which leads the scheme to an inevitable collapse since the earnings, if any, are sooner or later going to be less than the payments to investors, or in other cases because, as more investors become involved, the likelihood of the scheme coming to the attention of authorities increases and the scheme is interrupted by legal authorities before it collapses or because a Ponzi scheme is suspected or because the promoter is selling unregistered securities.

 The following graph is an interesting and clear rappresentation of how the scheme actually works.