In 1919, Boston resident Charles Ponzi devised a brilliant investment plan. He would buy international reply coupons (which could be redeemed for postage stamps in other countries) in places where they were relatively cheap, exchanging them for more-expensive postage stamps in the United States. He then would sell the stamps at a huge profit -- up to 400 percent. This was perfectly legal, but his greed led him to devise a fraudulent scheme.
He began to court investors in 1920, promoting unheard-of returns of 100 percent within 90 days, but repaid these investors with money collected from new investors instead of with actual returns. As long as new investors entered the fray, his scheme could continue; but a newspaper's investigation into his returns triggered a run on his company. Unable to repay the investors, his fraudulent activity was exposed and Ponzi was arrested.
Ponzi pled guilty to 86 counts of mail fraud and served a 14-year prison term. He died in Brazil in 1949, with hardly a penny to his name. He didn't invent this particular crime, but it became known as a Ponzi scheme because of the publicity it generated.
Ponzi Schemes: Overview of the Offense
A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. Organizers of this type of fraud promise to invest the money and generate high returns for investors, often boasting of minimal risk. Instead of investing the money, however, they keep some for themselves and pay early investors with the rest.
Without new money (via new investors), these schemes generally run out of steam and collapse as more investors demand returns than the fund is able to repay. Ponzi schemes often share the following characteristics, according to the U.S. Securities and Exchange Commission (SEC):
- Unusually high returns without a corresponding risk - The prospect of high returns generally comes with high risk.
- Abnormally consistent returns - All investments have their peaks and valleys, so investments with high returns that seem immune to broader trends should be viewed with suspicion.
- Unregistered investments - Registration with the SEC or state agencies provides transparency into the health, finances, and management of an investment.
- Unlicensed sellers - An investment with something to hide may use unlicensed sellers.
- Secretive and complex strategies - Again, the lack of transparency should make would-be investors skeptical.
- Paperwork errors or inconsistencies - This could be a sign that the books are being "cooked" and that the investment is a fraud.
- Problems with payments - Ponzi schemes stay in business by limiting payouts, so they may be late with payments or try to dissuade investors from cashing out.
How Ponzi Schemes Differ From Pyramid Schemes
These types of schemes are often confused with pyramid schemes, similar financial frauds with some key differences. The pyramid scheme is similar in that it requires a steady influx of cash in order to survive. But instead of new investors, the pyramid scheme makes money by recruiting new participants, who pay to join and are encouraged to recruit additional people. When the pace of new recruitment slows, the organization typically collapses as funds for commissions dry up.
The term "pyramid" refers to the structure of the organization. Generally, a few people at the top (including the founders) collect money from many people at the bottom. Most people don't make much money -- particularly latecomers -- and may be stuck with products they can't sell, but they're motivated by the opportunity to recruit people under them.
They're often mistaken for so-called "multi-level marketing" organizations such as Amway Corp., which are similar to illegal pyramid schemes but deemed legal. Specifically, the FTC concluded that Amway (whose model has been copied by other companies) is legal because:
- It doesn't charge up-front "head-hunting" or investment fees from new recruits;
- It doesn't require distributors to buy large amounts of nonreturnable inventory; and
- It provides ways to help distributors earn money from selling products directly to consumers.
Typical Criminal Charges for Ponzi Schemes
Besides Charles Ponzi himself, the most notorious perpetrator of this kind of fraud is convicted felon Bernie Madoff. His far-reaching scheme defrauded several high-net-worth individuals, including movie director Steven Spielberg. Madoff pled guilty to 11 federal counts related to the scheme, including securities fraud, and was sentenced to 150 years in prison in 2009 after bilking investors out of an estimated $64.8 billion.
In addition to securities fraud and mail fraud, perpetrators of Ponzi schemes also may face charges of wire fraud or commodities fraud. Those who are convicted or plead guilty also may be required to pay restitution to their victims, although the nature of the crime typically leaves very little money with which to do so.
Charged for Running a Ponzi Scheme? Get Professional Legal Help Today
Prosecutors took a hardline stance on Ponzi schemes in the wake of Bernie Madoff's public downfall, so you'll want to be prepared if you've been charged with a crime relating to such a scheme. A seasoned attorney will be able to challenge the evidence and provide the best possible outcome. Get started today and contact a criminal defense attorney near you.