Ponzi Schemes

In 1919, Boston resident Charles Ponzi devised a foolproof investment scheme. He would buy international postal reply coupons in countries where they were relatively cheap. He would exchange them for more expensive postage stamps in the United States. After that, he would sell the stamps at a huge profit. Often, he would mark up the prices by 400%. This was perfectly legal.

Charles Ponzi's greed led him to devise a more fraudulent investment scheme. In 1920, he began to court investors with an opportunity for unheard-of 100% returns within 90 days. But those "investments" were not invested in anything. Ponzo paid early investors with money collected from new investors. As long as new investors bought in, his scheme could continue.

Eventually, newspaper investigations into his returns led federal authorities to investigate. Nervous investors demanded their money back, which was increasingly difficult for Ponzi to repay. The government seized his assets and exposed the fraudulent activity. Ponzi was arrested. He pleaded guilty to 86 counts of mail fraud and served a 14-year prison term. He died in Brazil in 1949.

At the time of his death, he had hardly a penny to his name. Although he did not invent this crime, it became known as a Ponzi scheme. This was because of the publicity he generated around this time of fraudulent investment schemes.

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 high returns for investors with minimal risk. Instead of making a legitimate investment, they keep some for themselves and pay earlier investors with the money of those who came later.

Do Ponzi schemes still happen? Yes! Recently, Ponzi schemes have become a concern for the United States government. Although crypto-currencies are drawing less attention, the U.S. Department of Justice paid much attention to whether Ponzi schemes were becoming an issue in cryptocurrency. For example, in December 2022, the U.S. Department of Justice (DOJ) announced charges against the architects of two digital currency Ponzi schemes.

Investigations, prosecutions, and sentencing of people involved in such schemes continue today. And there is the infamous Bernie Madoff. Madoff, one-time chairman of the NASDAQ stock exchange, perpetrated the largest Ponzi scheme in history. His far-reaching scheme defrauded many high-net-worth people, including movie director Steven Spielberg. Madoff pleaded guilty to 11 federal counts related to the investment scheme, including securities fraud. He got a sentence of 150 years in prison after bilking investors out of an estimated $64.8 billion.

According to CNBC, 2019 saw the largest number of Ponzi schemes since the Great Recession. Authorities uncovered 60 alleged Ponzi schemes totaling $3.25 billion in investor funds.

How Ponzi Schemes Differ From Pyramid Schemes

Ponzi investment schemes are often confused with pyramid schemes. This financial fraud has many similarities but some key differences.

A pyramid scheme requires a steady influx of cash to survive. Instead of bilking money from investors, the pyramid scheme makes money by recruiting new paying participants. Those new members are then encouraged to recruit more people. When new recruitment slows, the organization typically collapses as commission funds 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 later investors.

In 2019, Washington Attorney General Bob Ferguson filed suit against the clothing company LuLaRoe. He charged the multi-level marketing company with violating Washington's Anti-pyramid Promotional Scheme Act and the Consumer Protection Act.

The lawsuit cited LuLaRoe's bonus structure and unfair refund policy as problematic. It also said LulaRoe used deceptive misrepresentation of profitability to persuade thousands of people out of millions of dollars. The company paid $4.75 million, of which $4 million went to LuLaRoe sellers in Washington who had lost money. The company also changed its business practices.

It's difficult to distinguish illegal pyramid schemes from legal multi-level marketing companies. For example, the Federal Trade Commission (FTC) concluded that the well-known company Amway was not a pyramid scheme because:

• It did not charge up-front "head-hunting" or investment fees from new recruits;
• It did not force distributors to buy large amounts of nonreturnable inventory; and,
• It provided ways to help distributors earn money from selling products directly to consumers.

Typical Criminal Charges for Ponzi Schemes

The government charges Ponzi schemes and other types of investment fraud as securities fraud or commodities fraud. These cases typically include other criminal charges as well, such as:

• Wire fraud
• Mail fraud
• Investment adviser fraud
• Conspiracy
• Money laundering
• False statements
• Perjury
• False filings with the Securities and Exchange Commission (SEC)
• Theft

People convicted of this fraud can serve long prison sentences. They may have to pay restitution to their victims, although the nature of the crime typically leaves very little money to do so.

Involvement in Ponzi schemes can result in fraud charges. The government takes fraudulent schemes very seriously. These convictions can have severe penalties that are civil and criminal.

Warning Signs of a Ponzi Scheme: How to Avoid Investment Scams

Ponzi schemes and other investment scams share the following characteristics, according to the U.S. Securities and Exchange Commission:

• Unusually high returns without corresponding risk: The prospect of high returns generally comes with high risk.
• Abnormally consistent returns: The market has peaks and valleys. Investments with a high rate of return that seems immune to broader market trends should raise a red flag.
• Unregistered investments: Registration with the SEC or state agencies provides transparency into an investment fund's health, finances, and management.
• Unlicensed sellers: An investment opportunity with something to hide may use unlicensed sellers.
• Rogue brokers: Avoid brokers not registered with the SEC or the Financial Industry Regulatory Authority (FINRA). FINRA operates a BrokerCheck database that allows people to check the broker registration status and any past disciplinary action. Never make checks payable to the broker instead of the company.
• Secretive and complex strategies: Lack of transparency should make would-be investors skeptical.
• Paperwork errors or inconsistencies: This could be a sign that the books are being "cooked."
• Problems with payments: Ponzi schemes stay in business by limiting payouts. Payments may come late, or the fund might try to dissuade investors from cashing out.

If you believe you have become the victim of a Ponzi scheme, contact law enforcement to report it. Contact the FTC and the SEC, as well. They have hotlines for reporting these schemes.

Curious about the Legality of an Investment? Get Professional Legal Help Today

Be prepared before getting involved in an investment scheme. If you are charged with investment fraud, a seasoned attorney will be able to advise and defend you.

Contact a criminal defense attorney near you. Contacting a criminal defense lawyer is essential if you've been accused of orchestrating a Ponzi scheme. This white-collar crime can carry severe penalties. An experienced criminal law attorney can help secure the best possible outcome if you're facing charges for such a crime. They can help with your defense strategy.

Federal agencies take Ponzi schemes very seriously. Federal charges for this crime are equally as serious. Contact a lawyer today for legal advice if you're facing a legal issue related to a Ponzi scheme.