Many people are familiar with the term, “Ponzi scheme”. You know they are bad and you know to avoid them, but defining and recognizing a Ponzi scheme may be a bit more difficult.
Named after Charles Ponzi, a 1920’s investor who made millions of dollars off of his customers, a Ponzi scheme is an operation where the operator, or organizer, pays returns to his investors from the money he’s made from new investors, instead of from the profit the investment has actually made. The operator then pockets any profit that is actually made as well as the investor’s payments that he is not returning to other investors.
For example, say Charles Ponzi convinces me to invest $50,000 in XYZ Corp. XYZ Corp. may or may not actually exist, but regardless, every month XYZ Corp. sends me a dividend of $10,000 I think the $10,000 must be because XYZ Corp. is doing really well, and realize that in five months I’ll have already broken even on my investment. What a steal, right? Well, in reality, the 10,000 I’m receiving isn’t coming from any legitimate profit at all. It is actually coming from my neighbor, Sally, whom Charles also convinced to invest. Therefore, a Ponzi scheme gives the illusion of profit and success when it reality it is a house of cards waiting to crumble.
Eventually, of course, the house does fall. Since the only money going into the scheme is from new investors, when the organizer runs out of people to recruit as investors, the money stops coming in. When the money stops coming in, the payouts stop coming in the mail, and before I know it, it’s my third month as an investor and I’ve lost $20,000. (This example is of course incredibly simplified for just a basic understanding.)
Typically at this point, the investor will either abscond with the money he has made from investors, or criminal charges will be filed. At that point, however, he may have already spent most if not all of the investors’ money, and recovery will be difficult.How do I recognize it?
Ponzi schemes often wave several red flags that investors should pay attention to, some of which are discussed and summarized below.
- High returns with no risk – This type of investment, if legitimate, does not exist. An investment can yield high returns, but it will also come with high risks. An investment can be low risk, but it will likely also come with low yields over a long period of time. Investors should be wary of brokers who promise too much.
- Consistent returns – As the stock market goes up and down each day, so too will your investments. Keep an eye on returns that are too consistent. For example, in the scenario above, I received $10,000 exactly every month. This is extremely unusual for a legitimate investment. Not only is it incredibly high, it never changed.
- Unregistered investments – in order for a security to be sold, it must first be registered with the SEC, unless it meets an exception to registration under SEC rules. Keep a watchful eye on investing in unregistered securities, which are less regulated, and thus, often times, more troublesome.
- Unlicensed brokers – FINRA requires all brokers to be registered with them. Check FINRA’s website to ensure your broker is licensed and registered with both the SEC and FINRA before investing.
- Complicated investment strategies – fraudulent brokers know that the people on Wall Street speak a completely different language than their investor’s on Main Street. A good investor will act as a translator, explaining what things mean and why an investment will meet your investment objectives and needs. A fraudulent broker will use this difference to confuse you and trick you into agreeing with them. Before agreeing to anything with a broker you don’t know, do your research and ask for help.
If you, like thousands of other people, have already fallen victim to a corrupt broker by way of a Ponzi scheme, please do not feel alone and do not be embarrassed. The dedicated securities attorneys at Fitapelli Kurta have extensive experience handling these matters. In fact, our firm prosecutes cases nationwide on behalf of investors like yourself. The law provides you with an avenue for recovery in these cases, but time is of the essence so please, do not delay. Call Fitapelli Kurta today for your free case evaluation. All of our cases are taken on a contingency fee basis. If you don’t win, we don’t win. Call now.