Taken For a Ride: Ponzi and Pyramid Schemes

If something sounds too good to be true, it probably is.


When it comes to your money, taking the utmost care with investments is key. However, the world is full of unscrupulous people who would like nothing more than to take your money from you. There are many ways that these types of people accomplish this goal, but perhaps the most widely used method is the Ponzi or pyramid scheme.

First implemented on a large scale by Italian immigrant Charles Ponzi in 1910, a Ponzi scheme encourages investors to buy into an enterprise or business with the promise of quick and large returns. The initial investors are then asked to recruit more investors. Once that happens, the initial investors are paid with the funds from the second round of investors or with existing capital. No one, however, is ever paid with funds that are actually generated by the enterprise or product.

When the money that has been paid into the fund reaches a high enough level, the promoter typically disappears with the investment funds. However, as payouts begin to decline, many investors are likely to begin demanding their promised returns, which causes the rapid unraveling of the scheme. At this time federal investigators are likely to become involved.

A pyramid scheme is very similar to a Ponzi scheme. Again, it involves a business model or product that requires an initial investment. Investors recruit others into the scheme, and the initial investors are paid from the secondary investment funds. Left unchecked, this process can continue for some time, but the top tier of investors is the only one that ever collects a return. Pyramid schemes are illegal in many countries around the world, including the United States.

Perhaps the most notorious Ponzi scheme to have taken place in the United States was implemented by Bernie Madoff, and exposed in 2008. As the proprietor of a large investment firm in New York City, Bernie Madoff promised bigger than normal returns on investment, thus luring many clients with large amounts of money to invest. He falsified trading records and dates, rarely or never made actual investments with his clients’ money, and generated payouts using the funds from other clients. With an estimated $65 billion stolen in fraudulent investments, Bernie Madoff pulled off the largest Ponzi scheme in history and was sentenced to 150 years in federal prison.

Although everyone is familiar with Ponzi and pyramid schemes, and these schemes should theoretically be more difficult to pull off than ever, they still happen. There are, however, several steps that potential investors can and should take to ensure that a potential investment opportunity is a legitimate one, and the people operating them are who they say they are.

Investigate, Then Investigate More

Ultimately it’s your money, and you’re responsible for making sure that your investment choices are sound ones. Do your homework thoroughly and investigate every aspect of the person and their investment history.

  • Is this person a legitimate financial adviser or planner?  The truth is that anyone can call themselves a financial planner. Make sure to inquire about their licensure and verify that with the organizations that issue credentials. The National Association of Personal Financial Advisors is a good place to start. Additionally, verify any company with the Securities and Exchange Commission.
  • Become familiar with the investment process.  Many people may not have a clear idea of how investment funds work. Talk to an accountant or other finance specialist and get clear and concise information about the ins and outs of investing.

Be Careful Whom You Trust

Unfortunately, the people who are most likely to encourage you to invest in a Ponzi scheme are friends and family members. This is now known as affinity fraud. Because people are more likely to trust a friend or family member, their recruitment into a Ponzi scheme is more easily accomplished.

Be wary when someone encourages you to consider an investment opportunity. Though this person may be a trusted friend, you don’t know their recommendation is going to be a sound one. If you do decide to take that type of advice from a friend, make sure to conduct your own investigation into the company.

Investing money can be a wise choice, especially when it is done through a certified financial planner or accountant. However, the risks are simply too great to trust your money to any type of nontraditional or suspicious investment scheme. Always choose to err on the side of caution and remember the “if it sounds too good to be true” adage, as it’s directly appropriate to the concept of financial investments.

Taken For a Ride: Ponzi and Pyramid Schemes

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