A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier investors and to use for personal expenses, instead of engaging in any legitimate investment activity.
Why do Ponzi schemes collapse? With little or no legitimate earnings, the schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out.
The scheme is named after Charles Ponzi who used the technique in early 1920. Ponzi did not invent the scheme (for example Charles Dickens’ 1857 novel Little Dorrit described such a scheme decades before Ponzi was born), but his operation took in so much money that it was the first to become known throughout the United States.
Ponzi found his way to get rich quick using a vagary of the postal system. At the time, it was common for letters abroad to include an international reply coupon ― a voucher that could be exchanged for minimum postage back to the country from which the letter was sent. You only had to purchase postal reply coupons cheaply in some foreign country, send them back to the U.S. to swap them out for American stamps of a higher value, then sell these stamps.
Ponzi started buying and selling postal reply coupons using agents in his native Italy, and he was making a good living doing it. And then he got greedy. He started to recruit investors into his system with the promise of 50 percent returns in just a few days. Investors would pay their cash in, and sure enough, Ponzi would get them the promised return. Within two years, he had employees all over the country recruiting new takers for this foolproof investment strategy.
Ponzi was pocketing millions; at his peak, Ponzi was raking in $250,000 a day. So much money was flowing in from new investors; he could just pay off the returns for the old ones from the new cash. In fact, Ponzi didn’t even need to pay off the old investors, since many of them wanted to reinvest their returns in this wonderful business.
Eventually, Clarence Barron, owner of the Wall Street Journal and founder of the financial magazine that bears his name, realized Ponzi was running a con. Barron figured that Ponzi would have to be moving 160 million coupons around to raise the cash he needed to support the business. Since there were only 27,000 postal reply coupons circulating in the world, Ponzi’s story didn’t check out. Things only got worse when the Postal Service reported that there wasn’t a huge flow of the coupons from one country to the other.
Barron’s conclusions ran as front-page news in the Boston Post in July 1920. But many people chose not to believe the paper’s report. Few believed that the man who had “tripled” their life savings could be a crook. In fact, the morning that the Post ran Barron’s report, investors lined up around the block outside of his office in an attempt to give him more money. Ponzi later boasted that he’d taken in a million dollars in new investments the day the report ran.
The next month, regulators raided Ponzi’s office and discovered that he didn’t have a huge quantity of postal reply coupons. Since Ponzi had used the mail to notify his marks of how their “investments” were performing, he faced serious mail fraud charges; in total, the government brought 86 charges against him in two separate indictments. Ponzi pled guilty to one of these charges in exchange for a light sentence of five years.
He served around three and a half years, then got his release to face state charges, for which he received a sentence of nine more years. Upon his release, Ponzi was deported to Italy and spent the rest of his life in poverty before dying in 1949 in Rio de Janeiro, where he’s buried in a pauper’s grave.
OTHER PONZI SCHEMES
Some of the more interesting Ponzi schemes, before and after Ponzi:
- In 1899 William “520 Percent” Miller opened for business as the “Franklin Syndicate” in Brooklyn, New York. Miller promised 10% a week interest and exploited some of the main themes of Ponzi schemes such as customers reinvesting the interest they made. He defrauded buyers out of $1 million and was sentenced to jail for 10 years.
- In the 1930s, Ivar Kreuger, a Swedish businessman, known as the “match king”, built a Ponzi scheme, defrauding investors based on the supposedly fantastic profitability, and ever expanding nature, of his match monopolies. The scheme soon collapsed and Kreuger shot himself.
- Between 1970 and 1984 in Portugal, a woman known as Dona Branca maintained a scheme that paid 10% monthly interest. In 1988 she was sentenced to 10 years in prison. She always claimed that she was only trying to help the poor, but in her trial it was proven that she had received the equivalent of almost $120 million.
- In January 1984 Adriaan Nieuwoudt started the so-called “Kubus” scheme with a so-called beauty product in South Africa. Subscribers to the scheme bought a “biological substance” called an “activator” that was used to grow cultures in milk. After growing for a week or two, the cultures were harvested and dried, and sold back to the scheme. The cultures were never used for a beauty product but were simply ground up and resold to further investors as activators
- 1600 investors in the Diamond Mortgage Company and A.J. Obie, two firms with the same managers, lost approximately $50 million in what the Michigan Court of Appeals described as “the largest reported ‘Ponzi’ scheme in the history of the state.” It led to the passage in 1987 of the Mortgage Brokers, Lenders, and Servicers Act.”
- Between 1978 and 1983 Ron Rewald ran an investment firm in Hawaii. The firm declared bankruptcy in 1983 and was revealed to have been a Ponzi scheme which defrauded over 400 investors of more than $22 million. Rewald claimed that he had been operating the firm as a front for the CIA.
- In Romania, between 1991 and 1994, the Caritas scheme run by the “Caritas” company of Cluj-Napoca, owned by loan Stoica promised eight times the money invested in six months. It attracted 400,000 depositors from all over the country who invested the equivalent of $1 billion before it finally went bankrupt in 1994, having a debt of $450 million. The owner, Ioan Stoica was sentenced in 1995 to a total of seven years in prison for fraud, but he appealed and it was reduced to two years. He then appealed to the Supreme Court of Justice and the sentence was reduced to a year and a half.
- In late 1994, the European Kings Club collapsed, with ensuing losses of about $1.1 billion. This scam was led by Damara Bertges and Hans Günther Spachtholz. In the Swiss cantons Uri and Glarus, it was estimated that about one adult in ten invested into the EKC. The scam involved buying “letters,” valued at 1,400 Swiss francs that entitled buyers to receive 12 monthly payments of 200 Swiss francs. The organization was based in Gelnhausen, Germany.
- From 1993 until 1997 a church named Greater Ministries International in Tampa, Florida, headed by Gerald Payne bilked over 18,000 people out of $500 million. Payne and other church elders promised the church members double their money back, citing Biblical scripture. However, nearly all the money was lost and hidden away. Church leaders received prison sentences ranging from 13 to 27 years.
- In 2000, a Ponzi scheme perpetrated by Scientology minister Reed Slatkin came unraveled when SEC regulators became aware that Slatkin was not a licensed investment adviser. Slatkin had raised some $600 million from over 500 wealthy investors, mostly Hollywood celebrities.
- In 2001, the Haitian population fell prey to Ponzi schemers offering rates up to 15%. The outfits called “cooperatives” appeared to be implicitly backed by the government and became wildly popular in the population at large who felt safe since the coops were openly advertising on the radio, TV ads, with Haitian pop stars as spokespeople. It is estimated that more than $240 million were swindled from investors, equivalent to 60% of the country’s GDP.
- The Brothers was a large investment operation, eventually exposed as a Ponzi scheme, in Costa Rica from the late 1980s until 2002. The fund was operated by brothers Luis Enrique and Osvaldo Villalobos. Investigators determined that the scam took in at least $400 million. Most of the 6,300 victims were American and Canadian retirees but some Costa Ricans also invested the minimum $10,000. In May 2007 Osvaldo Villalobos was sentenced to 18 years in prison for fraud and illegal banking. Luis Enrique Villalobos remains a fugitive.
- In Oct, 2006 Gregory Nathan, a Sydney fund manager, was arrested on charges for what investigators discovered to have been a Ponzi scheme. Nathan, a notorious gambler, reported returns that were always stellar, prompting many to invest their life savings. Nathan didn’t discriminate, victims included his mother, his girlfriend, his flat mate, the elderly and handicapped. Nathan falsely reported his fund had $22 million under management, when the most it could have had at any one time was approximately $4.9 million. From 2001 – 2006 an estimated $8.8 million was lost by an untold number of investors believed to be in the hundreds. In a desperate late bid to perpetuate the scheme, Nathan sent an email to existing clients on Oct 9, 2006 — just days before placing his companies in administration — encouraging them to increase their investment. In September 2008, Nathan was sentenced to a total of seven years imprisonment including a five year non-parole period.
- On June 27, 2007, former boy band mogul Lou Pearlman was indicted by a grand jury on several counts of fraud which is turning out to be one of the longest running U.S. Ponzi schemes ever, lasting over 20 years. The final total damage may rest somewhere near $500 million.
- On December 10, 2008, Bernard Madoff made an admission to his sons that his investments were “all one big lie.” The following day he was arrested and charged with a single count of securities fraud. As of December 2008 the losses were estimated to be $65 billion, making it the largest investor fraud in history. Madoff was sentenced to 150 years in prison on June 29, 2009.
If you know of any other interesting Ponzi schemes, leave a comment.