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How to Recognize a Ponzi Scheme

The Ponzi scheme is a notorious type of securities fraud, and for good reason. Because it functions by paying off newer investors with money from previous investors while little to no actual investing is going on, everything looks to be on the up and up. Although eventually every Ponzi scheme will run out of new investors to dupe, many of these scams can run for a long time.

So what is a wise investor supposed to do? If a Ponzi scheme is so undetectable that newer investors are being paid and previous investors are able to say they've received the "promised" returns, how can an average investor sniff out a fishy deal? As securities fraud attorneys, we'd like to say that, luckily, with a little education, any investor can be wise to the biggest red flags.

What Is a Ponzi Scheme?

Before you are able to recognize the warning signs of a Ponzi scheme, it is important that you understand what this type of fraud entails. Charles Ponzi was one of the most notorious people who participated in this type of scam, which is why it was named after him. Basically, he collected money from people who wanted to invest in his business and then paid investors large interest payments from the money he obtained from the new investors. While Ponzi didn’t create this form of investment fraud, his operation was the first to become known in the United States.

Ponzi schemes can be difficult to identify. One of the most recent examples involved a man from Santa Ana, CA, who allegedly used money received from new investors to make payments for principal and interest to previous investors. The earlier investors believed that they were receiving returns on their investments. This scam reportedly cost investors $14.5 million. Unfortunately, this case is not isolated, as there are regularly reports of Ponzi schemes resulting in financial loss.

Red Flags of a Ponzi Scheme

When you are looking into a new investment opportunity, it's important to take the time to check out both the person offering the investment and the investment itself. Verifying that both the promoter and the opportunity are legitimate can save you a lot of time, money, and heartache.

Any person offering an investment should:

  • Be registered to sell investments in your state
  • Have a history that is clear of any disciplinary action or a pattern of complaints
  • Be able to explain his or her investment model to you in terms you understand
  • Be willing and able to provide all of the documents and information you need

Beyond checking out the person offering the investment, you should also look into the actual opportunity itself. If an opportunity features the following, it could be a Ponzi scheme:

  • "Guaranteed" High Returns
    Any investment with “guaranteed” high returns should be carefully examined.
  • Hidden Information
    Excuses about missing paperwork, errors, or secretive strategies are red flags.
  • Consistent High Returns
    Be cautious of investments that generate high returns unaffected by the market
  • Unregistered Investments
    Most cases of investment fraud involve investments that have not been registered.
  • Unlicensed Sellers
    Many Ponzi schemes involve unregistered firms and/or unlicensed individuals.
  • Pressure to Reinvest
    Ponzi schemes collapse without regular income or when too many investors cash out.

Steps to Avoid a Ponzi Scheme

  • Check out the credentials and background of the person who has approached you about the investment. You can check the company out with the BBB. If the person is a broker, you can use his or her CRD number to gain more insight into the broker’s record.
  • Have an attorney review any contracts that you are given. Don’t send any money until you have had the contracts analyzed by a lawyer that you can trust.
  • Be cautious if a money manager wants to be your custodian. A custodian is a broker-dealer that maintains investment accounts. If a money manager asks you to write a check directly to them, it is a red flag. It would be better to write the check to the custodial firm.
  • Make sure you understand your investment. If the investment appears complicated or if it cannot be properly explained, you may not want to hand over your money.
  • Trust your instincts. There are times when your instincts will tell you something is wrong. If you don’t feel comfortable about an investment, walk away.

Examples of Real-Life Ponzi Schemes

Mutual Benefits Company Scandal (2003): Joel Steinger and his company, Mutual Benefits Corporation, carried out a Ponzi scheme by attracting investors with promises of high returns for life insurance polices from terminally ill patients. Steinger bribed doctors to provide false information regarding the patients' expected lifespan; investors filed complaints after 90% of patients lived much longer than expected.

Petters Group Worldwide Scandal (2003): Tom Petters and his company, Petters Group Worldwide, accomplished their nearly $4 billion dollar fraud scheme by creating a complex web of false invoices, fake purchase orders, and a network of co-conspirators to deceive investors into believing they were investing in legitimate businesses.

Madoff Investment Scandal (1991-2008): Bernie Madoff carried out his $65 billion Ponzi scheme (the largest Ponzi scheme in history) by using the funds from new investors to pay returns to earlier investors, while also using a significant portion of the funds for his personal use and to cover up the fraud. He also falsified account statements and other records to make it appear as though the investments were performing well.

Stanford Financial Group Scandal (2012): Allen Stanford and his company, Stanford Financial Group, ran a $7 billion Ponzi scheme by selling certificates of deposit with absurdly high returns, promising investors that their funds were secure and insured. In reality, the majority of the funds were used to finance Stanford's lavish lifestyle, pay returns to earlier investors, and to pay for the company's operating expenses.

Take Action to Protect Your Rights - Call Meyer Wilson

The first step you should take if you suspect a Ponzi scheme is to contact an experienced investment fraud attorney. Failure to do so may result in evidence becoming too obscured to properly establish your case. An attorney will take the time to go through your options and determine the best course of action. Choosing the right legal representative is not easy. However, it is absolutely critical in establishing an effective legal strategy.

The right law firm should possess the following qualities:

  • Established, recognized experts in investment fraud cases
  • Track record of successful outcomes in investment claims

If you believe that you may have been the victim of a real estate Ponzi scheme then it is important to contact an experienced investment fraud attorney. Meyer Wilson has successfully represented more than 800 investors in stockbroker mediation, arbitration, and litigation claims.

Report a Ponzi Scheme

After contacting our firm, we can help you report a Ponzi scheme to the SEC as part of the SEC Whistleblower Program, which provides incentives and protections for individuals who provide credible tips about federal securities law violations, such as Ponzi schemes.

The information contained in The Firm’s posts on its blog, fraud alerts, investigations or elsewhere on the site is based upon information obtained from other sources including, but not limited to, news outlets and federal, state, and regulatory agency filings. All suspects and subjects of postings herein are presumed innocent until proven guilty in a court of law or administrative action and any and all crimes are alleged until a court or regulatory agency finds otherwise .

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