A few years back, Bernie Madoff brought fame to a scheme known to many as a Ponzi scheme. What is Ponzi scheme? Well if I were to guess, based on the word Ponzi, I’d say that is sounds like a delicious Italian dish. It sounds like a flaky dessert, or something with pasta and cheese in my mind. Unfortunately, Ponzi schemes aren’t delicious at all.
Ponzi schemes or Ponzi scams are named after Charles Ponzi. In the 1920’s Ponzi attracted investors with a plan of investing into postage stamp arbitrage. The idea was to buy postage reply coupons at discount value in other countries. A postage reply coupon is a coupon that can be exchanged for postage stamps. Their prices vary with time and location so they can be redeemed at the higher face value in the United States. In reality the act of buying and selling in so many small transactions may have produced little or no profit because of service charges. He promised clients a 50% profit in 90 days (some sources say 50% in 45 days). There was a huge demand for his service, and thousands signed up. By the end, he had taken millions from his investors. He would take money from new investors, and use it to pay off old investors, which would attract more clients. Ponzi was eventually charged with mail fraud in 1920, and deported Italy in 1934. Though he wasn’t the first to run this scam, the scale at which he ran it brought infamy to his name.
The biggest and most famous Ponzi scheme in U.S. history was run by Bernie Madoff. Madoff ran his scheme from the 1970’s until it fell in 2008. His plot was similar to that of Charles Ponzi, but the money was supposedly put into traditional financial market trades rather than postage stamp arbitrage. The trades were never made, and the money was kept to pay the ringmaster as well as older investors who exited earlier. The scam was working well until the 2008 market crash. He had an estimated $50 billion riding on his fund. Madoff’s fund was still showing sizeable returns of 4.5% through October of 2008 while the markets were hurting. Though he was showing gains for his investors, they started requesting withdrawals of their money. Within a short time he owed investors $7 billion, which he couldn’t actually return. This led to his confession and eventual imprisonment. Needless to say, tons of inestors lost their savings in a long, drawn out ordeal that ended abruptly.
The fact that many “sophisticated investors” were taken along for the ride shows that we all have to do our homework when entering a deal with someone who will control our money. The fact that Madoff was already famous in the finance industry may have gotten people to relax, assume that everything was cool, big is better, and trust that the team of experts they’ve signed with had done all their homework. I hate homework as much as the next guy, but there are times when you’ve just got to do it.
As an investor, there should be some transparency in the fund. You should occasionally be able to see where the money is actually being traded. You should also understand exactly what kind of system is being used in their trading. It should be simple enough for you to explain to others once explained to you. You may also want to contact an expert to analyze the fund. Managers should be willing to share information about how the fund operates. Secrecy should get u wondering. Avoid managers who have faced fraud charges in the past. Guaranteed gains is another warning signal. Financial markets can be all over the place. Even the best funds will have periods where the fund is in the red. When words like “safe” or “guaranteed” get thrown around, beware. I would also recommend someone you personally feel comfortable with. Try to establish such long term relationships with people you like and trust. There are obviously many other things to look out for. I recommend reading up on, various funds and advisors when searching.
When funds get revealed as Ponzi schemes, many investors who fall victim to them say they ignored their gut feelings when they had warning signs that the fund was not legit. Don’t ignore signs. Ask questions when you have them. After all it is your money that keeps a fund going.
Now I hate to be the guy to say,“If it sounds too good to be true, it probably is.” But I just had to spit it out. (You may want to punch me in the face for saying that, but it’s usually true).
Post By: Tahric Finn