What is a Ponzi Scheme?

Published by Thomas Herold in Accounting, Investments, Laws & Regulations, Trading

The term 'Ponzi Scheme' is included in the Investments edition of the Herold Financial Dictionary. Get yourself a copy now on Amazon - available as Kindle or Paperback.

Ponzi Schemes prove to be frauds surrounding investments that are related to the pay out of returns to investors in the scheme that are covered using contributions from new investors. The individuals who run Ponzi schemes are able to attract newer investors through boasting of tremendous opportunities that will guarantee terrific investment returns, typically with little to no risk.

With a great number of these Ponzi Schemes, the managers of the scheme concentrate their efforts on constantly bringing in new sums of money in order to be capable of giving out the payments that they promised investors from earlier time periods. Besides this, they utilize the new money for their own personal expenses. Rarely does any energy actually go into real investment opportunities and strategies.

Ponzi schemes always fail at some point in time. This eventually happens since there are no real earnings to distribute. Because of this problem, Ponzi schemes need constant money flowing into them from newer investors in order to survive. As attracting newer investors becomes more challenging, or if a great number of currently involved investors request their money back, then the Ponzi Scheme will likely fall apart.

Ponzi Schemes actually earned their name from a famed early con artist Charles Ponzi. He became famous after he tricked literally thousands of well to do New Englanders into pouring their money into his speculation in postage stamps in the 1920’s. The allure of his scheme proved to be hard to resist, since bank accounts were paying only five percent annual returns while he offered investors incredible returns of fifty percent in only ninety days. In the early days, Charles Ponzi really did purchase a small quantity of international mail coupons to support his investment scheme. Before long, he decided to employ the money that came in to cash out earlier investors.

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The most successful Ponzi Scheme of all time proved to be the one run by Bernie Madoff. Madoff ran an over thirty year, over thirty billion dollar investment scheme that tricked thousands of investors out of their money. Madoff proved to have a different angle on his Ponzi scheme in that he did not offer his investors who were short term amazing returns. Rather than this, he sent out fake account statements that constantly demonstrated moderate but always positive gains, no matter how turbulent the market proved to be.

Bernie Madoff is presently undergoing a one hundred and fifty year sentence in federal prison for his activities. His investment advisory company began back in 1960 and did not come down until the end of 2008. All during the years that his scheme ran, he served as Vice Chairman of the National Association of Securities Dealers, and even as a member of the board of governors and chairman for the NASDAQ stock market.

The Securities Exchange Commission is ultimately responsible for discovering and prosecuting Ponzi Schemes. They typically utilize emergency actions to freeze assets while they break up the schemes. In 2009 as an example, the SEC actually pursued sixty different Ponzi schemes, the highest profile one of which turned out to be Robert Allen Stanford‘s $8 billion Ponzi scheme.

The term 'Ponzi Scheme' is included in the Investments edition of the Herold Financial Dictionary. Available now on Amazon in Kindle and Paperback.