The Top 10 Ways to Avoid Being Sucked into a Ponzi Scheme

Ponzi schemes galore: 23,000 YouTube videos show investment scams are not just for the rich and famous: Internet Scambusters #338

We might think of Ponzi schemes -- investment frauds that rely on ever-increasing inflows of cash -- as scams targeted only at wealthy people and organizations.

But 23,000 Ponzi-type videos on YouTube testify that we're all in the scammers' sights.

In this week's issue, we show why Ponzi schemes are on the increase and what you can do to avoid being snared.

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The Top 10 Ways to Avoid Being Sucked into a Ponzi Scheme


With the scale and some of the high profile names associated with the collapsed $50 billion Ponzi scheme run by Bernard Madoff, it's easy to think that these scams target just the rich and the famous -- or at least only people and organizations with big bucks.

Not so.

Ponzi schemes -- which pay "investors" inflated returns out of their own or new money plowed in by other suckers, until the whole thing collapses -- are all around us.

They're perhaps the biggest type of investment scam there is, and they suck in just about everyone from sports stars and major charities to individual retirees and "mom and pop" businesses looking to invest their profits.

(You can read more about Ponzis and the crook for whom they're named in this Scambusters first article, and about other investment scams in the second one.)

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7 Deadly Sins: Investment Scams Promise Shortcut to Economic Recovery

The really bad news is that the Ponzi scam situation is getting worse. It's "Ponzimonium" out there!

Fraud investigators report record numbers of these "robbing Peter to pay Paul" scams. And according to the Better Business Bureau, there are at least 23,000 of them being promoted online in YouTube videos!

Even without Madoff, Ponzi schemes that reach the courts are reckoned to cost investors globally almost $10 billion a year.

Some of these scams are tiny by Madoff standards -- "mini Madoffs" as one commentator described them. They invite investments of just $150 upwards -- but if you don't have much money, that can still be a lot to lose.

Many of them too are more "pyramid" and "gifting" schemes of the sort discussed in the articles mentioned above.

Here, we're going to stick with a stricter definition of a Ponzi scam as a scheme in which a single person or organization offers extraordinary rates of return in an investment, usually in hedge funds, stocks, commodities, currencies, real estate/timeshare, or Certificates of Deposit (CDs).

Ironically, the accelerating collapse of Ponzi schemes and the mushrooming numbers of similar new scams are both related to the same thing -- the recession.

Ponzi schemes only work when there's more money coming in than going out.

The scammers depend on two factors to keep this going -- current investors are so enchanted by the profits they think they're earning that they keep reinvesting them (so the scammer never has to pay out); and new investors are drawn in by what they see others apparently earning.

It's all a lie of course. The Ponzians are merely keeping most of the money for themselves, and using the rest to lull their victims into a false sense of security.

That is, until recession-hit investors start trying to withdraw their money at the same time as the supply of newcomers dries up.

That's what happened with Madoff and at least 20 multi-million-dollar scams that have been exposed in the first six months after he went under in late 2008.

And that says nothing of the hundreds of other schemes that are too small to merit even a paragraph or two in the local newspaper.

As investing guru Warren Buffett says, it's "only when the tide goes out that you learn who's been swimming naked."

But -- and here's the scary thing -- the global economic nose dive that's taking down Ponzi schemes with it is also encouraging more crooks than ever to set up new ones.

Why? Because people who lose their jobs often get a payoff from their employer, which they want to invest; second, because, with savings institutions offering paltry interest rates of just a couple of percent (at best), investors who've pulled their money out of the stock market or the bank are looking for better returns.

In fact, one of the most recently-discovered Ponzi schemes claimed it was actually linked to the government's Troubled Asset Relief Program (TARP) and that investors' cash would go into debt backed by the federal $750 billion rescue program.

This supposed TARP scheme offered what seemed to be a solid investment with a return of 12.5%.

But many Ponzi schemes offer returns so outrageously high -- 10% a month is not unusual -- that common sense should tell you it's a scam.

Yet people continue to invest. As one expert put it, "greed trumps fear."

So, how can you ensure you don't get snared in a Ponzi scheme?

Here's our list of the top 10 things to do (or not do) or watch out for.

  1. Don't be tempted by high returns. Legal or not, just about all investment returns are related to risk -- the higher, the riskier. Even in the world of legitimate investment, it's best never to put money at high risk that you can't afford to lose.

  2. Consult a third party, like an unconnected broker or financial adviser, about any unusual or high-return investment you are considering. It won't guarantee you safety but may reduce the risk of being caught out.

  3. Don't be fooled into believing an investment is safe just because someone you know recommended it. Affinity scams, as they're called, are one of the favorite methods used to lure people into Ponzi schemes.

  4. Don't put all your eggs into one basket. Diversify! Spread your money across different investments. And even consider working with several brokers or investment advisers.

  5. Examine the track record of the individual/organization. Are their financial claims independently audited? Is their performance record realistic? And does one person seem to dominate the organization?

  6. Also, review the lifestyle of the key figure behind the scheme. Many Ponzi scheme perpetrators turn out to have expensive taste for things like antiques, yachts, multiple homes and even sports teams. Check out their background -- easier than ever to do online.

  7. Beware of vague and unsubstantiated statements, both about the financial performance of the business and the actual investment strategy.

    Many Ponzi crooks claim their technique is secret, confidential or too complex for outsiders to understand. Bottom line: don't invest if you don't understand.

  8. If you're a member of a particular ethnic, religious or disability community, be particularly wary of supposed schemes claiming to be specifically structured for people like you. Again, it's another favorite Ponzi trick.

  9. Get as much information as possible in writing -- details of the offer, names of validating organizations, the organization's own research documentation, and copies of any contracts you will be asked to sign. Most Ponzi schemes are shallow in this area. Check what you do receive for poor grammar or confusing wording.

  10. Finally, a good anti-scam catch-all that we always stress: be skeptical. Don't take at face value claims that organizations are officially backed or licensed by or with investment authorities, or that they are endorsed by any particular organization. Says who?

If you suspect you're in a Ponzi scheme, or you already know you're a victim, you should get immediate, independent financial advice and, if appropriate, contact the Federal Trade Commission and/or law enforcement.

(We at Scambusters cannot and do not provide financial advice.)

Unfortunately, past experience suggests the best you are likely to get back, once the whole thing collapses, could be around 10 cents on the dollar -- if you're lucky. Also, if the scammer files for bankruptcy, the Bankruptcy Agent is legally entitled to call on past investors to pay back any returns they've received in the prior year.

With Ponzi schemes, everything ultimately comes back to Item #1 in our list above. Even a 10% annual return (which is what Madoff offered) should be enough to set the alarm bells ringing these days.

Can we ever learn the lesson of relying on common sense in place of greed?

Well, consider this: Even after scammer Charles Ponzi was jailed in the 1920s for his racket, supposedly linked to profiteering on international postage coupons, people still sent money to him in his prison cell, hoping to cash in. Yikes!

Time to conclude for today -- have a great week!

 

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