In December 2008, Bernie Madoff reminded the world about the devastation Ponzi schemes can cause for victims of financial crimes. In order to protect their financial interests, investors should learn how to identify a Ponzi scheme; those who have already been swindled should be aware that it may be possible to hold fraudulent actors responsible through a class action lawsuit.
What is a Ponzi scheme?
The Securities and Exchange Commission defines a Ponzi scheme as investment fraud where schemers pay off existing investors from monies collected from new investors while representing those monies as returns on legitimate investments. Typically, the fraudulent actors have not made legitimate investments at all, but rather have used the investors' money for personal use and to keep the scheme moving forward by generating sham returns.
Organizers of Ponzi schemes often recruit investors by promising high returns with little risk. Ponzi schemes collapse when the fraudulent actor is no longer able to find new investors and the money runs out.
Ponzi schemes are named after Charles Ponzi, who defrauded investors in New England during the 1920s. Ponzi promised his investors a 50 percent return on investments in as little as three months during a time when annual interest rates were about five percent. When discovered, Ponzi owed investors approximately $7 million. He served 14 years in prison for his crime.
Recent, infamous Ponzi scheme perpetrators
Two of the most recent Ponzi scheme perpetrators are Bernie Madoff and Allen Stanford. Madoff is currently serving a 150-year sentence in federal prison for a multi-billion dollar scheme affecting thousands of innocent investors. Unlike most Ponzi schemes, which promise high returns in the short-term, Madoff issued fake account statements that showed false but moderate returns, even when the economy took a nose dive in 2008.
Before being discovered as a sham, Madoff was viewed as a respected investor. He served on the board of governors for both the NASDAQ and the NASD and had a long-established career in securities trading dating back to the 1960s.
In June 2012, Allen Stanford was sentenced to 110 years in prison for a Ponzi scheme he ran that stole $7 billion from investors. His unwitting investors thought they were buying certificates of deposit from Stanford's bank in Antigua, but the funds really went to supporting Stanford's luxury lifestyle, bribes for securities regulators and funding failed business start-ups. In his 40-minute address to the court during his sentencing hearing, Stanford failed to offer an apology to his victims.
How can investors spot a Ponzi scheme?
There are several red flags that indicate an investment opportunity is too good to be true. First, be wary of investment managers who offer low risk for high returns on investments, especially during a poor economy or over a short period of time. Investors should also hesitate if managers promise guaranteed returns.
Additionally, investors should avoid investing with a firm that is not registered with the state or federal government, or invest in funds that are not registered with the SEC or state regulators. Investors should be wary of managers who are reluctant or unable to divulge their investment strategies or who do not provide paperwork like prospectuses or disclosure statements.
Lastly, investors who have trouble receiving payments from their investments or are strong-armed into rolling their payments into other, more supposedly lucrative investments should seriously consider withdrawing their money since these are strong signs that the investments are not legitimate.
Those who have fallen prey to a Ponzi scheme may be able to hold the schemer accountable through a class action lawsuit with the help of an attorney knowledgeable about securities and broker fraud class actions.