So what is a Ponzi scheme and why should you avoid getting entangled in one? A Ponzi scheme is an investment programme that is operated fraudulently because instead of the investor’s money being invested as promised, they are paid out from money put in by subsequent investors and not from returns from the supposed investments. The returns on investment that are offered to prospective investors are usually well above what can be earned from investing in funds, savings schemes or even property. In a rising economy the schemes can prosper as there will be a ready stream of investors who want to cash in on the good times and get a large percentage return on their money.

Many of the individuals and companies that have been sucked into these schemes are successful, reputable and financially sophisticated, so how have they been persuaded to part with their cash? A lot of these schemes are run by plausible, charismatic characters that go out of their way to ‘groom’ rich clients. They hang out at the places and events where wealthy people gather, and make friends and become part of the social circle. After all, wouldn’t you be more inclined to trust someone who had been introduced to you by your best friend? They hide behind a credible corporate facade and because it’s all about trusting a friend or known business acquaintance, potential investors are not as vigilant as they might otherwise be. It has to be said that greed also has its part to play, and that if something feels like it is too good to be true, it usually is.

The wheels started coming off many of these schemes at the start of the economic downturn of 2007. On the one hand people did not have so much cash available to invest, and on the other people who had already invested started wanting to have their original investment back. New money from investors could not keep up with paying out to old investors and many people were left in a situation where they had lost everything that they had put into the Ponzi scheme. Sometimes the Ponzi scheme is shut down by the Authorities before it collapses due to irregularities being detected .

The name ‘Ponzi scheme’ came from a villain by the name of Charles Ponzi who emigrated from Italy to the US in the early twentieth century and started a scheme that was based on arbitraging international reply coupons for postage stamps in the early 1920s.  He was promising 50% return on investments in forty five days or ‘double your money’ in ninety days. He soon stopped what he was supposed to be doing and began paying new investors directly from old investor’s money and skimming off vast sums for himself.  He managed to attract 40,000 people into his scheme who invested around $15 million, making him a millionaire several times over in six months. His was certainly not the first such scheme, but it was the first scheme that became notorious throughout the whole of the United States, so hence the schemes have been called Ponzi schemes ever since.

Perhaps the best known Ponzi scheme in recent years is that perpetrated by Bernie Madoff also in the United States.  His loss on investments of $65 billion has made him the largest investor fraudster of all time so far.  He was sentenced to 150 years in prison for his crimes in June 2009 and will certainly die in jail.  He leaves behind him a trail of individuals and companies whose economic health has been damaged, sometimes irreparably, by his fraud.  Pensioners have lost their life savings and homes, families have been pushed to the financial edge and over and some companies have lost large sums of money.  What seems inconceivable now is that Madoff had been brought to the attention of the Authorities as early as 1999 when a financial analyst Harry Markopolos put his name before the US Securities and Exchange Commission, saying that it was not in the bounds of probability that Madoff could have legally made the huge return on investments that he was claiming.

Recently an alleged large Ponzi scheme has also come to light in the United Kingdom.  A company called Business Consulting International run by a businessman called Pruthi and two associates had invited business acquaintances, family and friends to lend them money which in turn would supposedly be lent to businesses in trouble at very high interest rates.  An investigation was started in November 2008 and anguished investors have subsequently found out that they had been lied to and that they were very unlikely to get all of their money back.  Allegedly investor’s money, instead of being lent to businesses, had been spent on luxury items such as jewellery and expensive cars or siphoned off abroad.  As one of the associates used Surrey Cricket Club as a frequent haunt to lure in potential investors, it is believed that several of England’s top cricketers have been burned by the scheme.  Certainly many families and individuals have invested large sums of money which they are not hopeful of getting back and which, in some cases, has had a very serious negative impact on their finances, involving the loss of homes and businesses

So what do you do if you have some money burning a hole in your pocket and you want to invest it and want some high returns?  Be very wary of plausible, smooth-talking friends and acquaintances with ‘miracle’ schemes on offer.  If you are offered something that is ‘too good to be true’ it almost certainly is.  Do your homework and ask to see all the relevant paperwork and get it checked out by an unbiased professional.  Do not let a desire to secure your family’s future blind you to what could really be going on.  Do some research into  what is happening in the markets to see what returns are being made on other investments, and use this information as a yardstick as to what returns should be possible. If you are still drawn to invest in a scheme though, after taking all these considerations into account, do not put all your eggs into one basket.  Work out an amount of money that you feel you could stand to lose. An amount that if lost would not undermine your financial stability in any way, and only invest that sum.

Ponzi schemes have destroyed lives; so be a canny investor and err on the side of caution.