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Ponzi Scheme Overview and Analysis

Introduction

The principal goal of a commercial company is to realize a profit. Nevertheless, this intention can be achieved illegally, particularly by creating Ponzi schemes. At present, a financial pyramid is a standard model of fraud in the business investment environment. It is essential to explain its origins and features by analyzing the examples of notable Ponzi schemes in the 21st century, such as the Madoff, Stanford, Petters, and Maryland cases. Moreover, to prevent such pyramids’ further appearance, it can be useful to examine measures and policies that citizens and state authorities could take.

Ponzi Schemes Description

The Ponzi scheme is identified with the dishonest money-making system of Charles Ponzi. He was an Italian fraudster who moved to North America and operated in the early 1920s (Springer, 2020). According to Springer (2020), the Ponzi Scheme is an investment scam that pays money collected from new investors to initial ones. The concern of this system is that, eventually, not all investors receive payments. This form of fraud is often referred to as a financial pyramid.

However, there are significant features that differentiate the Ponzi scheme from the classic pyramid. Compared to the latter, the method has an ideological ruler who governs the entire system and receives the most profits (Springer, 2020). The basic principle is the multilevel marketing (MLM) system when a group of investors attracts others, contributing to the influx of new clients (Springer, 2020).

The Ponzi scheme is focused on attracting different financiers and retaining earlier ones by providing them with the conditions to reinvest their capital (Springer, 2020). In contrast, classic pyramids rely only on continually enticing new investors (Springer, 2020). The legend formed by the head of the Ponzi scheme is more convincing than the typical fraudulent systems (Springer, 2020). Thus, the lifespan of classic pyramids is several times less than the Ponzi scheme.

Ponzi Schemes Examples

Madoff Investment Scandal

One of the significant Ponzi schemes in history is Bernie Madoff’s scam; its real loss has never been calculated precisely. According to various estimates, Madoff could embezzle from $ 50 to 64.8 billion, thereby defrauding about 3 million people worldwide (Quisenberry, 2017). He started his business in 1980, trading on the New York Stock Exchange (Quisenberry, 2017). Madoff was one of the first businesspeople to use electronic technologies in trading, continually upscaling. Over time, under his management, investment funds began to appear, working with entirely different assets, including stocks and options (Quisenberry, 2017). Madoff’s reputation was impeccable; consequently, investors from all over the world were attracted to his reserves.

The pyramid principle was concentrated on the that Madoff’s corporation attracted money from other funds financiers, businesses, investment pools, supposedly spent in stock trading. One of the founders of Access International Advisers corporation, Thierry de la Villehuchet, was among the first who helped bring hundreds of million dollars from European investors (Quisenberry, 2017). For instance, the most famous clients were Steven Spielberg and Joseph Safra (Quisenberry, 2017). Financiers were attracted by a guaranteed income rate of 10-12% and an almost complete absence of management fees (Quisenberry, 2017). The scheme could work until 2008 since Bernard declared an average return on investment (Quisenberry, 2017). Thus, it is a classic example of a Ponzi scheme as the amounts were paid at other investors’ expense.

Allen Stanford Ponzi Scheme

The Allen Stanford Ponzi scheme suggested that investors would collect revenue by attracting new investors. The company was called Stanford Financial Group (SFG); Stanford took over the organization’s leadership in 1993 and by 2008 managed $ 50 billion in assets (Flynn et al., 2020). In 2008, Stanford’s private fortune was estimated at $ 2.2 billion (Flynn et al., 2020). The fraudulent activity was revealed when two financial analysts resigned from Stanford Financial Group, and lodged a lawsuit against the company’s fraud (Flynn et al., 2020). Significant exposures occurred afterward, following the collapse of Bernard Madoff’s scheme.

After SFG was scrutinized by the US Securities and Exchange Commission (SEC), the latter proved the company’s fraudulent activity. SEC statements emphasized that three of Allen Stanford’s companies, such as Stanford Group Company, Stanford Capital Management, and Stanford International Bank, sold their clients deposit certificates totaling $ 8 billion (Flynn et al., 2020). Simultaneously, the financiers promised buyers excessively high-interest rates, which they planned to pay at the expense of a diversified investment portfolio (Flynn et al., 2020). Over 20 years of existence, more than 30 thousand investors from about 100 countries worldwide were involved in the financier scheme (Flynn et al., 2020). A court sentenced Allen Stanford to 110 years in prison (Flynn et al., 2020). Hence, this is an example of a long-lived Ponzi scheme as interest payments were made at the cost of recently attracted stakeholders.

Tom Petter Ponzi Scheme

Another example of the Ponzi scheme in the 21st century is Thomas Petters’ company and his projects. He is a former American businessman, CEO of Petters Group Worldwide (PGW), who stole billions of dollars under reputable companies’ guises. Operations’ costs are approximately $ 3.65 billion; PGW owned Polaroid, Fingerhut, and a controlling share in Sun Country Airlines (Springer, 2020). Nevertheless, in the early 2000s, these corporations were thoroughly maintained by the billion-dollar Ponzi scheme.

Petters has attracted new investors into his business, ensuring that their capital is used to purchase consumer electronics. These products should have been resold subsequently at retailers such as Costco Wholesale Corp and BJ’s Wholesale Club Inc (Springer, 2020). Besides, Petters offered promissory notes through his large-scale brokerage company, suggesting a 15-20% return (Springer, 2020).

The company provided financing for the business, and investors believed they were in the electronics and consumer goods market (Springer, 2020). Regulators claimed that Petters defrauded financiers who funded earlier investors’ interests and the founder’s expensive lifestyle (Springer, 2020). In 2009, Tom Petters was sentenced to 50 years in prison for organizing a pyramid scheme (Springer, 2020). His activity is relevant to the classical Ponzi system as the company did not buy or sell real goods; it had no actual earnings, speculating capital expenditure.

Kevin Merrill, Jay Ledford, and Cameron Jezierski Ponzi Scheme

One of the more recent disclosures of the Ponzi scheme occurred in 2018. The pyramid creators Kevin Merrill, Jay Ledford, and Cameron Jezierski, promised investors would profit from buying and selling credit buckets (Gregg, 2019). The Maryland prosecutor’s office filed charges against the heads of the Ponzi scheme. According to estimates, it attracted more than $ 360 million of depositors’ funds (Gregg, 2019).

As a result, about $73 million of investment funds were stolen and misused from the total amount (Gregg, 2019). A large portion of the sums has been invested by over 200 individual investors (Gregg, 2019). They included small business owners, restaurateurs, construction contractors, retirees, medical specialists, lawyers, accountants, bankers, and professional athletes (Gregg, 2019). Fraudsters were creating false statements and forging documents to deceive their depositors.

Moreover, Merrill and Ledford promised investors significant returns in the near future. Regarding the indictment of federal attorneys in Baltimore, they advertised their expertise in collecting and reselling consumer debt (Gregg, 2019). Merrill and Ledford used legal entities and 55 bank accounts to transfer money from investors and continue building their pyramid scheme (Gregg, 2019). The funds aimed to meet the business creators’ needs, such as buying expensive cars, and real estate and paying dividends to the first investors.

How Ponzi Schemes Could Be Prevented

The examples of Ponzi schemes could have been prevented by checking the legality of companies’ activities. This can be achieved by law enforcement agencies; additionally, citizens’ appeals are required to initiate an inspection. There are several essentials for the organization of Ponzi schemes such as financial illiteracy, the imperfection of the relevant legislation, economic instability, and marketing campaigns. The SEC warns potential financiers that they should be wary of secure, low-risk investments with significant revenue (Springer, 2020).

New financial pyramids have been modernized and applied advertising tools, relying on advanced mental influence techniques to attract investors (Springer, 2020). Therefore, in case people suspect an illegal enterprise, it is necessary to report suspicious businesses to the city’s law enforcement authorities. It is more useful to prevent fraud than lose savings.

As an example, the Madoff scam was exposed by an ordinary accounting expert. Harry Markopolos was skilled at counting, which allowed him in the mid-1990s to start a second career as a financier (Reinicke, 2019). The employer – the management company Rampant Investment Management, commissioned Markopolos to study Madoff to create a similar financial product (Reinicke, 2019). He quickly realized that Madoff’s business was a Ponzi scheme and repeatedly reported this to his colleagues and the American authorities. Therefore, the case was solved due to financial literacy and analytical work.

With regard to the means which can prevent such schemes, it is needed to track advertisements of organizations that promise income being significantly higher compared to the market average. Due to regular inspections, such structures might be eliminated. Appropriate attention needs to be paid to educating the population about the economy, and improving people’s financial awareness. For instance, in the 2010s, the first large-scale plan against fraudsters was introduced in the United States (Springer, 2020). It was named Operation Broken Trust as, in most cases, the scammers received other citizens’ money at their disposal, using precisely the people’s trust (Springer, 2020).

The US Attorney General promised that the fight against financial pyramids in all their manifestations would continue (Springer, 2020). Overall, the Americans affected by such schemes should report to the authorities so that the criminals will be punished. The government not only catches fraudsters on their end but also warns potential participants in Ponzi schemes about the danger of losing their savings.

Conclusion

To conclude, the Ponzi Scheme is an investment scam that promises high return rates with minimal risk to investors. Such systems generate profits for early financiers by the new placement of capital. The most prominent examples of the Ponzi schemes have proved that the business areas affected by Ponzi schemes can vary considerably. With reference to measures that could have been taken to prevent fraud, they are primarily focused on verifying company documents and analyzing the organization’s activities. It is recommended to be concerned about profit sources and reasons why the business earnings are several times higher than similar structures operating in the market.

References

Flynn, K., Belak, P., & Andre, S. (2020). Sir Allen Stanford: Inmate# 35017-183; A case study of a Ponzi scheme and its aftermath. The CASE Journal, 16(4), 433-454. Web.

Gregg, A. (2019). Inside the scheme that allegedly used fake debt to steal $360 million from investors in Maryland and Virginia. The Washington Post. Web.

Quisenberry, W. L. (2017). Ponzi of all Ponzis: Critical analysis of the Bernie Madoff scheme. International Journal of Econometrics and Financial Management, 5(1), 1-6. Web.

Reinicke, C. (2019). Who is Harry Markopolos? The famed Madoff whistleblower could make millions after publishing a report accusing GE of fraud. Insider. Web.

Springer, M. (2020). The politics of Ponzi schemes: History, theory and policy (1st ed.). New York, NY: Routledge.

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