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Ponzi Schemes: History, Development and Prevention

Paper Type: Free Assignment Study Level: University / Undergraduate
Wordcount: 1990 words Published: 2nd Nov 2020

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Ponzi schemes are described as fraudulent investments that involve promises of unjustifiable high returns to the investors from fictitious sources. The organizers of the scam pay the old investors with the money from the new investors having been duped deliberately into believing that the narrative is true (Vander, Peter, and William, 2012). The organizers of the Ponzi scheme promise investors that they invest their money in opportunities claimed to generate high returns with little or no risk at all. Most often, the investment does not exist or only a small percentage of the money is invested in some complicated business.

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According to Ashraf, Gershman, and Howitt (2013), this kind of scheme tends to collapse over time due to the lack of legitimate earnings because they are camouflaged as real investments. For survival, the Ponzi scheme requires a constant flow of funds which may be a challenge when earlier investors cash out and they fail to attract new investors. This paper entails a description of Ponzi schemes, the examples of the scheme that have occurred, how they happened as well as how they could have possibly been prevented.

Brief History of Ponzi Schemes

The investment scam is named after Charles Ponzi, who was an Italian swindler in the early 1920s. He duped thousands of people into investing in a postage stamp speculation having envisioned a massive money-making scheme through a promised profits from international reply coupons. Earlier, Ponzi promised the unsuspecting investors a return of fifty percent within forty-five days yet he did not invest the money on the coupon business (Vander, Peter, and William, 2012). There was an impossibility of its survival but Ponzi managed to mislead investors into believing him. Ponzi scheme was later destroyed after it was discovered to be a fraudulent scheme he was charged with grand larceny.

Characteristics of the Ponzi Scheme

The con artists of Ponzi schemes are characterized by some features which act as a red flag to the investors. Sometimes the line between the scammers and entrepreneurs might get blurred causing innocent investors to fall victim to con artists (Ashraf, Gershman, & Howitt, 2013). The investors are therefore deceived as no wealth is created in the process.

The Rate of Return is Suspiciously High

Ponzi scheme promises a high rate of investment with little risks yet it is clear that every investment carries some degree of risk. It is also believed that those investments that promise higher returns involve more risks. The scheme, however, promised the surety of very high returns with low risks as such defrauding investors of their money.

Unregistered Investments

Ponzi scheme investments are not registered with the Securities and Exchange Commission. As such investors have very little access to key information about firms such as the entity`s products, services, finances as well as the management of the company (Ashraf, Gershman, & Howitt, 2013). This information provides a sense of credibility that aids decision making.

Consistent Returns

The con artists promise the investors overly consistent returns regardless of the prevailing economic conditions in the region where the company operates. The deal in the Ponzi scheme guarantees consistent profits to the investors yet investments are expected to go up and down during the process (Ashraf, Gershman, & Howitt, 2013). This makes the scheme unrealistic considering the nature of the overall market conditions.

Investors find it difficult to get their money back

Ponzi schemes victims find the utmost difficulty receiving payments from the company or cashing out their investment (Vander, Peter, and William, 2012). The con artists lure investors into believing that they can roll over their investment to earn even higher returns on their investments. The investors tend to believe them because initially, they are thriving at an alarming rate.

Examples of Ponzi Schemes that have occurred

Bernie Madoff

Bernie Madoff operated the world`s largest and famous Ponzi scheme having created one of the most popular financial firms that appeared in Wall Street. He was the former chairman of NASDAQ and he pleaded guilty in 2009 when he was unable to reimburse the investors their money. Madoff paid above-average returns to use the money invested by the new participants in the company (Ashraf, Gershman, & Howitt, 2013). He is believed to have defrauded over 4800 clients billions of money over a long period of around 20years. Madoff was charged with a single count of securities fraud and sentenced to 150 years in Jail.

The Bitconnect Crypto Currency Scheme

Bitcoin refers to a virtual currency that is traded on online exchanges used to purchase goods and services online (Vander, Peter and William, 2012). Amateur investors placed their funds in Bitcoin with expectations of gaining huge profits. Bitconnect was launched in 2016 as a lending platform where an investor would earn interest as returns on the investment. The investors were promised high returns with the assurance that their funds would be used for Bitcoin arbitrage activities that would generate more returns. Contrary to the promise, the invested Bitcoins were used to pay old investors while part of it was spent by the organizers of the scheme.

JSG Capital Investments

Jason Singh Gill was the owner of JSG Capital investments in San Diego. They made false promises and misleading representations to their investors (Vander, Peter, and William, 2012). They lured people into believing that they would use investor funds to purchase pre-IPO shares of private companies such as Uber Technologies and Airbnb. The company then fraudulently paid existing investors with funds from the new investors in the form of interest payments. This is having diverted investor funds to their accounts. Both Gill and Rios were charged with conspiracy to commit wire fraud by converting investor funds into cash and using it for their expenses as well as concealing the fraud. As a result, the brokers were banned from the industry violations related to selling the Woodbridge notes

Woodbridge Securities

The Woodbridge securities were a massive Ponzi scheme having thrived as the highest-earning unregistered brokers. The scheme swindled over 8400 retail investors by conspiring to commit mail and wire fraud (Vander, Peter, and William, 2012). The company was selling the securities unlawfully to unsuspecting investors. The scheme prepared and disseminated false marketing materials to get more new investments from the public who believed that it was a legitimate operation. Woodbridge Securities used new investor funds to pay the existing investors. The unregistered sales agents were then charged for defrauding investors by making them believe that it was a safe and secure business.

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How the Above Examples occurred

Bernie Madoff, for example, occurred when there were claims that the investment is risk-free with promises of constant returns and people believed the narrative by investing in the Ponzi scheme. The scheme typically used money from new entrants to make unachievable rates of return payments to the existing clients (Trifonova, 2014). The fraudulent scheme then collapsed when the new investors became few, barely enough to continue the scheme.

The Bitconnect Cryptocurrency scheme occurred when investors fell prey to con artists who were conducting a promotion on the virtual currencies. They had little understanding of the exotic product that they were lured into investing in (Trifonova, 2014). This was due to the new technology that many have limited knowledge of how it works.

The example of Ponzi schemes, JSG Capital investments occurred because the investors were not thorough in conducting their due diligence about the company investments in that they did not ask the right questions. The wire fraud duped investors by not investing in the purchase of pre-IPO shares of private companies as promised.

Woodbridge Securities scam occurred when the company violated the securities registration, the anti-fraud fraud provisions of the federal securities laws as well as the broker-dealer registration (Muhammad, Hussin & Razak, 2012). He is believed to have robbed innocent investors of millions of money in an investment scheme that involved both residential developments as well as commercial developments. They sought disgorgement of allegedly ill-gotten gains together with interest and other financial penalties.

Ways of preventing Ponzi Schemes

The Investor should ensure that the Seller is licensed

A genuine financial advisor, investment or brokerage company is always licensed, professionals. The investor should, therefore, check whether the firm is licensed before being engaged in a business that they end up losing their funds to con artists (Vander, Peter, and William, 2012). The investor should also look out for negative reports regarding the investment s before making decisions.

The Investment should be registered

The Securities Exchange Commission strongly encourages investors to check the issued investor alert as well as the agency’s Investor website to check the background information of people selling them investments. This will help to quickly identify whether they are legitimately registered professionals in the industry or not (Vander, Peter and William, 2012). The potential investors are to check with for filed complaints with the securities regulator in a particular worldwide before making any investment decisions.

Investors should be Skeptical

The investor should compare the risks with the potential rewards being promised by the company. A fraud or scam can be identified if one promises the investors huge returns with little or no risks involved (Vander, Peter, and William, 2012). The investors ought to be extra cautious if the business seems complicated or new in the business world instead of investing in a business that is hard to understand or follow its operations.

Good Understanding of the Investment

The investor should have a clear understanding of the investment. This can be by understanding the difference between a manager and a custodian (Vander, Peter, and William, 2012). One should be skeptical of obscure products as well as exotic investments that are not transparent assets. The investor should dig deep to know how long the investment company has been in existence including the services offered and the fees.

Reporting of Wrongdoing

The investors should know where to run to when someone contacts them unsolicited about an investment. Any complaint of a suspected Ponzi scheme or a scam should be filed with the Securities and Exchange Commission (Vander, Peter, and William, 2012). Ponzi schemes should be reported to the relevant authorities so that they can determine their legitimacy in the business environment.


  • Ashraf, Gershman, & Howitt (2013). How inflation affects macroeconomics performance: and agent-based computational investigation. Harvard: Harvard University.
  • Muhammad, Hussin & Razak (2012). Automobile Sales and Macroeconomic Variables: A Pooled Mean Group Analysis for ASEAN Countries, IOSR Journal of Business and Management, 2(1), 15-21
  • Trifonova, (2014). Collective investment schemes in Bulgaria – Current development during crisis
  • Vander, Peter, and William, (2012) "Marketing Fraud: An Approach for Differentiating Multilevel Marketing from Pyramid Schemes,” Journal of Public Policy and Marketing, Vol. 21, No. 1, pp. 139–51.


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