Study On The Ponzi Scheme Accounting Essay

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Charles Ponzi was one of the greatest swindlers in American history. The term "Ponzi scheme" is a widely known description of any scam that pays early investors returns from the investments of later investors. He promised clients a 50% profit within 45 days, or 100% profit within 90 days, by buying discounted International Postal Reply Coupons (IRC) in other countries and redeeming them at face value in the United States - a form of arbitrage. Ponzi was inspired by the scheme of Williams Miller, a bookkeeper who used the same scheme to take in $1 million.

An Italian citizen, Ponzi landed in the US on November 15, 1903 with $2.50. He quickly learned English and spent the next few years doing odd jobs and managed to work his way up to the position of waiter at a restaurant, but was fired.

A few weeks after he arrived in the US after a brief stay in Canada, Ponzi received a letter in the mail from a company in Spain containing an IRC. He found a weakness in the system which would, in theory, aloe him to make money.

The purpose of IRC was to allow someone in one country to send it to a correspondent in another country, who would use it to pay the postage of a reply. IRC's were priced at the cost of the postage in the country of purchase, but could be exchanged for stamps to cover the cost of postage in the country where redeemed. Inflation after World War 1 had greatly decreased the cost of postage in Italy expressed in US dollars, so that an IRC could be bought cheaply in Italy and exchanged for US stamps of higher value. This was a form of arbitrage, or profiting by buying an asset at a lower price in one market and selling it in a market where the price is higher, which is not illegal.

Seeing an opportunity, Ponzi quit his job to set his scheme in motion. He borrowed money and sent it to relatives in Italy with instructions to buy IRC's and send them to him.

Ponzi went to several friends and promised that he would double their investments in 90 days. Some people invested and were paid off as promised, receiving $750 interest on initial investments of $1250.

Soon, Ponzi started the Old Colony Foreign Exchange Company to promote the scheme. Word spread and investment gushed in. Ponzi hired agents and paid them generous commissions for every dollar they bought in. He began depositing the money in the Hanover Trust Bank of Boston. He could buy a controlling interest in the bank after depositing $3 million. People were mortgaging homes and investing life savings. Most did not take their profits, but reinvested.

Ponzi was bringing in cash at a fantastic rate but the simplest financial analysis would have shown that the operation was running at a huge loss. As long as money kept flowing in, existing investors could be paid with the new money.


Ponzi's rapid rise naturally drew suspicion when a Boston financial writer and a Boston furniture dealer filed a case on Ponzi because it was impossible for him to grow this much in such a short time span. The lawsuit was unsuccessful but people become suspicious. The Boston Post wrote an article on the growth of Ponzi and during that time he was earning $250,000 a day, which seemed to imply that Ponzi was indeed returning 50% return on investment after only 45 days. The Post's publisher Richard Grozier was suspicious and assigned reporters to check Ponzi out. He was also under investigation by the commonwealth of Massachusetts.

Collapse of the scheme

Clarence Barron, a financial analyst noted that to cover the investments made with the Securities Exchange Company, 160 million IRC's would have to be in circulation. However, only about 27,000 actually were. The US Post Office stated that IRC's were not being bought in quantity at home or abroad. The gross profit margin in percent on buying and selling each IRC was colossal, but the overhead required handling the purchase and redemption of these items, which were of extremely low cost and were sold individually, would have exceeded the gross profit.

Investors started to panic and so Ponzi paid out $2 million in 3 days to convince them.

Trouble began when McMasters, the publicity agent of Ponzi described as a financial idiot and that he found several highly incriminating documents. He wrote an article which said that Ponzi claimed $7 million in liquid funds and at least $2 million in debt.

However, trouble came from Massachusetts Bank Commissioner Joseph Allen. An investigation into Ponzi's banking practices found nothing illegal, but Allen was afraid that if massive withdrawals exhausted Ponzi's reserves, it would bring Boston's banking system to its knees. When Allen found out a large number of Ponzi-controlled accounts had received more than $250,000 in loans, he ordered two bank examiners to keep an eye on Ponzi's accounts.

They reported that enough investors have cashed their checks on Ponzi's main account there that it was almost certainly overdrawn. Allen then ordered the bank not to pay out any more checks from Ponzi's main account. He also orchestrated an involuntary bankruptcy filing by several small Ponzi investors. It forced Massachusetts Attorney General J. Weston Allen to release a statement that was little to support Ponzi's claims of large-scale dealings in IRCs. State officials then invited Ponzi note holders to come to the Massachusetts State House to furnish their names and addresses for the purpose of the investigation. On the same day, Ponzi received a preview of Pride's audit, which revealed Ponzi was at least $7 million in debt.

Law enforcement:

The legacy of Mr. Ponzi lives on as pyramid and Ponzi schemes continue to plague us and challenge the law enforcement community. Fortunately, in the US the Federal Trade Commission is just one among many agencies that have the authority to file suit to stop this type of fraud. The Securities and Exchange Commission also pursues these schemes, obtaining injunctions against so-called "financial distribution networks "which in fact sell unregistered securities. The US Department of Justice, in collaboration with investigative agencies like the FBI and the US Postal Inspection Service, prosecutes pyramid schemes criminally for mail fraud, securities fraud, tax fraud and money laundering.


  • ^ a b "Ponzi Schemes"[Internet] .Retrieved 2008-12-24 .US Social Security Administration.
  • ^ a b c d "Ponzi Payment". Time magazine. January 5, 1931.,9171,930255,00.html. Retrieved 2008-12-21. "In 1920 thousands of gullibles had a more ornate picture of him. He was then the shrewd, straight-eyed miracle man of Boston's Hanover Street. He promised his clients a 50% profit in 45 days. ... The essence of his scheme was to buy postal reply coupons in countries with depreciated exchange, redeem them at face value for U. S."
  • ^ a b c "Take My Money!". Time magazine. January 31, 1949.,9171,794507,00.html. Retrieved 2008-12-21. "In Italy, Ponzi got on the good side of Mussolini's Fascists, was sent to Rio de Janeiro as business manager for Italy's LATI airlines. The war ended his job; after that he eked out a meager existence as a translator. Committed to a Rio charity ward, blind in one eye and partly paralyzed, he said not long ago: "I guess the only news about me that most people want to hear is my death.""
  • ^ a b c d e "In Ponzi We Trust". Smithsonian magazine. December 1998. Retrieved 2008-12-21. "Ponzi himself was probably inspired by the remarkable success of William "520 percent" Miller, a young Brooklyn bookkeeper who in 1899 fleeced gullible investors to the tune of more than $1 million."
  • ^ Sobel 1968, p.17.
  • ^ Bloodletters and Badmen: A Narrative Encyclopedia of American Criminals from the Pilgrims to the Present, by Jay Robert Nash
  • ^ "Ponzi Arrested.". New York Times. August 13, 1920. Retrieved 2008-12-21. "Liabilities Put at $7,000,000. Federal Authorities Charge Using Mails to Defraud. State Warrant Charges Larceny. Claims $4,000,000 Assets. Bank Commissioner Fears Hanover Trust Assets Have Been Wiped Out. Investors Grow in Number. Attorney General Still Recording. Hundreds of Note Holders Caught in Crash. Liabilities running at least up to $7,000,000 and assets unknown, save for his assertion that they amount to $4,000,000, are among the echoes of the bursting of Charles Ponzi's bubble this noon, when he surrendered ..."
  • ^ "Proceedings to Deport Coupon Financier to Canada or Italy Are Begun.". New York Times. November 30, 1924. Retrieved 2008-12-21. "Charles Ponzi, promoter of the get-rich-quick scheme of four years ago which attracted investments of many millions of dollars, was arrested early today by immigration authorities on a warrant charging that he is in this country illegally. Deportation proceedings will begin immediately, it was said by Immigration Commissioner John P. Johnson."
  • ^ a b Florida Times-Union December 22, 2008-Ponzi lived here: Infamous name tied to scheme was local by Jessie Lynne Kerr
  • ^ "Ponzi Pardon Plea is Denied in Boston. Governor Ely Decision Is Followed by Court Move to Block Deportation.". New York Times. July 13, 1934. Retrieved 2008-12-21. "Governor Ely today denied Charles Ponzi's petition for a full pardon, which would save him from deportation. The Governor made his decision after a hearing at the State House in which Ponzi pleaded tearfully to remain in this country."