Too Big to Fail. The Big Short. HBO’s The Wizard of Wall Street.
In the aftermath of the recession we are all too familiar with Wall Street tales as told by Hollywood. Terms like “Ponzi Scheme” and people like Bernie Madoff have become a part of our culture and lexicon. Yet despite our increased wariness of financial scams, everyday people continue to fall prey to these Ponzi Schemes.
What is a Ponzi Scheme?
There are several characteristics that distinguish a Ponzi scheme from other types of fraud. At its core, Ponzi schemes promise to reward older investors with returns that are paid for with the money contributed by newer investors. This essentially creates a system that will last only as long as there is a steady flow of new money coming in.
Unlike other schemes that promise quick profit in a matter of weeks or months, Ponzi schemes often operate by promising longer term rewards on investments that will supposedly be paid out after several months or even years.
Ponzi schemes are privately traded rather than open to the general public. They rely on individuals to reach out to friends and acquaintances and recruit them as investors.
Bernie Madoff, for example, ran a decades long $65 billion scheme based in part on Wall Street connections, his high profile status, and on what was assumed to be his unassailable character. Everyone trusted him.
So why do people buy in to ponzi schemes?
The short answer is that Ponzi schemes are tough to detect.
While the Madoff scheme is one of the largest Ponzi schemes operated, many fall prey to smaller operations. In a recent case covered by Bloomberg News, Michael Scronic faces securities fraud and wire fraud charges from the U.S. Securities and Exchange Commission for defrauding friends and neighbors of $19 million.
Scronic sent personal emails to his investors, saying in one, “What’s cool about my fund is that i’m only in publicly traded options and cash so any redemptions are met within 2 business days so if you do need to withdraw for your business needs it will be quick and painless.”
But Scronic’s investors found that removing funds and receiving benefits was not painless at all. Scronic lost 88% of the deposits on risky investments and on his lavish lifestyle, which included a ski home and country club memberships.
Scam operators, like Scronic, rely on these individual relationships to convince people to invest. So it might not be just you who was duped, but your friends as well.
The promises of the investments offered are presented as fail safe and reliable. Investors are often given a guaranteed amount of return on their investment. Even in a good market, where investments fluctuate slightly, the opportunity for a reliable and secure investment is too good to pass up.
Unfortunately, these investments are too good to be true.
When the scheme crumbles
Cracks in the scheme emerge when scam operators call with offers to invest more, using phrases such as “once in a lifetime opportunity,” “unique investment,” and “limited offer.” Cash flow is short, and operators are attempting to raise more capital.
When the operator is unable to secure new funds, investors stop seeing the promised return on investment. Contacting the scam operator to make withdrawals, excuses are given as to why the money cannot be returned at the moment. Sometimes requests for the money are simply ignored.
For victims of Ponzi schemes, the results are devastating as families lose nest eggs, college, and retirement savings.