In 2008, thousands of people discovered that they had lost money as Bernie Madoff was arrested, and he admitted that the wealth management arm of his business was a Ponzi Scheme. His clients were victims of a $64.8 billion scheme.
How can you protect your investments and make sure that you are not victimized by a Ponzi scheme (or other investment scams and frauds)? Understanding how a Ponzi Scheme works and how to recognize one could be one of the most important steps you take in your preserving and protecting your wealth.
What is a Ponzi Scheme?
In short, a Ponzi Scheme is a supposed “investment” that usually does not actually buy stocks, bonds, real estate, or other common investments, but instead, takes deposits from new investors to pay returns to earlier investors. One of the hallmarks of a Ponzi scheme is that it promises unusually high returns without much risk. . Eventually, there are not enough funds form new investors to support the scheme, causing it to crash. It’s very similar to a pyramid scheme.
To make the scheme work, the Ponzi scheme promoter needs a constant influx of new investors. Using the “carrot” of little or no risk, the promoter will entice people to invest while promising high returns, usually many multiples of what a reasonable stock and bond portfolio would provide. Since these are not real investments, existing investors can only be paid as long as new investors continue to make deposits. If the Ponzi schemer reports investment returns, statements are prepared to make the investments and their supposed returns look legitimate, but, in reality, no investments are being made, so these statements are worthless.
The economic downturn of 2008 is what lead to the exposure of Madoff’s scheme. As people held on to their money due to economic uncertainty, deposits into his fund slowed down. Madoff was not able to maintain the cash flow to pay older investors the money they thought they had earned, which lead him to seek loans and ask both new and older investors for more money. At some point, the SEC became aware of his activities, and he was arrested. His clients were caught unaware, and many lost their life savings.
The only way to protect yourself from this type of scheme is to know how it works and how to spot it.
Characteristics of a Ponzi Scheme
There are several red flags that you can look for when you are considering whether an investment is legitimate or might be a Ponzi or other fraudulent scheme:
• High returns are promised with little or no risk
• Returns stay consistent despite market downturns
• Investments are not registered with the SEC (Securities Exchange Commission)
• The sellers are unlicensed
• Investments are not explained or kept secret
• Paperwork is kept from investors
• Clients can’t easily remove money
• Claims that the investment is available only to a select group and should not be discussed with anyone else
• High fees are charged
If you notice any of these signs when considering an investment, do more research before you commit.
Protecting Your Investments
Too often we leave our street smarts at the door when we think an investment or business opportunity is legitimate. When investing, keeping a wary attitude will help protect you and your assets from those out to take your hard earned money. If it sounds to good to be true, it probably is. Returns higher than usual indicate higher risk, up to and including the risk that the investment is a Ponzi scheme or other fraud.
Gaslowitz Frankel LLC is Georgia’s premier fiduciary litigation law firm. The firm provides representation to individuals, executors, trustees, investors, shareholders, and financial institutions in complex fiduciary disputes involving wills, estates, trusts, guardianships, businesses, and securities and investment disputes.
If you or a loved one feels they may be involved in a Ponzi Scheme, we can help. Call the firm at 404-892-9797 for a free consultation.