Ponzi schemes, like the one perpetrated by Bernard Madoff, have been around for almost a century and are one of the oldest and most common forms of fraud.
The first known Ponzi scheme was operated by Carl Ponzi himself.
Ponzi collected US$9.8 million from more than 10,000 investors in Boston in the 1920s, including 75 per cent of the city’s police force. He paid $7.8 million to his investors as a “return” on their investments and then spent the rest of the money.
Ponzi was able to attract investors by offering thema 50 per cent return on their money every 45 days. Unfortunately, as is the case in Ponzi schemes, these returns were not based on real investments. Instead, they’re taken from the investors’ own money and from the contributions of new investors — a classic case of borrowing from Peter to pay Paul.
The Ponzi scheme eventually collapses when the number of new investors starts to fall and there is not enough money to pay the returns.
Ponzi’s original plan was to buy international postal reply coupons cheaply overseas, turn them into U.S. postage stamps and then sell them for a profit. According to one commentator, Ponzi would have needed to buy and transport literally tens of millions of coupons to make the plan viable.
The plan wasn’t viable and finally collapsed when the local media heard about the case and began to investigate it. Ponzi was arrested, convicted and jailed, and the case went to bankruptcy court.
In the end, everyone lost money. The bankruptcy trustee sued the investors who did make money so that Ponzi’s debts could be paid to his creditors.
Ponzi schemes are often difficult to detect because they look like real investment opportunities. Investors get so-called interest cheques, even though in reality they are just getting their own money back.
Investors will regularly receive account statements that show profits, even though those profits aren’t real. They’re often so pleased when they get their returns they’ll encourage their family and friends to invest.
Ponzi schemes are usually spread by word of mouth.
For many years, the law in the United States has held that Ponzi schemes are inherently insolvent from the moment of their inception.
This was not the case in Canada until 2005, when the Alberta Court of Queen’s Bench came to the same conclusion in the case of Titan Investments.
In this case, investors purchased units in Titan, a limited partnership company controlled by a Mr. Comte. The value of their investments depended on the success of Titan’s investments.
Financial statements indicated that Titan was achieving good financial returns through trading in futures.
Despite the good financial results, Mr. Comte decided to dissolve Titan in 2004 and paid redemptions ranging from two per cent to 5,500 per cent to 87 of Titan’s investors.
Later, it was discovered that Comte had not traded in any securities for two years before the formation of Titan. Comte admitted to operating a Ponzi scheme, Titan was placed in receivership, and the receiver initiated court proceedings against the investors who had been paid the redemptions.
“The decision in Titan is notable for being the first in Canada to provide creditors and trustees some assistance in recovering improper payments for the benefit of the majority of creditors in similar fraudulent investment scenarios,” said Lyndsay Jardine, a business law lawyer with Wickwire Holm in Halifax.
The Ontario Securities Commission advises investors to watch out for investments that offer high returns and low risks, to check the registration of the investment and the person or company offering it, and to get a second opinion from a financial adviser, lawyer or accountant.
Ponzi is believed to have died poor and alone in Brazil in 1949.
His legacy is a legacy of deception and fraud, and the scheme that he created lives on and is still being used today.
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors. He can be contacted at boggsyourmoney@rogers.com.