Charles Ponzi perpetrated the first notorious investment scheme in the early 1900s – after whom the investment scheme was named. Ponzi schemes share a basic feature and red flags usually exist which can help investors avoid becoming victims. In a Ponzi scheme, the perpetrator convinces victims to “invest” money, for the promise of a high or consistent return. The fraudster continues recruiting new investors, and uses those new funds to pay off the existing investors. In other words, the payment of “profits” to any one investor, comes from another investor’s deposit of money.This type of scheme can spread quickly by word of mouth – especially as the fraudster gains a good reputation for paying on his promise of high and consistent returns. Ponzi schemes can attract individuals and even sophisticated institutions. Often the fraudster will prey on friends, acquaintances, relatives, busy professionals, pensioners, not-for-profits or members of their own cultural community.
These Red flags may help identify and avoid a Ponzi scheme.
- Guaranteed high returns and little to no risk. There is no such thing – all investing involves some level of risk, and usually the higher the returns, the higher the risk. Likewise, constant rates of return, regardless of market performance, is a red flag.
- Lack of Credibility. Either the investment or the investment organizer lacks relevant and recognised credentials, does not work for a licensed firm, and/or isn’t selling a registered investment.
- Lack of supporting documentation. The perpetrator gives little or no paper work supporting the investment. Documents showing ownership, account history, account numbers or transaction details, may be incomplete or not issued to investors.
- Lack of investment strategy or structure. If you cannot understand the investor structure or strategy, be diligent. A red flag will be raised if the investment is tied to payments that flow through offshore jurisdictions where the business purpose is not clear, or where payments flow through a tax haven.
- Lack of availability of the organizer. The investment organizer is hard to communicate with and does not make himself available.
Follow the old maxim: If it sounds too good to be true, it probably is.