Dictionary:
Pon·zi scheme (pŏn'zē)  |
[After Charles Ponzi (1882?-1949), Italian-born speculator who organized such a scheme (1919-1920).]
| 5min Related Video: Ponzi scheme |
| Wordsmith Words: Ponzi scheme |
(PON-zee skeem)
noun
An investment swindle in which high profits are promised from fictitious sources and early investors are paid off with funds raised from later ones. [After Charles Ponzi (1882?-1949), Italian-born speculator who organized such a scheme (1919-1920).
| Investment Dictionary: Ponzi Scheme |
A fraudulent investing scam that promises high rates of return at little risk to investors. The scheme generates returns for older investors by acquiring new investors. This scam actually yields the promised returns to earlier investors, as long as there are more new investors.
Investopedia Says:
The Ponzi scam is named after Charles Ponzi, a clerk in Boston who first orchestrated such a scheme in 1919.
A Ponzi scheme is similar to a pyramid scheme in that both are based on using new investors' funds to pay the earlier backers. One difference between the two schemes is that the Ponzi mastermind gathers all relevant funds from new investors and then distributes them. Pyramid schemes, on the other hand, allow each investor to directly benefit depending on how many new investors are recruited. In this case, the person on the top of the pyramid does not at any point have access to all the money in the system.
For both schemes, however, eventually there isn't enough money to go around and the schemes unravel.
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| Business Dictionary: Ponzi Scheme |
Any false investment opportunity where the promoter uses money from new investors to pay interest and principal redemptions of existing investors. The scheme collapses when required redemptions exceed new investment. Named after Charles Ponzi who perpetuated such a scheme in the 1920s under the pretense of his opportunities to make money through international currency transactions.
| Law Encyclopedia: Ponzi Scheme |
A fraudulent investment plan in which the investments of later investors are used to pay earlier investors, giving the appearance that the investments of the initial participants dramatically increase in value in a short amount of time.
A Ponzi scheme is a type of investment fraud that promises investors exorbitant interest if they loan their money. As more investors participate, the money contributed by later investors is paid to the initial investors, purportedly as the promised interest on their loans. A Ponzi scheme works in its initial stages but inevitably collapses as more investors participate.
A Ponzi scheme is a variation of illegal pyramid sales schemes. In a pyramid sales plan, a person pays a fee to become a distributor. Once the person becomes a distributor, he receives commissions not only for the products he sells but also for products sold by individuals that he brings into the business. These new distributors are beneath the person who brought them into the pyramid scheme, so they are "under the pyramid." In illegal pyramid schemes, only the people at the top of the pyramid make substantial money because they get a commission from the products sold by everyone below them. As more people become distributors, the persons lower in the pyramid have less chance to make money.
A Ponzi scheme was once was called a "bubble," but it was renamed in 1920 after Charles Ponzi and his Boston-based company had collected almost $10 million from ten thousand investors by selling promissory notes that claimed to pay 50 percent profit in forty-five days. When the scheme was exposed, a Boston bank collapsed, and investors lost most of their money.
Ponzi, an Italian immigrant, thought of profiting from the widely varying currency exchange rates for International Postal Reply Coupons (IPRCs), which were redeemed for stamps. IPRCs were intended to facilitate the sending of international mail. The sender put an IPRC, rather than a stamp, on a piece of mail going to another country, and the recipient exchanged the IPRC for the appropriate stamp in her country.
Ponzi contended that he could pay a small amount for IPRCs in weak-currency countries and then redeem them at a substantial profit in the United States. He correctly noted that a stamp transaction might yield a 400 percent profit, but the amount of profit in real terms was very small. Nevertheless, he promoted his idea through his Boston-based Securities Exchange Company. In March 1920 he began soliciting funds for purchasing the IPRCs with a promised 40 percent return in ninety days. Bank interest rates at the time were just five percent. Investors started loaning Ponzi their money, and within a short time he increased the promised return on forty-five-day notes to 50 percent. He also promised a 100 percent return on funds loaned to him for ninety days. He pledged to refund money on demand to any investor before the loan period was up.
Money soon flooded Ponzi's offices. By July 1920 he was taking in $1 million a week. Ponzi made an arrangement with the Hanover Trust Company of Boston to deposit his funds. Hanover officials soon realized that Ponzi was not paying his initial investors with interest income but with the deposits of the new investors. Nevertheless, the bank eagerly sold Ponzi a large amount of its stock.
On August 2, 1920, a Boston newspaper revealed the fraud and reported that Ponzi was hopelessly insolvent. Thousands of victims immediately demanded refunds. Ponzi paid as many as he could but exhausted his funds in a week. He then declared bankruptcy. In bankruptcy, the court ordered all of the persons who had been paid by Ponzi during the life of the scheme to return the proceeds to the bankruptcy trustee, who distributed the money on a pro rata basis to all of the other victims. Ponzi was eventually convicted of fraud in both state and federal court and imprisoned for several years.
The Ponzi scheme did not end with Charles Ponzi. It has proved to be a reliable scam in which persons are lured into giving their money to con artists who promise enormous financial returns. The early cycle of a Ponzi scheme appears to confirm the reliability of the investment, as some investors are paid the promised returns. The scheme is doomed to collapse when not enough new money exists to pay old obligations.
Gullible individuals are not the only victims of Ponzi schemes. In the early 1990s, John G. Bennett, Jr., and his Foundation for New Era Philanthropy lured many U.S. universities and nonprofit groups into investing millions of dollars in the foundation. Bennett promised these organizations that they would double their money in six months with the help of anonymous philanthropists. In May 1995 Prudential Securities, Inc., where most of the funds were deposited, discovered that New Era was under federal investigation and froze its accounts.
The action triggered New Era's bankruptcy. Bennett was later charged with eighty-two counts of fraud, money laundering, and income tax evasion. As with the original Ponzi scheme, defrauded investors agreed to be reimbursed for up to 65 percent of their losses, with the money coming from groups that had deposited money with New Era early in the scheme and made a profit.
Internationally, the nation of Albania was plunged into civil unrest in 1997 when a multimillion-dollar Ponzi scheme collapsed. Many Albanians had invested large amounts of their savings in the scheme, which allegedly had the backing of Albanian government officials. Faced with economic ruin, citizens rioted against the government.
| Wikipedia: Ponzi scheme |
A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors from their own money or t paid by subsequent investors, rather than from any actual profit earned. The Ponzi scheme usually entices new investors by offering return other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going.
The system is destined to collapse because the earnings, if any, are less than the payments. Usually, the scheme is interrupted by legal authorities before it collapses because a Ponzi scheme is suspected or because the promoter is selling unregistered securities. As more investors become involved, the likelihood of the scheme coming to the attention of authorities increases. While the system eventually will collapse under its own weight, the recent example of Bernard Madoff powerfully illustrates the ability of a Ponzi scheme to delude both individual and institutional investors as well as securities authorities for long periods: Madoff's variant of the Ponzi Scheme stands as the largest financial investor fraud in history committed by a single person. Prosecutors estimate losses at Madoff's hand totalling $64.8 billion.
The scheme is named after Charles Ponzi,[1] who became notorious for using the technique in early 1920. He had emigrated from Italy to the United States in 1903. Ponzi did not invent the scheme (Charles Dickens' 1857 novel Little Dorrit described such a scheme decades before Ponzi was born, for example), but his operation took in so much money that it was the first to become known throughout the United States. His original scheme was in theory based on arbitraging international reply coupons for postage stamps, but soon diverted investors' money to support payments to earlier investors and Ponzi's personal wealth.
Knowingly entering a Ponzi scheme, even at the last round of the scheme, can be rational economically if government bails out those participating in the Ponzi scheme.[2]
Contents |
Suppose an advertisement is placed that promises extraordinary returns on an investment — for example, 20 percent on a 30-day contract. The objective is usually to deceive laymen who have no in-depth knowledge of finance or financial jargon. Verbal constructions that sound impressive but are essentially meaningless will be used to dazzle investors: terms such as "hedge futures trading," "high-yield investment programs," "offshore investment" might be used. The promoter will then proceed to sell stakes to investors — who are essentially victims of a confidence trick — by taking advantage of a lack of investor knowledge or competence. Claims of a "proprietary" investment strategy, which must be kept secret to ensure competitive edge, may also be used to hide the nature of the scheme.
Without the benefit of precedent or objective prior information about the investment, only a few investors are tempted, usually for small sums. Thirty days later, the investor receives the original capital plus the 20 percent return. At this point, the investor will have more incentive to put in additional money and, as word begins to spread, other investors grab the "opportunity" to participate, leading to a cascade effect deriving from the promise of extraordinary returns. However, the "return" to the initial investors is being paid out of the investments of new entrants, and not out of profits.
One reason that the scheme initially works so well is that early investors — those who actually got paid the large returns — commonly reinvest their money in the scheme (it does, after all, pay out much better than any alternative investment). Thus, those running the scheme do not actually have to pay out very much (net)—they simply have to send statements to investors showing them how much they earned by keeping the money, maintaining the deception that the scheme is a fund with high returns.
Promoters also try to minimize withdrawals by offering new plans to investors, often where money is frozen for a longer period of time, in exchange for higher returns. The promoter sees new cash flows as investors are told they could not transfer money from the first plan to the second. If a few investors do wish to withdraw their money in accordance with the terms allowed, the requests are usually promptly processed, which gives the illusion to all other investors that the fund is solvent.
This simplistic notion of the Ponzi scheme is typically embellished with several (or many) feints that help prove seeming legitimacy to the ruse. For example, Madoff famously refused some investors' money, even when they begged him to take it. To an outside observer, these sorts of often high-profile "exclusivity" acts tend to discredit doubts — if it was a fraud, why would Madoff refuse more cash? Such illusions of normal business-as-usual reinforce a Ponzi scheme as a real investment.
The catch is that at some point one of these things will happen:
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 | Dictionary. The American Heritage® Dictionary of the English Language, Fourth Edition Copyright © 2007, 2000 by Houghton Mifflin Company. Updated in 2009. Published by Houghton Mifflin Company. All rights reserved. Read more |
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| Investment Dictionary. Copyright ©2000, Investopedia.com - Owned and Operated by Investopedia Inc. All rights reserved. Read more |
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| Business Dictionary. Dictionary of Business Terms. Copyright © 2000 by Barron's Educational Series, Inc. All rights reserved. Read more |
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| Law Encyclopedia. West's Encyclopedia of American Law. Copyright © 1998 by The Gale Group, Inc. All rights reserved. Read more |
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| Wikipedia. This article is licensed under the Creative Commons Attribution/Share-Alike License. It uses material from the Wikipedia article "Ponzi scheme". Read more |
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