1. Introduction to Ponzi Scheme
Ponzi scheme refers to a deceitful investment programme in which the operator uses the money received from new investors to pay others that give their money earlier on (Johnston, Johnson, & Hummel, 2010). Ponzi scheme operators often promise the investors faster and higher returns. They also assure investors of little to no risk at all on those investments (SEC, 2019). When they use money from later investors to repay the ones that invested first, the original investors start believing that the operators have unique investing strategy (Weisman, 2020). This also makes the original investors more likely to give testimonials and attract new investors to the scheme. An individual that used such a scheme to make millions of dollars for himself, from 40,000 investors, at the start of twentieth century (1919-1921) is Charles Ponzi (Johnston et al., 2010). Similar to others, Charles Ponzi’ scheme failed due to lack of consistent money flow from beginner investors. The real problem emerges when the operator cannot get a substantial number of new investors. Since his arrest on 12 August 1920, therefore, similar scams have been associated with Ponzi’s name.
2. Ponzi schemes and the People who started them
Several Ponzi schemes have happened in the recent past but four stand out (Caroll & Morvilla, 2010). One of the Ponzi schemes is the $3.7 billion undertaking by Tom Petters in September 2008. Petters’ company and home were raided by the FBI following the realisation that he operated this huge Ponzi scheme for about a decade. The second happened at the onset of 2009. This Ponzi scheme by Robert Allen Stanford was worth $8 billion. SEC and the Department of Justice began investigation the Stanford Group Chairman after he was suspected of operating a fraudulent business. Next Ponzi scheme was by an attorney in Florida, Scott Rothstein. On realisation that the secrets of his operation were coming to light, Rothstein fled the U.S. In November 2009, he returned and was arrested on 1 December same year. The final Ponzi scheme example in this discussion is the approximately $65 billion project by Benard Madoff. This one was discovered in December 2008.
3. Current Ponzi schemes that still exist
A factor that Johnston et al. (2010) noted in their work is that Ponzi schemes have become larger overtime. That is, the most recent Ponzi scheme operators have swindled larger sums of money from investors. The most recent example of such schemes that still exist is the one by Bernard L. Madoff (Johnston et al., 2010). Madoff was arrested in 11 December 2008.
4. The main characteristics of a Ponzi scheme, what they do and how they make money
One feature is that the operators get money from investors by promising high returns from purchase of certain products. In the case of Tom Petters, for example, he and co-operators convinced investors to contribute funds for buying electronic merchandise which would be sold at a profit. However, the promise is never met (Johnston et al., 2010). In the case of Bernard Madoff, also, his law firm convinced investors to buy shares in a campaign that was not for sexual harassment or whistle-blowers. Again, the success of the Ponzi scheme operators results from their vast knowledge of the industries in which they operate (Brazel, 2021). This enables them to pick strategies that appear more convincing and believable to new investors. To stay in the game, the Ponzi schemers employ secretive approaches in that they only inform investors about what they earn periodically but to not disclose the actual returns (Yang, 2014). Through such means, the schemes run for several years before the concerned authorities know they exist.
5. Risks of a Ponzi Scheme
The risks apply to both the financial institutions and the plaintiff (the defrauded investor). The resentful investors are very likely to engage in recovery attempts against the solvent groups irrespective of their awareness of the Ponzi scheme in which they were involved, and financial institutions are usually the most targeted (Johnston et al., 2010). The highest litigation risk applies to the financial institutions that were aware that what they promoted was a Ponzi scheme.
Moreover, the banks and other micro-finance setups that facilitated the related investments on behalf of the investors face very high litigations as well. For this reason, Johnston et al. (2010) reported that there is a significant rise in the number of lawsuits filed against financial institutions. Generally, the plaintiffs’ allegations against the financial institutions include negligence, violation of fiduciary duty, assisting and covering up fraud. To prove the violation of fiduciary duty, the claimant has to provide a case-specific proof of a trust that was established through particular trust.
The situation is complicated as a bank owes no fiduciary duty to its customers, and what they two parties share is simply a debtor-creditor relationship. Again, to succeed with negligence claim, the plaintiff has to show that a duty existed between the financial institution and the defrauded investor due to actions of the Ponzi scheme operator. The plaintiff, may then show how the financial institution breached the duty. Lastly, the plaintiff has to give proof that the financial institution delayed or hindered or defrauded the concerned creditor of the debtor. To recover losses incurred as a result of Ponzi scheme, the claimants should offer evidence that the operator of the Ponzi scheme violated fiduciary duty and that the involved financial institution knew about the violation.
6. Points from the Three Main Ponzi scheme cases
The Ponzi schemes often run for at least a decade before the government authorities discover their existence. The Ponzi schemes by Tom Petters and Robert Allen Stanford, for instance, ran for over 10 years and the one for Bernard Madoff lasted over 20 years (Yang 2014) getting money from new investors to repay initial investors. Aside from government investigation, the Ponzi scheme operators have several private civil lawsuits. Petters’ assistants like Deanna Coleman and Larry Reynolds had other criminal charges against them. Madoff also had many other lawsuits in the U.S. and Europe. The additional charges are often related to theft, fraud, perjury, and money laundering (Yang, 2014). The same applied to Rothstein and Standard.
7. What Causes it to go Down so Bad
Bernard Madoff operated the biggest Ponzi scheme ever recorded. The investors he defrauded lost a sum of around $billion, collectively, and Madoff had to serve a prison term lasting 150 years or due in 2139 (Maglich, 2014). The main point of failure is the lack of sustainability of Ponzi schemes. The entire scheme collapse in the event that the operator flees with the rest of the investment money, when the flow ceases due to lack of new investors, or when the existing investors decide to quit and take their returns. In specific, Madoff’s scheme began its collapse after clients leaving the scheme requested for $7 billion (Yang, 2014). Madoff did not have that much, and this raised suspicion.