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Understanding Ponzi schemes and how to recognize them

| Jul 21, 2020 | Federal Securities Law |

A Ponzi scheme is a financial scam that lures investors by promising they can make money fast on their investment with little risk. It works in the same manner as a pyramid scheme by paying the old investors with the money new recruits provide. The scheme can break because it eventually runs out of investors. A fraudulent business in Pennsylvania or another state will thus put all their effort into finding new investors.

The name derives from Charles Ponzi, a known con artist. Ponzi schemes first appeared in the late 1800s started by Sarah Howe and Adele Spitzeder. Two of Charles Dickens’s novels, “Little Dorrit” and “Martin Chuzzlewit,” mention Ponzi schemes. The notorious scheme by Charles Ponzi involved international postal reply coupons issued by the United States Postal Service. The buyer of the coupons could purchase postage in advance to use in the mail they sent, or arbitrage, and then exchange it for stamps.

Arbitrage is legal, but in 1919, Ponzi found a way to scam investors using his company called Securities Exchange. He told investors they would profit 50% in 45 days and 100% in 90 days. Ponzi didn’t invest the money as promised; he gave money to old investors, claiming they had made a profit. The Boston Post conducted their own investigation of the Securities Exchange company, which led to Ponzi’s arrest in August 1920.

The Ponzi scheme still exists in modern times changing with technology. Some signs of a Ponzi scheme include refusing investor access to reports, complex methods, promise of low risk and high profits, and investors not being able to withdraw money from the scheme. A legal investment will be registered under the Securities and Exchange Commission.

Investors should be aware that Ponzi schemes come in many forms. If an investor feels that they have been scammed, a securities law attorney may be able to assist them.