Ponzi and Pyramid Schemes

Our whistleblower attorneys represent individuals with evidence of the operation of a Ponzi scheme or pyramid scheme in violation of federal securities laws. By reporting these investment frauds to the Securities and Exchange Commission, insiders and investors can help the U.S. Government protect other investors from the devastating financial loss caused by these schemes. For a free initial legal consultation concerning the operation of the SEC whistleblower program, please call our law firm at 1-800-590-4116.

What is a Ponzi scheme?

A Ponzi scheme is a type of investment fraud where the incoming money of new investors is used to pay the returns (redemptions may be a more accurate term) of other investors. The legitimate returns from the investment activity, if any, are less than the profits promised to investors.

Why is it called a Ponzi scheme?

Charles Ponzi was a businessman in Boston after World War I that discovered the potential to profit through the purchase of an international reply coupon. Ponzi believed he could profit from the purchase of postage in Italy, which was cheap due to post-war inflation, and then exchange it for postage in the United States at a substantial profit. When he attempted to redeem the postal coupons in the United States, he had difficulty doing so.

Nevertheless, Ponzi began taking investments promising 100% returns on their investments in only 90 days. He paid off early individuals on their investment and other investors began pouring in money. Most did not take out their money and reinvested the profits.

Ponzi made no effort to generate profits. Instead, he paid off existing investors seeking to cash out their funds by paying them with the money received from new investors.

Government officials and reporters began questioning how Ponzi could be earning the tremendous returns he promised. After Ponzi stopped several runs on the bank by paying out large sums of money to his investors, he ran out of money and the scheme collapsed.

Why do Ponzi schemes collapse?

There are a few different ways these fraudulent schemes come to an end. In many cases, it is a combination of factors. Among the reasons are insufficient new investors to sustain the cash flow, excessive redemptions by current investors, or the operator running out of money due to embezzlement. These conditions occur more frequently in periods of economic slowdown.

The Bernie Madoff Scandal

The largest Ponzi scheme to date was executed by Bernie Madoff, who took approximately $20 billion from investors over decades prior to the collapse of the scheme in December 2008. By the end, Madoff had misled investors into believing their accounts were valued at nearly $65 billion when in reality he possessed only around $200 million to $300 million.

The Madoff Whistleblower: Madoff was a respected member of the investment community who dodged the attempts by whistleblower Harry Markopolos to raise the alarm with the SEC and other investors. Markopolos attempted to recreate the returns promised by Madoff years before the scheme collapsed and found it impossible. Nevertheless, Markopolos could not get the SEC to take recognize the issue and stop Madoff.

The story of Markopolos, Madoff and the SEC was one of the catalysts for the creation of the Dodd-Frank Act’s whistleblower programs at the CFTC and SEC.

Pyramid Schemes

There is a similar investment fraud called the pyramid scheme. In this fraudulent scheme, the promoter offers high returns to those who hand over their money and subsequently encourage others to do so as well. The money from new investors is used to pay returns to the older investors.

A pyramid scheme may be masked by the operators with the appearance of a legitimate multi-level marketing program. A legitimate MLM uses the profits from downstream sales to pay bonuses to the individuals who recruited them. Pyramid schemes differ from MLM companies because there are little legitimate sales. Instead, the operators pay off earlier investors the returns promised not with profits, but the incoming funds of those making subsequent investments.

Pyramid schemes frequently target individuals online, overseas and in U.S. immigrant communities. They promise easy returns in exchange for the payment of a one-time, annual or recurring monthly membership fee. In reality, the funds are not used to generate sales or returns but merely redistribute the incoming funds to those investors requesting a payout.

When the SEC takes an enforcement action against these operations, they typically charge them with (1) fraudulent or deceptive conduct in the purchase or sale of securities, and (2) the offer or sale of unregistered securities.

The SEC Whistleblower Program

Whistleblowers earn rewards under the Dodd-Frank Act when their information and evidence results in monetary sanctions of more than $1 million, and they otherwise meet the terms and conditions of the program.

For a free initial legal consultation concerning the operation of the SEC whistleblower program, please call our law firm at 1-800-590-4116.

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