What Is a Ponzi Scheme?

Our specialist commercial litigation team are increasingly instructed in disputes that carry the hallmarks of collective investment schemes and ponzi schemes. This is especially the case where, for example, property investors are sought to invest in schemes with ‘guaranteed rent’. On closer examination we find new investor money is being sought to repay older investor funds. There can be additional elements of professional negligence where solicitors or other professionals have failed to spot or advise on these incredibly high risk transactions. If you think you might be in this position contact our specialist commercial litigation team and we will be happy to help you. We have and are acting in these disputes across the country including with millions and tens of millions in dispute and acting for tens of investors who have been wronged.

Ponzi schemes have captured public attention for decades, and it’s vital to recognise their characteristics to avoid falling victim to them. These fraudulent operations often begin with enticing promises of high returns and low risk, drawing in investors unaware of the lurking dangers.

Although they seem like legitimate opportunities, they are scams which leave victims desperately trying to recover their losses. This article explains the history, warning signs and distinctions from pyramid schemes, all essential for protecting yourself from this common form of financial fraud. 

For further advice, contact Helix Law today. 

A Brief History of the Ponzi Scheme 

Why Is It Called a Ponzi Scheme?

The term “Ponzi scheme” originated in the 1920s and is named after an Italian man, Charles Ponzi. He moved to the US and launched an investment strategy that promised investors a 50% return within 90 days by purchasing postal reply coupons.

Mr Ponzi paid older investors with the money he received from newer ones instead of from legitimate profits. Authorities eventually investigated and discovered that his business was fraudulent. 

While this wasn’t the first of its kind, it became well-known due to its scale, with reports of investors collectively losing around $20 million. 

Examples of Ponzi Schemes 

Bernie Madoff

One of the most notable cases was orchestrated by Bernie Madoff, a financier who encouraged victims to invest in blue-chip stocks and promised lucrative returns. As a former chairman of the Nasdaq stock exchange, his reputation meant investors trusted him with vast sums of money. 

Mr Madoff used money from new investors to pay returns to older ones. The operation unravelled in 2008 during the financial crisis when many sought to withdraw their investments. In total, he defrauded victims of around $65 million. 

Allen Stanford

Mr Stanford from Texas created a Ponzi scheme through an offshore bank account in Antigua. He sold fraudulent certificates of deposit, promising high returns. As with the other cases, Mr Stanford used funds from new investors to pay old ones and to fund his luxurious lifestyle. In total, he attracted around $7 billion worth of investment. 

The US Securities and Exchange Commission investigated him in 2009, and the court sentenced him to 110 years in jail. One of the main difficulties with this case was its international impact, making it much more challenging for victims to recover their funds.

How to Spot Ponzi Scheme Red Flags 

Guaranteed High Returns With Little Risk

One of the biggest telltales is a promise of a high reward with minimal risk. By nature, investments fluctuate with the market, and nobody, however experienced, can guarantee a specific return. Therefore, overassurance and unrealistic returns are things to look out for. 

Unclear or Complex Investment Strategies

Fraudsters often hide behind a seemingly complicated investment strategy to hoodwink their victims. An investment manager should be able to explain how it works and the potential risks. 

High-Pressure to Buy

Schemers may use high-pressure sales tactics to rush victims into investing. Such tactics could include giving an unrealistic deadline to sign up or convincing investors they don’t have the time or need for independent financial advice. 

Difficulty Withdrawing Funds

Investments should be readily available to withdraw if and when an individual chooses to. If a request to withdraw is delayed or comes with conditions, this may signify a Ponzi scheme.

What Are Pyramid Schemes?

A pyramid scheme is another form of financial fraud. In a pyramid scheme, people earn money by recruiting new participants instead of selling legitimate products or services. Every new participant usually pays a fee, which the fraudster uses to pay existing members. 

They usually collapse once the influx of new members slows down or stops, with most participants losing all their money. 

Examples of Pyramid Schemes 

Fortune High-Tech Marketing

Fortune High-Tech Marketing (FHTM) was a company founded in 2001 that recruited representatives to sell various products and services and earn a commission. However, following investigations in 2010, it was revealed to be a pyramid scheme, with representatives paying sign-up fees the company used to pay existing members.

The Federal Trade Commission (FTC) shut the company down in 2013 and reached a settlement requiring FHTM to repay nearly $8 million to those affected. However, the company neither admitted nor denied that its business model was fraudulent.

Herbalife

Herbalife still exists as a multi-level marketing company specialising in selling dietary supplements. However, in 2016, it agreed to a settlement with the FTC to pay $200 million following allegations that it was a pyramid scheme. The model relied on recruiting distributors to buy Herbalife products and onboard new members. 

The company has since restructured its business model to focus on actual product sales. 

The Main Differences Between Ponzi and Pyramid Schemes 

While both schemes pay returns to earlier investors with money from newer participants, key differences exist:

• The fraudster claims to manage an investment with legitimate returns in a Ponzi scheme, while a pyramid scheme relies on recruitment.
• Ponzi schemes often appear to have an individual or organisation in control, while pyramid schemes rely on a network of participants recruiting others. 
• Pyramid schemes are often disguised as multi-level marketing ventures, whereas Ponzi schemes masquerade as investment opportunities.

Frequently Asked Questions 

How Does a Ponzi Make Money?

A Ponzi scheme relies on new investor funds to pay out returns to earlier investors. It doesn’t rely on income from selling products or services, so the model usually collapses once new investments die down or stop. 

Is It Illegal to Have a Ponzi Scheme?

Yes, in the UK, Ponzi schemes are illegal and a form of investment fraud. Fraudsters misrepresent how they use victims’ funds and falsely guarantee a particular return. The punishments range from director disqualifications to imprisonment and substantial fines. 

Final Thoughts

Ponzi schemes have a history of defrauding investors by promising high returns with minimal risk while relying on a constant influx of new investors to pay off earlier ones. Over time, they collapse, leaving most participants with significant financial losses. The Bernie Madoff and Allen Stanford cases highlight the devastating impact these fraudulent activities can have on individuals and institutions. 

Understanding the warning signs, such as unrealistic returns and unclear investment strategies, is crucial to avoid falling victim. By contrast, pyramid schemes rely on recruitment rather than investment. Both are forms of financial fraud with serious legal consequences, and suspecting you’re involved in one can feel daunting.

We often encounter these disputes in the context of ‘guaranteed returns’ on property investments. A failure to advise on a ponzi scheme will usually amount to professional negligence if a solicitor instructed has failed to review or advise at the time the transaction is contemplated and/or is going ahead. As professionals are insured these are usually good claims worth pursuing. 

If you think you may be a victim or need legal advice on property investment or financial fraud or misrepresentation, including where ‘guaranteed returns’ have not materialised, contact our specialist commercial litigation team at Helix Law today for expert assistance. We’d love to help you.