Madoff – the new name behind the Ponzi scheme

by Natalie MacLellan on June 29, 2009

in Fraud Prevention, In the News, Red Flags of Fraud

You can’t check the news today without reading about the sentencing of Bernard Madoff, who received 150 years for operating his multi-billion dollar Ponzi scheme.

Madoff jailed 150 years for ‘massive’ fraud (Globe and Mail)

Madoff gets 150 years for fraud (CBC)

What is a Ponzi scheme, and how can you recognize and avoid it?

The Ponzi scheme was named for Charles Ponzi, a clerk in Boston who first devised such a scam in the early 20th century.

To best understand a Ponzi scheme, think of the chain letters that were all the rage in junior high school – when people still used snail mail. If you sent a letter to six friends, who sent a letter to another six friends and everyone also sent two postcards, then all participants were supposed to receive 36 post cards from exotic locations all over the world. How many of you sent the letter? (Don’t be shy, we’ve all done it.) Now how many of you actually received 36 postcards?

Ponzi schemes are run in a similar fashion. Typically, investors are recruited through promises of high returns. Early investors often receive returns fairly quickly from “interest cheques.” They may be so pleased with their returns that they re-invest, or recruit friends and family as new investors.

Here’s the catch: The investment doesn’t exist. The “interest cheques” are paid from investors’ own money and the contributions of new investors. The scheme eventually collapses when the number of new investors drops.

Just as with the chain letter, where you may have received a few postcards before things petered out, with a Ponzi scheme, you may receive some returns, perhaps even for years, before new investors run out and the money dries up. Then you discover you weren’t receiving “interest” after all, and your initial investment is gone.

Of course, all you ever invested in your chain letter (I hope) was your time and your hopes. And the cost of a few stamps. Sadly, many have lost much, much more to Madoff and other scammers.

Can you indentify the Red Flags in the Ponzi description? Learn more about how to spot a fraud.

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