Home -> Law Blog Directory -> Corporate & Securities Law Blogs -> OverRegd - Securities Regulation and Litigation Blog

Corporate & Securities Law

: OverRegd - Securities Regulation and Litigation Blog

Another Day, Another Ponzi-Scheme...

Anyone following recent blog posts or the news in general should rightfully be shocked by the recent number of Ponzi-schemes being discovered. Every day it seems the regulators are uncovering another one and there appears to be no end in sight. The question everyone should be asking is why are so many schemes coming to light now? And a follow-up question should be how can we prevent this from happening in the future?

For those of you unfamiliar with securities jargon, a Ponzi-scheme basically takes the shape of a pyramid in which the perpetrator (at the top) takes money one from one or more individuals with the promise to repay them at some point, usually at an attractive interest rate often unobtainable through traditional investments particularly in a troubled economy. As subsequent layers of investors are added to the pyramid, money from new investors is used to repay earlier investors; think along the proverbial lines "robbing Peter to pay Paul." Schemes like this (as evidenced by the Madoff scandal) can go on for years, even decades, without detection. So why are so many scandals coming to light now?

The answer is that not all Ponzi-schemes are created equally. Some schemes, arguably the more basic ones, involve simple conversion of investor funds, meaning that the initial promise made to investors to put the money in some investment vehicle was simply never effectuated. The perpetrator accumulates more and more money, often feeding investors reasons along the way as to why promised investment dividends or interest cannot be paid, and then disappears in the middle of the night with all of the cash. Compared to other types of Ponzi-schemes, these tend to last a relatively short period of time.

Other types of Ponzi-schemes, which we could call "hybrids," are more complex. There may actually exist an investment vehicle that the perpetrator places some of the money into while at the same time pocketing a portion of the funds for himself. On the other hand, the perpetrator may take the money and put it into an investment completely different than what was explained to the investor with the intention to generate profits to cover those portions of the funds the perpetrator has pocketed for himself. There are numerous other types of Ponzi-schemes as well but these are some of the most common.

The simplest explanation for why the schemes seem to be popping up everywhere now is largely due, in part, to tight credit markets and the near global market downturn. Where as before, Ponzi-scheme artists could have taken a portion of the funds obtained from investors and put the money into a booming sector of the market to generate money in the short term to repay investors at higher levels of the pyramid, there has simply been no thriving sector. Compounding the problem is the fact that banks, in general, have begun to tighten lending requirements making loans to the the public less accessible and less generous, thus foreclosing other avenues of funding for Ponzi-scheme artists looking to keep the scheme afloat. Finally, general investor sentiment and concern has caused individuals to cash out investments and put their money into relatively pedestrian investments such as money market funds or checking/savings accounts. Thus, when an unsuspecting mid-level Ponzi-scheme investor decides to cash in his or her investment, the result of doing so can wreak havoc on a Ponzi-scheme, as the perpetrator will need to scramble to find cash to pay the investor lest the pyramid fall apart - and that cash is not as readily accessible as it once was.

So what can we do to keep this from happening in the future? The short answer is due diligence. Ponzi-schemes, while coming in a variety of flavors, appear to share certain common attributes, including investors being provided very basic account statements, sudden stoppage of investment or dividend payments, lack of transparency in communications with company management, and the promise of seemingly unobtainable, sustainable investment returns often combined with the promise of little or no investment risk. Of course, these are but a handful of cautionary signs investors might look for in assessing whether they are the victim of a Ponzi-scheme, and it should be stressed that just because an investment stops paying dividends or goes out of business does not mean the investment was part of a Ponzi-scheme.

At the end of the day, the old adage "if something sounds to good to be true, it probably is" sill applies in the 21st century, and all of us would benefit from exercising a little more caution. No doubt many more Ponzi-schemes will be exposed in the coming weeks and months, and on that note, you may wish to check out the Securities and Exchange Commission website sec.gov/litigation/litreleases/2009/lr21155.htm for its July 27, 2009 litigation release regarding the matter SEC v. John J. Bravata, et al, Case No. 09-CV-12950, a case in which the SEC recently obtained a court order to halt an alleged ongoing fraud and Ponzi scheme conducted in the Detroit area by two individuals and two companies they control involving $50 million and at least 440 investors.

Full post as published by OverRegd - Securities Regulation and Litigation Blog on July 30, 2009 (boomark / email).