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Ponzi Scheme

16 October, 2023

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People prefer to invest in a company that offers services or products to generate profits. However, shady stockbrokers invest clients’ money in imaginary firms with the intention of stealing it. Afterward, they find fresh investors to use their money for distributing “returns” to earlier investors through a practice called the Ponzi scheme.

What is a Ponzi Scheme?

A Ponzi scheme is a tactic used by scammers to commit investment fraud, recruiting individuals to invest in firms that do not exist. The criminal steals all the money after solidifying the investment. Then, the scammers hire new investors and use their investments to pay off earlier ones to make it sound like they are generating profits for initial investors. 

The practice was named after Charles Ponzi, an Italian businessman who pulled off an infamous and very large scheme in 1920. The Italian businessman did it by establishing a shell investment firm supposedly centered on purchasing international postal vouchers in Europe and exchanging them for higher-priced US postage stamps. Although this practice (known as arbitrage) was not illegal, falsely claiming that his firm was doing it—and instead using funds of new investors to pay off the initial ones—was a crime. Bernie Madoff carried out the largest Ponzi scheme in history that deceived thousands of investors and caused them to lose billions of dollars.

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How Does a Ponzi Scheme Work?

To commit a financial Ponzi scam, criminals first convince individuals to invest in an enterprise that is fake. They usually promise the investors to generate high profits with little risk and this very reason is enough to attract the target (investors). Scammers also make stories and provide forged documentation to make it appear like a legitimate business for an individual to invest in.‍

After stealing the initial investments, the criminals create an illusion for the investors that they are getting profits. Scammers use the same tactic with other individuals to convince them to invest and then use those funds to pay off the initial investors, pocketing an extra portion for themselves. Criminals use sophisticated methods to make the business deal sound like a legitimate one, although it is not.

Here is a brief overview of how a Ponzi scam works:

  1. A scammer attracts a group of investors to make an investment in a company that is imaginary.
  2. Investors fooled by the Ponzi fraud end up giving their money to the scammer, who keeps the funds for themselves.
  3. To create the illusion that their investment is generating profits, the criminal then targets new individuals and convinces them to invest in the shell firm.
  4. New investors entering into the scheme hand over their money to the scammer, who then distributes it among initial investors while also keeping some amount for themselves.
  5. Scammers repeat steps 3 and 4 until they find no new investors, and the Ponzi scheme collapses.


Ponzi Scheme vs. Pyramid Scheme

A Ponzi scam is a type of pyramid fraud, but there is a thin line of difference between both.

A Ponzi scheme usually relies on a single individual or group to enroll fresh investors to pay back the earlier ones. In this scheme, an investor makes a one-time investment and waits for the returns passively. However, the pyramid scheme offers incentives for investors to actively recruit new individuals into the scam. This involves letting investors collect  “initiation charges” from the individuals they enroll, with a portion to be paid to the scheme organizers and previous investors.

What to Do if Scammed by a Ponzi Scheme?

With technological advancement, the Ponzi scheme has also changed. Scammers are becoming sophisticated in targeting investors to fulfill their illicit intentions. In case you become a victim of the Ponzi scheme, here is what to do to protect yourself: 

  • Cancel all future payments with the company you are investing in.
  • Cut off the communication with the company and the scheme organizer.
  • Document all the communication you have had with the shell firms, such as letters or emails – these may serve as evidence in case you are required proof of being scammed by the Ponzi scheme.
  • Report the organizers of this scheme to the Financial Conduct Authority (FCA) on 0800 111 6768.
  • Criminals often sell individuals’ confidential details, so be cautious of scammers targeting you again using fake identities.

Be cautious of “fraud recovery fraud” – this is when a scammer claims to be a legal professional or a police officer and offers to help Ponzi scheme victims regain their money. The scammer promises the victims to get their money back but by paying charges for the services they get from so-called legal professionals or police officers.

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