The Ponzi Scheme is initiated when one schemer collects investments from multiple “investors” below them. In order to pay back those investors, the main schemer must come up with new funds, which cannot be actual returns as there is no business taking place.
Instead, the head schemer fabricates “returns” by gaining new investors and using their investments to pay those who invested before them. This scheme requires exponential growth of investors in order to keep paying back those above them, making it seem as though the non-existent company is growing, along with its revenue.
Everyone is always playing ‘catch up’, though they may not know it, and instead believe that the company is truly turning out these profits. Ponzi schemes typically promise a payout to investors at a later date whenever the product or company sees big returns.
Under the Dodd-Frank Act, whistleblowers who provide the SEC with specific, credible, and timely information about a Ponzi scheme may be eligible to receive a whistleblower reward of between 10% and 30% of the monetary sanctions collected in actions brought by the SEC and related actions brought by certain other regulatory and law enforcement authorities.
Difference Between Ponzi Scheme vs Pyramid Scheme
A Ponzi scheme promises future returns on a particular investment and requires new investors to be brought into the fold for the scheme to succeed. Whereas a pyramid scheme promises easy profits to an “investor” who brings along another “investor” and relies heavily on new member / investor recruitment for the scheme to succeed.
Identifying a Ponzi Scheme
The Securities and Exchange Commission (SEC) has identified the following traits to watch out for, which often point to a Ponzi scheme:
The promise of high returns with very little risk
Consistent returns regardless of market conditions
Investments not registered with the SEC
Investment strategies too complex to explain
Clients not allowed to view paperwork for their investment
Clients facing issues when retrieving their money
Investors should be skeptical of any investment guaranteeing high returns at a specific date with low to no risk, or of any investment not registered with the SEC.
Cryptocurrency Ponzi Schemes
In July 2013, the U.S. Securities and Exchange Commission (SEC) published an Investor Alert relating to the prevalence of Ponzi schemes in the virtual currency industry. Not only did the SEC fear Ponzi-style frauds to occur within the buying and selling of these cryptocurrencies, but they noted that the virtual monies could be used to carry out other crimes as they tend to have less oversight.
Common red flags for crypto Ponzi schemes, according to the SEC, include high returns with little risk, overly consistent returns, unregistered investments, unlicensed sellers, secretive or complex practices, and difficulty receiving payments, among others.
Another common crypto fraud is called ‘rug pulling’, which is an exit scam that occurs when a developer fraudulently pumps up the price of the token before ‘puling the rug’ on the company and completely draining the token’s value. The price becomes zero, and the liquidity pool is empty.
Ponzi Scheme Example
Imagine for a moment, two friends Hayes and Robert.
Hayes promises Robert 20% return on a particular investment of $1,000. Robert decides to invest, expecting the value of that $1,000 to increase to $1,200 by the end of the year. During that same year, Hayes also promises his friend Lynn a 20% return on the same investment of $1,000. She agrees and expects $1,200 by the end of the year as well.
Now, Hayes (the fraudster) has $2,000 on hand, and is able to make Robert whole by paying him $1,200 as he expects. However Hayes must continue to recruit new investors in order to pay back Lynn, as he is shy -$200 after his payment to Robert, or more if he is using this money for personal purchases.
Why is it called a “Ponzi” Scheme?
The name Ponzi scheme comes from the Italian-born swindler and con artist Carlo “Charles” Ponzi, who in 1920, came to the U.S. with a money-making scheme.
In essence, Ponzi would guarantee clients 50% profit within 45 days, and 100% in 90 days through the arbitrage of postal reply coupons Investors were attracted to this scheme, and instead of investing the money on coupons, Ponzi simply redistributed it to previous investors, telling them they made a profit.
The Ponzi scheme was named after Mr Ponzi, but the original scheme can be attributed to William “520 per cent” Miller, or Adle Spitzeder of Germany or Sarah Howe.
Bernie Madoff and the Most Famous Ponzi Scheme in History
Bernie Madoff was an American con artist responsible for the largest Ponzi scheme in history, defrauding investors of over $64.8 billion over the course of more than 17 years. Although nobody knows how long this scheme was going on for.
Madoff promised investors extremely high returns for investing in their firm’s split-strike conversion strategy. When receiving cash in for the investment, Madoff would use it to pay existing clients who wanted to cash out. And the scheme continued until 2008, until Madoff revealed the scheme to his sons, who immediately turned him in to authorities.
Like most con artists, Madoff had created a charismatic persona that attracted investors. He was often described as being generous, giving, and charitable. With this persona, he was able to defraud nonprofits, charities, and $2.4 billion from members of his synagogue.
On January 24, the U.S. Securities and Exchange Commission (SEC) issued a $28 million award to joint whistleblowers who alerted the agency to ongoing fraud, allowing the SEC to return millions of dollars to harmed investors. Qualified SEC whistleblowers, individuals who voluntarily disclose original information that contributes to the success ...
On January 19, the U.S. Securities and Exchange Commission (SEC) awarded $18 million to three whistleblowers who separately made disclosures which contributed to the success of the same enforcement action. The whistleblowers’ voluntary disclosures led to millions of dollars being returned to harmed investors. Qualified SEC whistleblowers, individuals who voluntarily ...
On January 12 and 13, the U.S. Securities and Exchange Commission (SEC) issued three separate whistleblower awards totaling over $6.2 million. The awarded whistleblowers voluntarily provided original information to the SEC that led to successful enforcement actions. Through the SEC Whistleblower Program, the SEC pays out monetary awards to qualified ...
A Ponzi scheme promises future returns on a particular investment and constantly requires new investors to be brought into the fold for the scheme to succeed. A schemer uses the cash from the new investor to pay back the original investor, plus their “guaranteed return.”
Whistleblowers who provide the SEC with original information about a Ponzi scheme may be eligible to receive an award of between 10 and 30 percent of the sanctions collected in actions brought by the SEC Office of the Whistleblower and other regulators. Sanctions must be over $1 million for a whistleblower to qualify – and only individuals may qualify.
The SEC has pointed out a few red flags to look out for when evaluating an investment to determine if it is a Ponzi scheme. Investors should be skeptical about an investment if it (a) guarantees a specific return on a specific date, and/or (b) if the investment is not registered with the Securities and Exchange Commission. Unregistered securities are not subject to regulation, which poses an incredible amount of risk to investors.
Ready to Blow the Whistle?
Information submitted in the client intake form or in email from anyone seeking legal help is covered under the attorney client and work product privileges to the fullest extent of the law. We also highly encourage you to learn about our intake process before submitting an intake.
Your communications are secured and sent over 256-bit SSL encryption. Protect your identity and confidentiality, do not use any devices owned or controlled by a private corporation or governmental entity. It is also recommended to protect your online identity by establishing a new email account that does not identify you and to avoid the use of other online platforms that may disclose your identity.
Subscribe to our newsletter to receive whistleblower news and resources crafted & curated by the partners and associates at KKC.
The information you obtain at this site is not, nor is it intended to be, legal advice. You should consult an attorney for advice regarding your individual situation. All information submitted in the client intake form or in email from anyone seeking legal assistance is considered covered under the attorney client and work product privileges to the fullest extent of the law. While we treat your information as confidential, a lawyer-client relationship is created only by express written agreement signed by both you and Kohn, Kohn & Colapinto.