Financial scams have been around forever, but few are as infamous as Charles Ponzi’s. The main twist in his scheme was quickly paying early “investors” high payouts from the pot of investors’ money rather than profits. To this day, original investors in Ponzi schemes, after collecting tremendous returns as promised, become boosters, helping the scammers rope in many more victims. Ultimately it all collapses, but not before the thief has assembled a significant fan club who’ve unwittingly done the hard work of selling the scam. Ponzi schemes take on many guises and feed on the trust of innocent people, making them very hard to spot sometimes. However, there are usually telltale red flags to tip off alert investors. Even if someone trustworthy is vouching for an investment, the following things should give you pause.
Illogically high returns
The most obvious red flag is an offer of unusually high returns, especially if it comes with guarantees. Investments work like a marketplace, so why would someone offer financial terms that are much better than the going rate? Guaranteed investments (CD’s, bonds, etc.) tend to provide returns in the low single digits. Why is this one different? And other investments tend to max out at 7–15%, depending on the risk involved and an investor’s deal access. If someone really could generate guaranteed double-digit returns, why are they interested in small investors? Banks, institutions, and super-wealthy families would immediately write a $100 million check for truly guaranteed 12% returns! Like a Rolex on sale for $99, investments offering spectacularly high returns are almost certainly scams.
Surprisingly steady payouts
Investments tend to be somewhat volatile and/or illiquid. To a large extent, the need to risk and wait for the return of capital is precisely why investors “deserve” their investment returns. If someone offers steady, quick returns, you need to wonder whether they are really investing or just handing back a sliver of your own money, waiting for the pot to grow before they bolt. One flag in the massive Madoff/Ponzi was its rock-solid growth despite supposedly being invested in volatile stocks. Steady returns are great, but only if they make sense.
Black box story
While some Ponzi schemers stick to tried-and-tested fields, claiming investments in local real estate or stocks, it’s harder to hide scams within these traditional investments. Scammers instead often mask their schemes with complexity and put some distance between their targets and the supposed sources of returns. The gamut of revealed Ponzis attests to the creativity of the criminal mind. Foreign gold mines, cryptocurrency, international diamond trading, sports tickets, lawsuit promissory notes, charity matching, credit card miles, and discounted supply sales are just a sliver of the cover stories used by frauds to semi-plausibly explain supposed returns. It helps the story when the players actually mining the gold or crypto are mysterious people who only speak Cantonese or Swahili. The company’s location deep in France ensures that the average Israeli and American is totally in the dark.
Lack of verification
External corroboration and oversight provide critical protection against scams. Independent reviews by known lawyers, title companies, accountants, brokers, large investors, and bankers offer a significant line of defense against scams. And if misconduct does arise, the involved experts will often be the ones to shut it down or at least raise the alarm by stepping away. A few years back, someone was advertising a scheme to the frum community that smelled suspiciously like a Ponzi in the making. But because he claimed a prominent accounting firm was auditing his books, a few phone calls shut the whole thing down! As soon as the respected firm spread the word that they did not bless the arrangement, the promoter immediately closed up shop with no loss of investor funds.
Trust gone bad
On the other hand, when trusted professionals or communal figures are themselves duped, or worse, go rogue, the damage tends to be massive and catastrophic. Ponzis tend to lean heavily on affinity. Targeting a specific group type and using promoters from within already established religious, ethnic, or social networks makes it much easier to gain trust and overcome other glaring red flags. Historically, the largest schemes involved trusted communal figures who, maliciously or mistakenly, fished their extensive networks to trick even sophisticated professional investors.
Although it’s tough to pierce the most sophisticated scams, thankfully, most criminals aren’t that good. Keeping an eye out for these known red flags can help you avoid the commonplace Ponzi schemes.
What about Madoff?
Bernie Madoff’s $60 billion scheme ripped off some of the world’s largest and brightest investors. While Madoff didn’t offer extremely high returns, there were still some obvious red flags about his investment fund. First was the fund’s total stability in all market conditions; analysts found it puzzling, bordering on the impossible. The slick operator was also unusually secretive about his investment operations and relied heavily on affinity marketing, paying feeders to rope in investors from afar. Perhaps most tellingly, his auditor was a one-person operation, totally unheard of for a multibillion-dollar fund.
Why were these signals missed? Madoff had an impeccable industry resume and was trusted at the highest levels of the finance world. He owned a legitimate and hugely successful brokerage firm and even served on government panels to combat investment fraud! In addition to being a cold-hearted genius, Madoff’s gold-star legitimacy blinded virtually everyone. Government regulators who were tipped off in detail by whistleblowers also couldn’t fathom that the whole thing was a facade. The oversight of visible red flags is part of another sad chapter in Ponzi history.