How To Avoid Falling For A Ponzi Scheme

Are you considering taking on a side hustle? Although we all desire to make quick money, if an opportunity appears too good to be true, it may not be legitimate. Sometimes scams look like a reputable business but are really a Ponzi scheme in disguise.

Many people are sucked into schemes through their desperation or hopefulness to earn some extra cash or for financial freedom and are often unsuspecting prey for various scams and schemes created by smart people who are out to strip the unaware of their money.

What Is A Ponzi Scheme?

A Ponzi scheme is a fraudulent investment scheme where profits are paid to current investors using money obtained from new investors. Those who organize Ponzi schemes often claim they will invest your money and produce substantial returns with minimal or no risk. In many cases, the fraudsters do not invest the funds. Instead, they utilize them to compensate earlier investors and keep a portion for themselves.

Since Ponzi schemes generate little to no genuine income, they rely on a continuous stream of fresh funds to stay afloat. As it becomes increasingly difficult to recruit new investors or a large number of existing investors withdraw their funds, these schemes are prone to collapse.

The term “Ponzi scheme” is derived from Charles Ponzi, who conned investors in the 1920s with a scam related to postage stamp speculation.

The Scheme

In 1920, Charles Ponzi established Securities Exchange Co., where he offered stock or promissory notes promising a 50% return on investment after 90 days. The money invested by shareholders was intended to purchase International Reply Coupons (IRCs), which would be redeemed in the United States.

However, Ponzi did not use the funds to buy IRCs as promised. Instead, he utilized the money obtained from new investors to pay returns to old investors.

Ponzi justified his actions by blaming the Universal Postal Union for suspending the sale of IRCs once they discovered his coupon redemption scheme. After attempting to circumvent the suspension, he resorted to his “Rob Peter to pay Paul” approach. The scheme worked for a while, and in the first eight months of 1920, he amassed $15 million (equivalent to $220 million in 2022).

To keep the scheme going, Ponzi informed investors that he had developed an intricate network of agents purchasing IRCs overseas, which he could redeem in the U.S. for a substantial profit. In reality, there was no such network, and he relied on new investments to pay off old investors.

Ponzi schemes are not relegated to the dusty pages of history.


Recent Ponzi Schemes

Bernard Madoff

Over several decades, Bernard Madoff provided his investors with consistent and stable annual returns using falsified account statements and other fabricated documentation that persuaded them that their funds had been invested in legitimate ventures. The investments appeared to be genuine, especially to those receiving payments. However, there were no actual investments or returns. Madoff paid the initial investors “returns” with money provided to him by a steady stream of new investors.

As the global economy began to decline in 2008, a significant number of Madoff’s investors required money and began requesting to cash in their investments. This was when Madoff’s Ponzi scheme fell apart – he did not have enough money to cover his investors’ demands, and finding new investor money became increasingly difficult in the economic downturn.

Tom Petters

Tom Petters, the CEO and chairman of Petters Group Worldwide, was responsible for a Ponzi scheme that totalled $3.7 billion.

Investors were under the impression that their investments were being used to purchase retail goods, primarily electronic products, which would then be sold to discount stores at a profit.

In reality, Petters was not investing any of the money in retail merchandise. Instead, he used a portion of the funds to finance his extravagant lifestyle, while the rest went towards paying off new investors. He was convicted and sentenced to 50 years in prison in 2010.

What Is The Difference Between A Ponzi Scheme and a Pyramid Scheme?

Ponzi schemes and pyramid schemes are both types of investment fraud that involve recruiting new investors to pay off earlier ones. However, there are some significant differences between the two.

A Ponzi scheme typically involves a single person or entity promising high returns to investors and then using the funds obtained from new investors to pay earlier ones. Meanwhile, a pyramid scheme involves multiple levels of participants who recruit others beneath them to invest and receive a percentage of the money earned by those recruits.

Neither type of scheme is sustainable in the long term, as they rely on a constant flow of new investors to pay off earlier ones. Additionally, both are illegal, although pyramid schemes are sometimes disguised as legitimate multi-level marketing programs.

How To Avoid Ponzi Schemes

Most people would love to invest their money in a guaranteed deal that promises high returns. But be cautious if a broker or anyone else tries to sell you on such an offer. You could be scammed by a Ponzi scheme, which has ripped off investors for billions of dollars for almost a century.

In a typical Ponzi scheme, scammers promise great and consistent returns. And they deliver – but only for a while. In reality, they’re not investing in anything. Instead, they’re using money from new investors to pay off their old obligations, including the exaggerated returns promised to the early birds. However, the scheme eventually crumbles when it fails to attract enough new investors to keep it going.

There are several red flags when it comes to any Ponzi Scheme

Ponzi schemes have some tell-tale signs you should watch out for. Here are some red flags to keep in mind:

  • High returns with little or no risk: Be wary of investment opportunities that promise guaranteed high returns. Every investment involves some degree of risk, and higher returns often mean higher risks.
  • Overly consistent returns: Investment returns tend to fluctuate over time. Be cautious of investments that generate steady positive returns regardless of market conditions.
  • Unregistered investments: Ponzi schemes involve investments that are not registered with government or official regulators. Registration is important because it provides investors with information about the company’s management, finances, and services.
  • Unlicensed sellers: Investment professionals and firms are required to be licensed or registered by federal and state securities laws. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
  • Secretive, complex strategies: Avoid investments that you don’t understand or can’t get complete information about.
  • Issues with paperwork: Account statement errors could be a sign that your funds are not being invested as promised.
  • Difficulty receiving payments: If you have trouble receiving payments or cashing out, be suspicious. Ponzi scheme promoters sometimes offer higher returns to participants who stay put to prevent them from cashing out.

How To Report A Ponzi Scheme

The Australian Government is taking steps to reduce the risk, occurrence, and impact of fraud. They encourage individuals to come forward and report any suspicions of fraud and promise to assess and investigate such reports promptly and fairly in accordance with the Australian Government Investigation Standards (AGIS).

To report suspected fraud or unethical behaviour impacting the department, individuals can contact the department’s Fraud Reporting Team via email at or by phone at 02 6141 6666. If the suspected fraud involves other Australian Government agencies or payment of Commonwealth benefits, individuals should report to the relevant agencies or use the Australian Government Services Fraud Tip-Off Line.

Individuals can choose to remain anonymous when providing information, but the more details they can provide about the individuals involved, the actions or activities suspected to be fraudulent, and the time and place of occurrence, the better equipped the department will be to investigate the matter.

By following the tips provided, you can learn how to avoid falling prey to Ponzi schemes and recognize the warning signs. It’s important to keep in mind that investing is not a fool proof method of generating extra income, and anyone claiming otherwise may be attempting to defraud you. Always be vigilant and on the lookout for key red flags when considering any investment opportunity. Call your nearest ITP Tax Accountant if you think you’re a victim of a Ponzi scheme.