Charles Ponzi, the namesake for the Ponzi scheme, was an Italian born American Immigrant. What he established is a pyramid scheme with few differences, where initial investors and the top investor see returns on their investments, but the dividend payments were coming from new investors, and not from actual profit made on investments. Ponzi’s scheme lasted roughly eight months and he is attributed with swindling over $10 million from over 40,000 investors (Peterson-Kramer and Buckhoff 48).
This graph, taken from the article Beware of False Profits by Bonita K Peterson Kramer and Thomas Buckhoff, depicts how the number of investors continues growing in order to increase revenue generation. Another problem with the sustainability of a Ponzi scheme is that little to no funds are actually invested into legitimate investments, instead all of the invested money being dispersed as dividends to early investors. Eventually, as the amount of new investors dwindles, the ash flow ceases and the scheme is exposed.
Previously in the article, Ponzi scheme’s were compared to pyramid schemes. A pyramid scheme is fairly infamous due to “to-good-to-be-true” money opportunities where a new investor or salesperson is recruited in order to recruit more people. A Ponzi scheme is promoted as an investment opportunity; in contrast the pyramid scheme pushes the ability to rise through the ranks of a pyramid organization for a higher return on products or services sold.
Alas, have no fear, there are some warning signs that will help potential investors identify Ponzi schemes. The most obvious warning sign comes from the age-old adage, “If it seems too good to be true, it probably is.” If an investment promises excessively high rate of return, it is probably a risky investment. The second warning sign is if an investment makes consistent returns, with no adjustments being taken for the state of the economy. So, if an investor is seeing all of their other investments decrease or stop dividend payments and stock prices continually decrease, yet one investment continues to pay out, it is probably a risky investment. Other warning indicators may be guaranteed returns with little to no risk to the investor, promises of quick payoffs, and incomplete, vague descriptions of how the investment is actually generating revenue.
This list, provided again by Peterson Kramer and Buckhoff, shows a list of red flags for Ponzi Schemes.
The article by Peterson Kramer and Buckhoff continues to provide action steps to help an organization avoid investing in a Ponzi scheme. Including skepticism, verifying information, analyze the information, and resist the temptation of large returns through sacrificing investment research.
The article effectively covered a brief background of the Ponzi scheme and its operations, as well as how to recognize, avoid, and exit a Ponzi scheme. There is a further discussion of what happens when a Ponzi scheme fails. The authors appear to have the credentialing to be authoritative resources on the information provided.
Peterson Kramer, Bonita K., and Thomas A. Buckhoff. “Beware of False Profits: The Ponzi Scheme Is Alive and Well and Seeking Your Money.” Strategic Finance(2012): 47-52.
Accounting Forensically 