Bernard Madoff, former NASDAQ stock exchange chairman, has been running a humongous ponzi scheme for years, right under SEC Chairman, Christopher Cox’s nose. Now it is out in the open. Madoff is under house arrest. Questions are being raised about the competency of Christopher Cox and investors are out $50 billion dollars. How could this have been avoided? What exactly is a ponzi scheme and how does it work?
A ponzi scheme is a con. It works by the paying the oldest investors with new money. The longer the ponzi scheme runs the more investors it must bring in. As the first level of investors are paid, and they will be paid in order to legitimize the ponzi scheme to others, more investors must be brought in to cover the payout. As the ponzi grows, an ever-increasing amount of money is required to pay off investors. A well run ponzi scheme will have investors only taking “interest” and reinvesting the principle. If several investors cash out or if there is a slow down in bringing in additional funds, the ponzi scheme will start to collapse on itself. This is what happened with Bernard Madoff. The money going in and out of the investment firm triggered the attention of the authorities. Why Christopher Cox and the SEC failed to notice this the first time Madoff was investigated is quite amazing.
What to look for and how to avoid a ponzi scheme. A major red flag that something is fraud is the only income generated by the investment is money from new investors. Another iten to look at is the rate of return. Ponzi schemes tend to have extremely high rates of return when compared to similar investments. For example if an investment firm was telling you they can guarantee a 30% rate of return for your investment, it is most likely a ponzi scheme or some other con. In this economic environment, 5-8% is extremely good. 30% is unheard of. The term “guaranteed rate of return” should be a warning sign. Bank accounts, Certificate of deposits (CD), Money Market accounts, Treasury Bills, and Government bonds have a fixed interest rate. This is the only way to guarantee a rate of return.
Before you put your hard earned money into any investment, check out the investment and the invest firm offering the investment. All financial advisors must be licensed. The same holds true for anyone offering stocks, annuities or securities as investments. All stockbrokers must be registered with the SEC. You can easily check the status of any license with them. Use caution when making money from something seems too easy or too good to be true. High rates of returns; guarantees you will not lose money; phrases like “we invest in offshore gold, mining, banking and currencies” are all red flags. Someone appearing out of the blue who is actively recruiting new investors should be viewed with great suspicion. Furthermore, all legitimate investments will send your withdrawals via a check in the mail or direct deposit money into your existing bank account. Be very cautious of having to go someplace to pickup cash. Ask for a printed propectus of any investment. By law it must be provided to you upon request. Finally, if you feel that something may not be legitimate, inform local law enforcement. They are usually very interested in anything that sounds like a ponzi scheme or con.