To Avoid Ponzi Schemes, Exercise Due Diligence When Investing

by Paul Davis

Ponzi schemes have been around for over a century, but small businesses still sometimes fall victim to them. Here's what you need to know in order to recognize them.

Paul Davis
On Crime & Security


Mario Puzo's fictional crime boss Vito Corleone, otherwise known as "The Godfather," told Sonny, his violent offspring, that a lawyer with a briefcase could steal more than a thousand men with machine guns.

So can a securities broker, we've now learned. With the arrest of New York investor Bernard L. Madoff for securities fraud involving at a multi-billion dollar Ponzi scheme, both prominent business figures and small business people have learned they have been swindled out of their investments. This is the largest fraud case in U.S. history.

According to the U.S. Justice Department, Madoff met with his senior employees on December 10th and informed them that his investment business was a fraud. Claiming that it was "all just one big lie," and that "it was, basically, a giant Ponzi scheme," Madoff estimates that his fraud will cost at least $50 billion.

"We are alleging a massive fraud -- both in terms of scope and duration," said Linda Chatman Thomsen, the Director of the SEC's Division of Enforcement. "We are moving quickly and decisively to stop the fraud and protect remaining assets for investors, and we are working closely with the criminal authorities to hold Mr. Madoff accountable."

The SEC charged Madoff and his investment firm with violations of the anti-fraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Advisers Act of 1940. The securities fraud charge carries a maximum penalty of 20 years in prison and a maximum fine of $5 million.

The SEC said their investigation is ongoing.


Michael Chiklis, the bald, fireplug actor who portrayed a corrupt cop for six years in "The Shield," told the Associated Press that he once fell victim to a Ponzi scheme, so he plans to produce and act in a TV drama about the Ponzi scam artists.

Calling the conmen "business scoundrels," he said he was gathering material from other Ponzi victims. The victim stories are both sad and shocking.

"If I had hair, it would curl," Chiklis said.

Although the Madoff case made front page news, many more smaller-scale Ponzi schemes are being committed against small business people.

According to the FBI, a Ponzi scheme is essentially an investment fraud wherein the operator promises high financial returns or dividends that are not available through traditional investments. Instead of investing victim's funds, the operator pays "dividends" to initial investors using the principle amounts "invested" by Subsequent investors.

The scheme generally falls apart when the operator flees with all of the proceeds, or when a sufficient number of new investors cannot be found to allow the continued payment of "dividends."

The Ponzi scheme was named after Charles Ponzi (1889-1949), a small time swindler who hit the big time when he invented a lucrative con in the 1920s that netted him more than $15,000,000.

Ponzi's con was simple. He operated an extremely attractive investment scheme in which he guaranteed investors a 50 per cent return on their investment in postal coupons. Although he was able to pay his initial investors, the scheme dissolved when he was unable to pay investors who later put money into the scheme.

It was good while it lasted, but Ponzi was eventually arrested and spent four years in prison.

The FBI offers a couple of common sense tips to avoid Ponzi schemes:

As with all investments, exercise due diligence in selecting investments and the people with whom you invest.

Make sure you fully understand the investment before you invest your money.

About the author: 
Paul Davis is a writer who covers crime & security for newspapers, magazines and the Internet. He can be reached at

Paul Davis on Crime & Security
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