From Postage Stamp Fraud to Stock Market Catastrophe: The Evolution of The Ponzi Scheme

There are lessons to be learned from the Ponzi School of Fraud.

Perpetrators of Ponzi schemes can expect inevitable downfall and look forward to lifelong prison sentences. Some may even enjoy a certain amount of fame.

A Ponzi scheme is basically asking a few people to put up some money – with the promise of major and immediate profits – and then pocketing that money and paying them off with other investors’ money, thereby widening the pool of money, until old investors ask for their money back, new investors cannot be found and there is no option but to cut and run.

So for such an unsustainable, failure guaranteed model, why are they as common as they are? Why are they often caught so late? Maybe we can understand by studying the motives of these villains.

Charles Ponzi

The original get-rich-quick fraudster gave his name to the practice. Charles Ponzi was an Italian criminal who paid off his investors with money from other, newer investors, instead of money made from the fruits of careful, legal, investment strategies. Operating in the early twentieth century, Ponzi took advantage of the postal system. He got the idea when, one day, he received a letter from a Spanish company with an international reply coupon (IRC), which, when redeemed, acted as free postage back to the sender’s country. He realised he could buy these up and exchange them for postage in another country, where the value was higher. Ponzi did have agents working for him abroad and made a profit this way. But he wasn’t satisfied; he brought in investors for higher profits and paid them back with money from other investors. He lived the high life, making up to $250,000 per day.

The Boston Post blew his cover (as a result, the paper performed a public service, won their first Pulitzer, and positioned themselves on the right side of history). Arrested in 1920, Ponzi was charged with 86 counts of mail fraud. He spent 14 years in prison, a lenient sentence as seen through the lens of hindsight and compared to those who followed in his footsteps. Ponzi died penniless in 1949.

Bernie Madoff

Arguably the most famous alumni of the Ponzi graduate programme is Bernie Madoff, who swindled the largest sum of money from his investors: $65 billion, from thousands of victims. Madoff had a golden reputation; he helped launch the Nasdaq stock market and was a noted philanthropist. But far from having the midas touch, there was no way he could have feasibly had such large returns from his investments. Another red flag should have been that investors could withdraw their initial investment at any time, unusual for such great sums of money. Madoff had a broad supply of investors, thanks to multiple feeder funds, like Ascot Partners, generating money for him. When everything came to light, many victims did not even know the funds they had invested in were tied to Madoff.

He was caught in 2008, largely due to the financial crisis. He was charged with 11 felony counts, including mail and wire fraud. Madoff was found guilty in 2009 and sentenced to 150 years in prison, the maximum possible sentence. He is currently serving his time. His sons, partners of Bernard Madoff Securities, turned their father in. Both brothers died; Mark Madoff was 46 when he committed suicide on the second anniversary of the father’s arrest, and younger brother Andrew Madoff died from cancer at 48.

Tom Petters

Tom Petters provides another cautionary tale. Though smaller in scale than Madoff’s brazen cons, Petters still made off with $3.65 billion. Hailing from Minnesota, he will likely spend the rest of his life behind bars as he was 53 in 2010, when sentenced with 50 years in prison, the longest prison term ever ordered in the state’s history for financial fraud cases. Petters’ posse persuaded investors to provide Petters Company funds to purchase merchandise to be resold to retailers at a profit. In fact, the funds were redirected, to satisfy Petters’ lavish lifestyle, his business needs or to lull investors into a false sense of security. Petters admitted to faking purchase orders. He would have had total access to the vendor list and huge contracts. It would have been easy for him to forge POs and get deliveries without making a payment. He has maintained his innocence when it comes to mail and wire fraud and money laundering.

So why are such schemes caught so late? They are based on belief, hope and trust. Facts, checks and balances don’t come into play for investors. They briefly succeed when word of mouth speaks louder than words on paper.

It is easy to avoid a ponzi scheme. With a centralized procurement system, fraudsters are eliminated. And with a proactive, instead of a reactive spend culture, you can track and authenticate an order from request to pay.

Has Your Business Been a Victim of Fraud?

It never pays off to be a financial schemer. Unless you want to swap a business suit for an orange jumpsuit and die alone and impoverished, be transparent with your spending. There is always a better way.