Ponzi Schemes

Named after Carlo Ponzi, an early 20th century fraudster, the Ponzi scheme is one of the most notable types of investment fraud. A Ponzi scheme operates by using new deposits to pay out fictitious “returns” to existing investors, requiring a constant flow of new deposits to continue to operate.

Today, these schemes often start and flourish during a bull market. They often take the form of promissory notes, long maturity bond-type investment or somewhat illiquid investments that either “reinvest interest or dividends” or pay interest on a monthly basis, but investments that do not have you looking for the return of principal soon. Broker dealers may be responsible for these fictitious investments if it was run out of their office or branch office and they omit to properly supervise the broker and catch the fraud, even if it was an alleged “outside business.”

In 2012, Malecki Law helped a New York community of Ponzi scheme victims recover over $5.5 million, and the cases involving this scheme are not finished – Ms. Malecki is looking to achieve a full recovery for the victims, if possible.

A Ponzi schemer is a type of confidence man, or “con man,” who takes advantage of investors by promising higher than market returns, achieved over a relatively short period of time. Rather than actually investing the deposited funds to earn “bona fide” returns, the Ponzi schemer typically uses the investors’ money to fund his own lavish lifestyle.

Ponzi schemers rely heavily on investors’ trust, which is earned either by pre-existing status in the community (such as Bernie Madoff) or by delivering on early promises of returns (often paid out from that same investor’s initial deposit).

Investors can easily fall prey to Ponzi schemes for a variety of reasons, including affinity fraud. Perpetrators of affinity fraud typically rely on a shared ethnicity or religion to earn a victims trust. A Ponzi schemer may also use the appearance of exclusivity to maintain his victims’ trust. Investors are led to believe that the Ponzi schemer is doing something special for them, making the victim feel fortunate to have gotten involved. For example, Bernie Madoff famously turned away investors if they did not have enough to meet his minimum investment requirement.

Ponzi schemes succeed by abusing investors’ trust and keeping them in the dark about where their money is really going. Because of their implicit trust, investors can be reluctant to ask about exactly how the money will be invested for fear of sounding foolish or impolite. Even those who do ask questions may simply be told that it is “very complicated” and accept that as a satisfactory response.

A Ponzi scheme can grow exponentially as investors tell their family and friends about the great investment they made. However, regardless of how large the scheme gets and how it is conducted, virtually all Ponzi schemes eventually end in a similar fashion. As the pool of new investors dries up, the Ponzi schemer is left without sufficient funds to continue to pay out the fictitious returns to his investors, and the scheme implodes - leaving investors with nothing.

Not all Ponzi schemes are conducted by licensed stock brokers. However, licensed stock brokers have been known to take advantage of their position as a trusted financial professional to operate Ponzi schemes and bilk their customers out of millions upon millions of dollars.

This threat has been recognized by both the Securities and Exchange Commission and the Financial Industry Regulatory Authority. Brokerage firms are obligated to supervise their brokers to prevent such schemes from occurring. As part of their supervisory obligations, firms must monitor and keep track of investments being sold by the broker that are not offered directly by the firm (known as “selling away”), as well as other businesses their brokers are engaged in away from the firm (known as “outside business activities”).

Brokerage Firms’ obligations to supervise their brokers are outlined in the FINRA Rules, and include Rules 3010 and 3270. Notices to Members, such as NTM 98-38, explain to firms what they should look out for and how they should supervise their brokers. Violations of these rules and guidelines can result in a firm being found liable and having to reimburse a Ponzi scheme victim for their losses. Firms also can be held liable to victims for violating FINRA’s “Suitability Rule,” since a Ponzi scheme is never a suitable investment for anyone.

Through private lawsuits and regulatory investigations, brokerage firms have been forced to compensate victims of a Ponzi scheme carried out by one of their brokers. Merrill Lynch recently paid the victims of one of its brokers in full. Such successful Ponzi scheme cases against firms are usually based on the firm’s failure to properly supervise their broker during the time he was running the Ponzi scheme.

Investors who have been the victims of a Ponzi scheme may be entitled to some or all of their money back from the brokerage firm who registered their broker. To fully explore their rights, such investors should call the securities fraud attorneys at Malecki Law.

For prominent Ponzi schemes and securities fraud cases around the country, visit our Communities pages.

Top 5 Signs You May Be The Victim of a Ponzi Scheme
  1. Statements about your investment do not come from your regular brokerage firm
  2. Guaranteed returns are decreased or stopped altogether
  3. Your financial adviser stops answering your questions and stops returning your calls
  4. Your financial professional asks you for leads to new investors
  5. You cannot verify the information your financial adviser is telling you

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