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Securities Compliance Sentinel Analysis of cutting-edge securities industry issues

How To Spot A Ponzi Scheme

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

Ponzi schemes seem to be more and more common over the last few years.  Whether the ponzi scheme is a multibillion dollar scheme, or a smaller scheme involving several thousand dollars, they all share certain common characteristics.  The most common characteristic among ponzi schemes is that they tend to show their investors relatively consistent gains, even when the markets are extremely volatile.  For example, during the tech bubble burst in the early 2000s, Mr. Madoff reported steady gains of about 12% or so a year.  Most experienced and some inexperienced investors are probably consciously or subconsciously aware that those types of consistent gains, during a recession, should raise some eyebrows.  The reason Mr. Madoff could perpetrate his fraud for so long, however, is that investors let their greed blind them to common sense.  In essence, investors should remember that if an investment opportunity seems to good to be true, it probably is and investors should be cautious.

Another common characteristic is that many of the investors in a ponzi scheme tend to be from the same affinity groups, such as social, economic, religious or cultural.  In the Madoff scheme, nearly all of the investors were wealthy individuals or charities.  Many investors unknowingly invest in a ponzi scheme through the recommendation of a friend or relative.  As a result, investors often fail to do their normal due diligence because they are disarmed by their friend’s or relative’s glowing recommendation of the investment.  Investors should remember to do their normal due diligence before investing in a fund based on any recommendation.

There other common characteristics of ponzi schemes include complex or secretive investment strategies, issues with paperwork and difficulty receiving payments.  Although legitimate funds could, from time to time, share some of these characteristics, it is important that all investors follow the advice of a former president, “trust but verify”.