Financial desperation: A breeding ground for investment scams

Fraudsters know that desperate times call for desperate measures and now, more than ever, we need to remain vigilant against investments scams and schemes. It’s hard to believe that 100 years after Charles Ponzi pulled of his audacious investment scam, would-be investors are still falling for Ponzi schemes. Named after Charles Ponzi, who promised investors in New England a 40% return on their investments in 90 days compared with 5% interest earned in savings accounts, the Ponzi scheme is the oldest and most common type of investment fraud. As the coronavirus pandemic leaves more and more people in financial distress, the breeding ground for new and more advanced investment schemes is unfortunately fertile.

In its simplest form, a Ponzi scheme is a pyramid scheme that operates on the basis of ‘robbing Peter to pay Paul’. The promoter (or the fraudster setting up the Ponzi scheme) pays the initial investors enormous returns using the investments of later investors rather than from business profits. Ponzi schemes generally have no viable business model and very rarely generate any legitimate profits of their own. Their survival is dependent on a constant flow of new investor money which, if not found, will result in the ultimate collapse of the entire scheme. However, finding new recruits becomes more and more difficult as the scheme matures because the exponential nature of the recruitment format simply cannot work mathematically. Once the supply of new recruits starts to dry up, the scheme will collapse and the promoter will be unable to pay out promised returns.

While the Ponzi scheme is still in its infancy earlier recruits can and do make money because, by entering early, they have greater success in recruiting new members whose ‘investments’ are used to pay their ‘returns’. In reality, however, there is no investment and there are no returns. The promoter is merely using the funds invested by the later recruits to pay the earlier recruits in order to build their trust and motivate them to find more ‘investors’.

Once the supply of new investors inevitably dries up and the promoter begins defaulting on his payments, investors become suspicious and distrustful. Sadly, however, many Ponzi scheme investors are slow to admit that they have fallen victim to a Ponzi scheme – both out of embarrassment and fear. While it is widely believed that victims of Ponzi schemes are greedy and money-hungry, the reality is that most are financially distressed and utterly desperate. Once investors become suspicious of the scheme, they fear that any public exposure will create a crisis of confidence amongst the other investors which, in turn, will make matters worse. Caught between a rock and a hard place, many are left with no choice but to remain in the scheme in the hopes they will recover some money.

If you are unsure whether an investment is genuine or is possibly a Ponzi scheme, here’s what to look for:

Abnormally high investment returns

The most obvious sign of any investment scheme is the promise of an abnormally high investment return. While Ponzi schemes may take a variety of forms, they all follow the same intrinsic theme: investors are promised they will make a much higher return than can be achieved through any conventional investment opportunity.

Guaranteed returns

The words ‘guaranteed returns should sound the alarm bells. When it comes to investing, no return is ever guaranteed and even the most modest investment carries some risk. Be highly suspicious of anyone who offers you a guaranteed return on your investment.

Consistently high performance

By their very nature, the investment markets rise and fall over time, and your returns in any reputable investment will reflect these market fluctuations. Be sceptical of any investment that promises consistently positive returns regardless of overall market conditions.

Vague business model

If you don’t understand the business model after a 5-minute explanation, stay away. The investment’s business model should be easy to understand and, as an investor, one should be clear where and how returns are generated. Fraudsters are notorious for using complicated verbal constructs in order to intimidate would-be investors. These are smoke-and-mirror tactics used to confuse and bully investors. As Warren Buffett is famous for saying: “Never invest in a business you can’t understand.”

The need for more investors

The survival of any Ponzi scheme is dependent on its ability to continually attract new investors. Without an ongoing stream of new investors, the fraudster is unable to pay the previous investors, and the whole scheme will unravel. If you are pressured into finding new investors or offered rewards be very suspicious.

Pressure to reinvest

Ponzi schemes will collapse without regular income or if too many investors withdraw their funds. In order to remain afloat, the promoter will offer investors higher returns if they don’t cash out or if they reinvest their money. While on paper investors believe their investments are gaining incomparable ground, the truth is that most Ponzi schemes don’t make any investments on behalf of their investors at all. If you’re pressurised or rewarded for reinvesting, be alarmed.

Pressure to act now

Ponzi fraudsters are also notorious for creating a false sense of urgency by leading the investor to believe the deal is only valid for a limited period of time. The investment opportunity is often shrouded in secrecy, and the investor is pressurised to ‘act now’ while the ‘once-in-a-lifetime’ window of opportunity stands obscurely and suspiciously ajar. Pressure to invest within a certain period of time is foreign to sound investing principles and should be considered a red flag.

Credibility through association

A Ponzi scheme promoter generally creates an air of exclusivity by luring would-be investors into his inner circle of family and friends. By proximity to those who are close to the fraudster, the investor’s fears are allayed – after all, foxes never prey near their dens and thieves don’t rob from their own homes. This is a powerful psychological tactic used by fraudsters to build credibility through association with reputable people who are known to them. Remember, Bernie Madoff managed to deceive those nearest and dearest to him, including his own sons.

Before investing your hard-earned money in any investment, we would advise the following:

Take your time and do your research. Do not allow yourself to be pressured into an investment.

Research the company or scheme online. Is it registered with the CPIC? Is it registered with the Financial Services Conduct Authority? Does it have a registered business address and verifiable contact numbers?

Phone the Financial Services Conduct Authority and check whether the company has a registration number and is in good standing. Check what other professional or industry bodies it is registered with.

Insist on seeing their marketing material and fund fact sheets. Do you understand the business model? Do you know what underlying products your money is being invested in? Are the company’s registration numbers reflected on all their material, including their website?

Remember, the person recruiting you is not in a position to give you independent advice. Rather, make contact with an independent advisor and ask for his/her opinion.

Check the credentials, qualifications and experience of the investment promoters. How much investment experience do they have? How long has the business been operating?

Search the investment scheme and the names of the promoters online. Check their personal Facebook, Instagram and Twitter feeds.

Stay safe.


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