So what exactly is a Ponzi Scheme?
Some History
The term 'Ponzi scheme' earns its name from the late Charles Ponzi, an Italian businessman and swindler who in 1920's Canada and the United States garnered popular attention through his fraudulent investment practices. Ponzi made a habit of paying old investors using the money invested by new clients under the guise of a revenue that did not actually exist. His promise of a 50% profit within 45 days or 100% of profit within 90 days was a "too good to be true" red flag commonly featured within Ponzi schemes, even to this day.
While Charles Ponzi provided the namesake for this particular type of fraud, he was not the first to implement it. With the rise of industrialism and the modern age in the nineteenth century, white collar crimes became increasingly easy access to large amounts of capital over implausibly short periods of time. Adele Spitzeder, a former actress turned banker, utilized what was perhaps the first recorded Ponzi Scheme in the early 1870's. Like Ponzi, she paid early investors with the money invested by later investors thus creating a hollow organization that promised revenue where there was in fact none. This cost her investors the modern equivalent of around 400 million euros, leading to a chain of suicides and a small financial collapse in Bavaria from where her private bank operated.
As the stock market became more of a fixed feature within western civilization, the use of Ponzi schemes and other get rich quick scams rose well into the late nineteenth and earlier twentieth centuries. Individuals such as William F. "520%" Miller, of whom Charles Ponzi likely received his inspiration, had managed to swindle millions from investors by the turn of the century. Yet through financial collapse, global disputes, government regulation, and the reassessment of the American dream, such white collar crimes were seemingly put to rest for a time following the 1920's. As the economy escalated later into the twentieth century, corporate power saw a surge in dominance as things such as unionization and government overreach eroded with the 1970's and 80's. This set the table for one Bernard L. Madoff and what would become the largest Ponzi Scheme to-date.
"Rob Peter to pay Paul";
1. Top Level, the Schemer
The mastermind behind the project, the origin of all fraudulent acts within the operation and the person entirely within the know of what deceitful activities are taking place. While the Schemer is often one person or party, it is not uncommon to have multiple people acting within this top level. The Schemer, along with his/her co-conspirators (often early investors) maintains just enough money from new investors to cover any potential withdrawals, thus giving the illusion of a successful business when the organization is in fact hollow. Most new investments typically find their way into the Schemer's pockets as well as the pockets of any co-conspirators and chief investors. The Schemer is the most likely to benefit financial from the scheme if the fraud is successfully achieved. They are also likely to receive the heaviest penalties if the scheme is uncovered by the law.
2. Second Level, the Early Investors
Next to the Schemer, these are the individuals and parties most likely to receive a high payout and profit from the operation. As those first onboard, these investors receive much of the fake "revenue" produced by the firm via the money entering in through the investments of newer investors. These investors serve both as security to the scheme through their large stakes first invested and as model examples to potential investors who see their high returns and may wish to join in. While early investors to a Ponzi scheme may be outside of the know concerning the fraud at play, many often are aware or at least partially aware of what is taking place. They choose to remain attached to the firm for the high returns regardless of the fact that they are in truth stealing from new investors. When a Ponzi scheme is uncovered, the early investors are often required to pay back this fake revenue to the new investors it was stolen from.
3. Third Level, the New Investors
In noticing the perceived success of the operation, these investors blindly join onto the scheme in hopes of achieving the high return rates of early investors. Their investments ultimately go on to fund most of the operation, paying early investors and the Schemer after being laundered into fake revenue. While some new investors may be partially aware of the reality of the operation and may even receive significant payouts (depending on the number of fresher investors behind them), most are unaware of the scam taking place and generally serve as both the prey and fuel to the operation.
4. Bottom Level, More New Investors
As the operation expands in popularity and appears to generate more revenue and returns through the input of new investors, even more investors will likely be compelled to join. This often extends to less wealthy individuals who easily fall prey to the operation's inflated promises. Fresh investors to a Ponzi scheme often suffer the heaviest losses as their investments are basically stolen to fund the returns of the operation's prior investors, the earliest investors receiving the highest priority. By this point in the scheme, the Schemer has likely capitalized significantly by pocketing much of the new investments used to also funnel into early investors. The assets of the operation remain significantly less than what is inflated to the public under the fragile assumption that most, if not all investors will never demand redemptions of their investment in full. The business remains hollow despite a veneer of success.
