Ponzi Schemes
Thomas Mullin
Ponzi Schemes
Ponzi schemes, named after the man who created them Charles Ponzi, are one of the uglier sides of accounting. A Ponzi scheme, also known as a pyramid scheme, is when a salesman, usually a very charismatic person, makes an “investment” sound like a great opportunity. They make false promises of great returns with their secret plan or business savvy. What really is happening is they are tricking many people into joining their plan. Instead of making any actual profit, they use money from their latest victims to pay off the earlier victims. This works as long as there are new investors lining up to join the salesman, and as long as no one already invested tries to take too much money out at once.
Charles Ponzi started these schemes back in the early 1900’s; Taking advantage of an eager American public, who were seeing a rising economy in a post World War I country. Ponzi scheme was that foreign postages could yield up to fifty percent returns in as little as forty-five days. By redeeming the coupons that were bought overseas, for a much cheaper price, he would be able to double there money selling them in America. The word of this amazing offer spread quickly through New York and the rest of the country. Before he knew it, Ponzi was receiving millions of dollars every week. A good portion of which was coming from the regular working class man, sending whatever they could afford to send that particular week. It was even reported that three quarters of the Boston Police department had invested in “Ponzi notes.”
Ponzi, who was never really satisfied with his earnings, made even more plans to get money out of people. Although he was very good at what he did, his charm and intelligence only went so far. The Boston Post, a financial journalist Clarence W. Barron and state banking officials started to investigate Charles Ponzi. They finally found out the Ponzi was nothing more than a con artist. He was arrested in 1920 for mail fraud, serving time in both federal and state prison. Ponzi, an immigrant from Italy who never became a citizen, was deported in 1934 back to Italy. It was there that he died fifteen years later, a poor man. Ponzi schemes did not end with the death of the originator. They can even be directly related to the fall of Albania, after it broke free from communism.
Albania was a country who was new to the game of freedom, having been under communist rule. Its private sector grew extraordinarily fast, with a country gross domestic production (GDP) of $600 million in 1995, up from next to zero in just a few years earlier. Of that $600 million, $350 million (15%) was in private savings. These new account holders were an easy target for Ponzi schemes or pyramid schemes. They also evolved the schemes, to look more realistic then before. Now some people would actually invest some of the money into companies, while still holding a majority of it. One woman, who ran a pure pyramid scheme by not investing in anything, offered 20 to 30 percent returns to investors, which was astonishing because the annual inflation rate was only 13. Before she was finally caught and arrested for fraud, she was able to amass $50 million from inexperienced investors.
She was only one of many schemes that happened. Two fund pyramids kept their money in commercial banks. In the last quarter of 1996, $250 million had accumulated in these accounts. Another pyramid scheme, the biggest in all of Albania, received nearly $500 million from people investing in supermarkets and other things. All together there were 16 pyramid schemes that accumulated an outrageous $1.2 billion by 1997, when the schemes were caught.
The public blamed the government for letting this happen. They were warned by many different organizations, including the World Bank. The government even made some pyramids legal. Associations between the corruption of the pyramids and the President, Sali Berisha, were pretty obvious. Albania was not the strongest financial country, but it was doing well before the crisis. It had a stable currency, and was on the rise. Since the explosion in 1997, Albania has struggled to return to form.
A more recent example of a Ponzi or pyramid scheme is Bernie Madoff. Bernie Madoff was the chairman of the NASDAQ stock exchange. Madoff was the founder and chairman of the Wall Street firm Bernie L. Madoff Investment Securities LLC. Madoff, a likeable guy, built the company up from next to nothing. He earned respect and became a member of many different organizations including SIFMA, and was an active member of NASD.
Madoff became a dot on the map of corruption in 1999 when Harry Markopolos, a financial analyst, informed the SEC that it was legally and mathematically impossible for Madoff to achieve the gains that he was reporting. Unfortunately, no one in the SEC listened to him. It was not until December 2008 that Madoff was finally caught. He admitted to his son, Mark Madoff, that everything was a lie. On March 12, 2009, Madoff pleaded guilty to 11 federal offenses, including securities fraud, wire fraud, mail fraud, and perjury. He was sentenced to 150 years in prison, the maximum sentence. When it was all said and done, Madoff stole an estimated $50 billion dollars, the largest Ponzi scheme in history.
Ponzi schemes are by far the ugliest part of accounting. It shows how lying can destroy personal relationships, finances, and even a country. The only ways to try to stop these despicable schemes are tougher SEC regulations on financial reports. The SEC needs to focus more on the substance of a financial report rather than the appearance. It should also consider tips from whistle-blowers, like Markopolos, more seriously. It is impossible for a government to completely prevent a Ponzi scheme, but hopefully the example they made of Madoff will deter people.
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