Charles Ponzi is the one that gives the The Ponzi scheme its name. He was a fraudster who told investors that their money would be doubled in ninety days. Even if he was successful in the beginning, the scheme’s fast growth in debt became unsustainable when investors started to withdraw their funds after learning of Ponzi’s bankruptcy.

How Ponzi Schemes Deceive People?

Although it is an old scheme, the Ponzi scheme still continues to deceive people and lead them to lose money and bankruptcy. Why do people still believe in such schemes? Because of the allure of easy money. The human inclination for shortcuts often leads people into the folds of these schemes, which appear to be legitimate investments.

The Ponzi scheme doesn’t provide a real profit to participants, because it makes people believe they are profiting by redistributing the funds to participants within the scheme. It continues like this as long as new participants are joining the scheme. Eventually, the collapse is inevitable as the scheme fails to attract new participants.

What are the Indicators of Ponzi Schemes?

Ponzi schemes have common indicators for both individual investors and financial institutions.

Indicators for individual investors include the following:

• High Returns, High Risks

They promise or guarantee that the investments will have high returns but often have high risk levels.

• Discouraging Withdrawals

They may offer high returns to prevent investors from withdrawing their funds.

• Pressure and Secrecy

They may put pressure on investors to make quick decisions and ask to keep the investment confidential.

• Opaque Business Model

Their business model may be too complex for an ordinary person to understand how returns are generated.

Measures to protect financial institutions from the Ponzi scheme include:

• Legitimate Registration

Verify if the company is registered and operates as a legitimate business rather than a shell company.

• Concerns About Address

Raise concerns if the company operates from a mailbox-only address, a virtual office, or a small private office incompatible with its claimed business size.

• History of Investigations

Investigate the company’s history for any investigations or disciplinary actions related to unfair practices or misrepresentations.

• Cautious Approach to Innovative Claims

Be cautious when a company makes grand claims about inventing new technology, or products or presenting a special investment scheme.

• Limited Employees Beyond Founders

Limited employees beyond founders could indicate a potential issue.

• Unrealistic Wealth and Owner Background

Unrealistic wealth compared to the client profile and previous criminal, bankruptcy, or civil court records for the owner(s) raise concerns.

• Lack of Audited Financial Statements

The absence of audited financial statements and large-scale transactions with unrelated businesses or accounts are red flags.

• Defensive Stance and Unusual Explanations

Companies taking a defensive stance to questioning and providing unusual explanations for business or account activities should be scrutinized.

Can Banks Get Fines from Ponzi Schemes?

Financial institutions (FIs) face liability if it is proven that they were aware of the Ponzi scheme. To defend against Ponzi scheme litigation, an FI must demonstrate its lack of awareness regarding the underlying fraud. Banks must take reasonable measures to scrutinize both existing and new clients, assessing their potential exposure to such schemes. Even minimal involvement, negligence, or failure to report Ponzi-related activities may expose banks to the risk of regulatory action and litigation.