What are Ponzi Schemes?
It is a deceitful investment that is often regarded as the ugly side of accounting. It is also sometimes referred to as a Pyramid scheme. It is a bad investment that pays returns to an investor from the money paid by later investors or from their own investment. The returns, unlike in a sound investment scenario, do not come from any real profit made by an organization or individual acting as the investor.
This is actually a dangerous way of attracting new investors by promising them with the scope of making higher profits than in other investments. It offers them short-term returns, which are either constant in an abnormal way or unusually high. Such a scheme can only continue if more money is put in by new investors. Unless this happens, the system is going to collapse. Even if there is any profit, it is less than the amount offered as payment to investors. Naturally, Ponzi schemes are bound to fail after a point of time. Due to this reason, these are stopped by legal authorities even before they actually collapse. As more and more investors get involved with a scheme, it is suspected by authorities. The promoter is suspected of selling non-guaranteed securities.
History of Ponzi Schemes
The scheme was first described in the famous novel “Little Dorrit”, written in 1857 by Charles Dickens. The novel describes a strategy that is similar to a Ponzi scheme. In Dickens’ work, it is shown to bring about the collapse of a bank leading to tragic consequences for the main characters.
However, it was not until 1920 that the scheme actually became popular. That year, a Jewish con artist and businessman named Charles Ponzi used a money making scheme to attract droves of investors. He offered astronomically high returns to investors, which was actually to be given from subsequent investments. Described later as “robbing Peter to pay Paul” the scheme was eventually busted and Charles Ponzi was incarcerated. The scheme owes its name to Charles Ponzi.
Who Creates Ponzi Schemes?
These are generally devised by a salesman, who works to put the plan together and attract investors. Hence, the originator of the strategy is the only person to be held responsible. If the participants are found to be party to the activity with full knowledge of the consequences, they can also be held responsible. If the participants are found unaware of the actual nature of the scheme during subsequent investigations, they will not be liable to criminal charges.
How Do Ponzi Schemes Work?
These strategies are based on investment management services that are deceitful in nature. A typical Ponzi scheme works like this:
- A person, typically a salesman or any fraudster having knowledge of financial operations, invents the scheme.
- He or she convinces investors of making investment, assuring them of high returns within a short time.