Ponzi Schemes Allow Organizers to Take Advantage of Investors

March 26, 2012 — 1,274 views  

Many people associate stockbroker Bernie Madoff with Ponzi schemes, but few may understand how the plans work and how they can be successful. Investment fraud remains a serious problem for people worldwide, but understanding how Ponzi schemes are constructed can help eliminate this risk in the future.

The U.S. Securities and Exchange Commission (SEC) notes that Ponzi scheme organizers promise substantial investment returns for funds contributed by new investors. People may claim they are completing transactions as a stockbroker, but could then use these funds for personal reasons. Rather than actually investing the money in potential stocks and bonds, these organizers spend it to find new investors and keep the scheme going. 

This fraudulent activity became notorious after Italian businessman Charles Ponzi, a con man, cheated thousands of New England residents using a postage stamp speculation scheme in the 1920s. Ponzi's ruse set the standard for plots used by Madoff and others. Ponzi promised people a significant return on their investment after three months, leading many New Englanders to fall into his trap. While Ponzi experienced success with the self-centered scheme, investors were left without money.

Ponzi schemes can collapse at any time because they operate on a "rob Peter to pay Paul" principle, according to the SEC. They require a continuous flow of investors to remain successful, and organizers may stop their operations when these financiers ask to cash out.