Ponzi Scheme

PONZI SCHEME & MADOFF INVESTMENT SCANDAL

Introduction A Ponzi scheme is a fraudulent investment



operation that pays returns to separate investors from

their

own

money

or

money

paid

by

subsequent investors, rather than from any actual profit earned. 



The Ponzi scheme usually entices new investors by offering return other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going.



The system is destined to collapse because the earnings, if any, are less than the payments.





The scheme is named after Charles Ponzi, who became notorious for using the technique in early 1920. He had emigrated from Italy to the United States in 1903.



Ponzi did not invent the scheme, but his operation took in so much money that it was the first to become known throughout the United States.



His original scheme was in theory based on arbitraging international reply coupons for postage stamps, but soon diverted investors' money to support payments to earlier investors and Ponzi's personal wealth.



The Ultimate Unraveling of a Ponzi Scheme The catch is that at some point one of these things will happen:





The promoter will vanish, taking all the remaining investment money with him/her.



The scheme will collapse under its own weight as investment slows and the promoter starts having problems paying out the promised returns. Such liquidity crises often trigger panics, as more people start asking for their money, similar to a bank run.



The scheme is exposed because the promoter fails to validate the claims when asked to do so by legal authorities.



External market forces, such as a sharp decline in the economy will cause many investors to withdraw part or all of their funds not due (at least initially) to loss of confidence in the investments, but simply due to underlying market fundamentals.

Madoff investment scandal 

Bernard

Lawrence

“Bernie”

Madoff,

1938

is

an

American convict, who was a financier, and Chairman of the NASDAQ stock exchange. He is the admitted operator of the Ponzi scheme that might be "the largest investment fraud in Wall Street history". 

In March 2009, Madoff pled guilty to 11 felonies and admitted to turning his wealth management business into a massive Ponzi scheme that defrauded thousands of investors of billions of dollars



Madoff said he began the Ponzi scheme in the early 1990s. However, federal investigators believe the fraud began as early as the 1980s, and the investment operation may never have been legitimate. The amount missing from client accounts, including fabricated gains, was $64.8 billion. The court appointed trustee estimated actual losses to investors of $18 billion.



On June 29, 2009, he was sentenced to 150 years in prison with restitution of $170 billion. According to the original federal charges,

Madoff

said

that

his

firm

had

"liabilities

of

approximately US$50 billion." Prosecutors estimated the size of the fraud to be $64.8 billion, based on the amounts in the accounts of Madoff's 4,800 clients as of November 30, 2008. Ignoring opportunity costs and taxes paid on fictitious profits, less than half of Madoff's direct investors lost money.



Investigators have determined others were involved in the scheme. The U.S. Securities and Exchange Commission (SEC) has also come under fire for not investigating Madoff more thoroughly; questions about his firm had been raised as early as 1999. Madoff's business, in the process of liquidation, was one of the top market makers on Wall Street and in 2008, the sixth-largest.