Roshan Jelal | Head | Fraud | FNB Commercial | mail me | 

The key to helping investors to better protect themselves from falling victim to investment fraud is to stay alert and be aware of the key characteristics and red flags associated with Ponzi and Pyramid schemes.

Ponzi schemes have existed for over one hundred years and range in shape, complexity, and size. Investors are often promised extraordinarily high returns within a short period of time, with little or no risk.

The money obtained from new investors is either used to pay returns promised to earlier investors or returns are paid from the initial investment, thereby creating an illusion of a very lucrative business. In the absence of any legitimate underlying business, this unsustainable scheme eventually collapses as it becomes impossible to attract new investors enabling the scheme operators to pay on promises made, particularly to earlier investors.

Red flags and tips for investors consider

These schemes rely solely on the steady stream of new investor (victims) funds. Whilst the scam often relies on word-of-mouth, social media has given it further momentum.

If you are wondering whether an investment opportunity may be a Ponzi scheme in disguise, there are a few red flags and tips to consider in order to protect yourself:

• Be cautious of opportunities promising high rates of returns with little or no risk attached. It is noteworthy that all investments carry some risk, particularly short-term investments with high rates of return.
• Look out for investment schemes that are not registered and licensed with the relevant regulatory authority. All financial services providers (FSPs) must be registered with the Financial Sector Conduct Authority (FSCA) to operate in the financial services industry. Therefore, it is prudent that you conduct your due diligence before investing.
• All investments must be sold by licensed professionals who you can and should validate through the FSCA, if not you may be dealing with a con.
• Beware of investment opportunities that lack transparency, a clear business model, or are exceedingly difficult to understand. You must always be able to understand how and where your hard-earned money is being invested.
• Never rush into investment opportunities, it is wise to take as much time as required to authenticate the entity and related parties.

Ponzi schemes versus pyramid schemes

Pyramid schemes which are just as unsafe as Ponzi schemes. These pyramid schemes require that participants recruit new people to join the scheme.

The initial participant often pays an upfront fee to sell the products or services. Post joining, the participant is enticed to recruit new participants and at each new tier or level, he/she will receive recruitment-based commissions which is usually paid from the fees received from each new recruit. Pyramid schemes inevitably collapse when participants are unable to recruit more people.

These schemes often mimic multi-level marketing concepts as both offer recruitment-based commissions. The difference is that with pyramid schemes the earlier participants take money from lower-tiered recruits whilst with multi-level marketing the commission and revenue are generated through product sales.

Here are some tips to protect yourself from fraudulent schemes:

• Pyramid schemes focus on the large sums of commissions you can earn through recruiting others.
• Often there is no actual product or service that is sold. If products and services are being punted, these may be vague, and benefits are unclear.
• Beware of fast, easy money, and passive income that requires little or no effort.

People need to take time to understand the red flags, validate and verify investment opportunities, as this time and effort could save you a lifetime of pain and financial loss.

Related FAQs: Ponzi and pyramid schemes

Q: What is the difference between a Ponzi scheme and a pyramid scheme?

A: The key difference is that in a Ponzi scheme, returns are paid to earlier investors using the capital of new investors, while in a pyramid scheme, participants earn money by recruiting new members into the scheme.

Q: How does a Ponzi scheme work?

A: A Ponzi scheme is an investment fraud where the operator promises high returns to investors but pays these returns using the capital of new investors rather than profits from a legitimate investment. The scheme collapses when it becomes unsustainable to recruit new investors or the flow of new money dries up.

Q: Can you name a famous Ponzi scheme?

A: One of the most infamous Ponzi schemes was orchestrated by Bernie Madoff, who defrauded investors of billions of dollars through his fraudulent investment scheme.

Q: What are some red flags of a Ponzi scheme?

A: Signs of a Ponzi scheme include promises of high returns with little or no risk, consistent flow of new investors required to pay returns to existing investors, and investments that seem too good to be true.

Q: What is the relationship between Ponzi and pyramid schemes?

A: Ponzi schemes and pyramid schemes both involve fraudulent investment strategies where existing investors are paid returns using the capital of new investors. The key difference lies in how participants earn money – through promised returns in a Ponzi scheme and through recruiting new members in a pyramid scheme.

Q: How can you differentiate between a legitimate investment and a Ponzi scheme?

A: Legitimate investments offer reasonable returns based on the underlying assets and market conditions, while Ponzi schemes promise unrealistically high returns with little to no risk, relying on a continuous influx of new investors to sustain the payouts.

Q: What are some of the characteristics of Ponzi schemes?

A: Ponzi schemes are named after Charles Ponzi, involve fraudulent practices to defraud investors, and depend on recruiting new investors to generate returns for existing participants.