Ponzi schemes are a type of investment fraud in which investors are paid by other investors’ capital, rather than by what they believe to be their investment in some commodity.
Ponzi schemes are a specific type of investment fraud in which:
- Investors are deceived into believing that they are investing their money into some stock or commodity when, in fact, they are not.
- Investors are enticed into investing in the scheme by being promised extraordinarily high or abnormally consistent returns on their investment.
- Investors in the scheme are paid out by subsequent investors’ capital.
- A stream of new investors is constantly needed to keep the scheme going.
Features of Ponzi Schemes
In Ponzi schemes, terms like “high-yield investment,” “hedge futures” and “offshore investments” are typically used on investors who may be unfamiliar with the stock market and, as a result, lack the foresight to question the specific investment strategies being used to grow their investments. What can be just as problematic is the fact that Ponzi schemes:
- Often grow out of legitimate investments like hedge funds and tend to be propagated when those running the investment fail to disclose the investment’s losses to their investors (for fear that investors will pull out of the investment)
- Do involve payouts to some investors in order to attract other investors, which can make it difficult for potential investors to identify the scam
- Typically involve sending out regular statements to investors as a way to dupe them into leaving their money invested in the scam (These falsified statements will generally show fake reports of high earnings on the investment.)
- Generally are associated with timeframes during which investors’ funds are locked into the investment, meaning that investors cannot pull out their money or collect returns on their investment for a given period of time (Typically, the longer a Ponzi scheme is operated, the longer these periods of the frozen investment last).
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