Ponzi Schemes Revealed

Bernard Madoff managed to scam billions of dollars from wealthy business owners, savvy investors, and even international banks. A classic Ponzi scheme, the return on investments was all smoke and mirrors: early investors were simply paid with later investor’s funds. The problem is that eventually it all falls apart and investors are left empty handed. So, what can the average investor do to avoid getting conned? It all comes down to asking the right questions, doing your homework, and using common sense.

In order for a scheme like this to work, there has to be a constant influx of new investors. Ponzi schemes rely heavily on word of mouth; recommendations from friends, family, business acquaintances. Trying out a new restaurant on the recommendation of a friend isn’t much of a risk; gambling your financial future on it is foolhardy. It’s easy to get caught up in the excitement of guaranteed high returns, but that’s the exact time to back up and take a good look at the situation. Con artists use psychological games to get investors hooked before they have a chance to really think about it.

The first thing to remember is the old adage, “If it looks too good to be true, it probably is.” Madoff’s company had consistently high returns and outdid almost everyone, even in volatile markets. Month in and month out, investors were receiving 8% and higher in returns. This also influenced the early investors to reinvest, and most of them lost everything. Logic argues that it isn’t possible to be that consistent with real investments. High returns equal high risk; this is a basic investment rule of thumb. If anyone is promising low risk and high return, there’s a good chance it’s a scam.

Before investing, check with your state’s securities division to verify the investment company is registered and in good standing. Check Security and Exchange Commission (SEC) records, not only for violations, but also for what isn’t reported. Madoff managed to avoid disclosure to the SEC by using a tactic that was legal but extremely unusual.

Ask for a sample statement and have it explained in detail. Get proof of past performance and verify the stated returns. Every investment firm is required to hire an outside auditor; get as much information as you can from the auditor, but also check out the auditor for reliability. Find out how accessible the account information is. The less convenient it is, the more likely an investor won’t even look at it, which is what a scammer wants. Madoff’s firm sent monthly statements by mail only; investors had no way to access their accounts online at any time. Many of them confessed to not reading their statements.

The bottom line is there are many different investment options available. If a friend tempts you with a get-rich-quick scheme and you want to give it a try, treat it like gambling. Don’t play with more than you can afford to lose. For serious investments, do your homework, know your risks, and invest wisely.