Written By: Phil Feigin
Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi was born 131 years ago this coming March, and died penniless in a Rio de Janeiro charity hospital two months shy of his 67th birthday, just two months before I was born, in 1949. While he did not invent the sort of scheme he pulled off in Boston back in 1920, the brazen and spectacular nature and scope of his fraud warranted naming rights.
By now, most are familiar with the classic Ponzi scheme pattern. A promoter raises capital from investors for an enterprise, promising high returns paid in short order, perhaps weekly, monthly or quarterly. The promoter actually pays initial investors the promised returns. Recognizing that the unbelievable has come true, i.e., the operation is returning 20% a month (or whatever), these first investors decide to reinvest their initial returns and let them and future returns roll over for a compounding effect. The hook is now sunk.
These early investors tell all their friends and provide testimonials. Some of them have swallowed the bait so hard, they may even start selling the investments to family, friends and anyone else who will listen. And then there’s the Internet and social media.
The cash rolls in. A few months or years later, investors ask to withdraw some or all their funds. They get excuses, but no money. In reality, there never were any profit- or even revenue-generating operations; all the scammer did was raise money and keep the imaginary balloon inflated. Those first returns were just of some of the investors’ own money. Most of the proceeds have now been drained away by the scammer, less occasional payouts to the “squeakiest wheels.” You know the rest: disconnected telephones, regulators, newspaper stories, subpoenas, interviews, denial, fury, fear, court documents, accountants, receivers, grief, greed, the occasional financial literacy editorial, clawbacks, those who weren’t bilked asking how those who were could have been so stupid, betrayal, desperation, anger, loss of trust and faith, excuses, recriminations, prosecutors, more court, retribution, contrition, sentencing, perhaps a legislative committee hearing or two, blame all around, and finally, nothing but hollow questions of how it all happened and what might have been. A complete waste, except for boosting the revenue of casinos, drug dealers, mansion and exotic car sellers and leasers, jewelry stores, fashion retailers, art dealers, hotels, airlines and fancy restaurants.
In the Post-Madoff Era (“PME”), barely a week goes by without word of a new Ponzi scheme being uncovered and shut down somewhere. As I see it, three factors have contributed to this apparent bull market in Ponzi schemes. First, we’ve had five years of recession and bad economic times. A lot of people lost a lot of money in investments and real estate, a lot of retirees are suffering, markets have been volatile, and traditionally safe returns have been microscopic. The allure of higher returns in the “safe” strategies only a promoter not burdened with the truth can promise has for some been too much to resist.
Second, in good times, investors don’t need to withdraw principal from good, growing investments. In bad times, or after bad news in the media, they flee to cash. In some ways, that explains the longevity of Madoff’s scam. It wasn’t until after the Lehman Brothers/Reserve Primary Fund debacle that people who had invested in “hedge funds” started asking to liquidate their holdings by the thousands. The volatile markets and continuing problems here and abroad, as well as Ponzi scheme revelations themselves, precipitated unprecedented and unanticipated investor requests for liquidation of alternative investments. The scammer’s inability to meet broad scale requests for cash meant the beginning of the end.
Third, it is my completely unverified opinion, supported by nothing more than my 34 years of dealing with and observing the SEC Enforcement Division staff, that, before the onset of the PME, Enforcement personnel viewed work on Ponzi schemes as somewhat beneath them. That was not the path to greatness within the Division. Working insider trading cases, major company accounting fraud, mutual fund finagling, Foreign Corrupt Practices Act violations, wire house deception—now, you’re talking. Not everyone in Enforcement is there to cash in with a Wall Street or D.C. law firm partnership after 10 or 15 years toiling away at the Commission, but that prospect is hard not to at least consider. It is only natural to aspire to advancement within the Division as well. Before the PME, work on Ponzi schemes simply was not pursued with much vigor.
Once the Madoff and Stanford revelations started pounding the SEC’s midsection, it seems Ponzi schemes became Public Enemy Number One at Enforcement (and at the state level as well). I’m guessing a memo went out to all SEC Enforcement staffers across the country to review any complaints received in the last three years for potential Ponzi schemes and prioritize them. Reports were requested and generated regarding any current investigation or litigation. Headquarters made it a point to emphasize every enforcement action taken against anything even resembling a Ponzi scheme.
It is my unofficial observer’s sense that the PME saw the creation of a new term: frauds were now described as “Ponzi-like schemes.” What in heaven does that mean? Does the Ponzi family have a copyright on the term, and SEC officials hoped the qualifier would avoid having to pay the royalties? “Operating a Ponzi scheme” is not an express violation or crime that I know of. You don’t get any more points if you prove it was a “Ponzi scheme” as opposed to some other form of fraud. It is merely a colorful and convenient way to describe how a lot of investment frauds operate.
I don’t think we will ever know if there have been more Ponzi schemes in the PME, or if it is simply a fact that more are being detected, investigated and publicized. In spite of the best intentions and efforts of financial regulators everywhere, the number of people willing to fall prey to Ponzi schemes seems endless and infinite. This demand inexorably leads to more and more scammers, who, in my experience, universally believe they are smarter than the morons before them who got caught.
The purported deterrent effects of heightened enforcement efforts and ever increasing prison sentences are myths. These scammers don’t think that way. As proof beyond my own personal experience in dealing with them, I offer the following as empirical evidence. If the scammers feared being caught, wouldn’t they take the money and run? Pull a “Body Heat”? Raise lots of money and then disappear to an unnamed Caribbean island and wile away the rest of their lives under an assumed name, tanning and sipping umbrella drinks by the pool? But, remarkably, few do. Perhaps their hanging around can be explained in part by their greed for ever more money and the lifestyle riches brings in South Beach, Beverly Hills or SoHo, but there’s got to come a point, no?
Well, Happy Birthday Charlie! Your soiled name lives on, and will for the foreseeable future. Would that it and the scams it describes wither and disappear into the ashes of history.