Ponzi Scheme and Investment Fraud Red Flags


Charles Ponzi

How do you know if you’re considering investing in a Ponzi scheme? The promoters will never come out and tell you they are running a pyramid scheme, so the investors have to be smart enough to recognize them on their own. The good news is it is easy to spot a Ponzi scheme.

Now I don’t mean that it’s easy to prove in a court of law that something is a Ponzi scheme. In a civil or criminal case, there are certain standards of proof that need to be met. But you’re not a court. You’re simply an investor. Whether you have $10,000 to invest or $10 million to invest, your money is probably pretty important to you.

If you can affirm that a few of the below items apply to the “investment” that you’re thinking about putting your money into, then you should immediately run in the other direction.

What exactly is a Ponzi scheme? It’s an investment scam in which there is little to no actual investment. A promoter presents the investment to you, explaining how he makes money using your money. Except there is usually little substance to the scheme. Instead, the promoter continuously solicits new investors, and the “new money” is used to pay off old investors. The old investors think they have made money on their investment (never realizing that what they were paid was just money from other investors) and often give credibility to the schemes by telling others how successful they were.

A scheme like this requires a constant influx of new money. The scheme is constantly getting larger, as a bigger pool of new money is always needed to pay off the old investors (and give the promoter money for himself). Eventually the scheme fails, often because not enough new money can be brought in to keep it running and investors figure out that there was no legitimate business behind the investment.

Video of Tracy Coenen on CNBC, talking about Bernie Madoff's Ponzi scheme

Here are some red flags about the “investment” you’re considering that might indicate it is a Ponzi scheme. (There were many red flags related to infamous scammer Bernie Madoff.) You can find out more about spotting Ponzi schemes and investment schemes in my book, Expert Fraud Investigation: A Step-by-Step Guide.

  • Promoters are not registered to sell investments (Consider doing a background check through Financial Industry Regulatory Authority (FINRA) if the promoter is U.S. based.)
  • Promoters have a history of being investigated and/or disciplined for actions related to investments (Google is your best friend for this one.)
  • Promoters and/or founders of the business/investment have criminal, bankruptcy, or civil court histories that are troubling (Use PACER to search all federal court records for a nominal fee. State courts generally have their own online systems, and access to them is growing daily.)
  • Difficulty in verifying whether there is a legitimate business behind the investment (Again, Google is your friend!)
  • Groundbreaking “new technology” or other special (but super secret) methods or assets, which are going to take the world by storm and be the greatest thing since sliced bread
  • Complicated alleged business model that prevents an experienced investor from understanding how money is really made
  • The alleged performance of the company is suspiciously higher than competitors or companies in related industries
  • No objective third-party information can be found about the company
  • Elaborate explanations for why the business cannot be verified
  • Unusually high rates of return offered on the investments (Note that this one is the most common across all Ponzi schemes.)
  • Returns on investment are guaranteed (Not to be confused with an annuity from a reputable company with a guarantee in the contract.)
  • Promoter downplays the amount of risk investors will be exposed to, often  using phrases such as “a sure thing”
  • Reluctance to provide documentation supporting claims being made about the investment and the business behind it
  • Address of the “business” is a mail drop location, virtual office, or small private office that couldn’t possibly hold a business the size that is being claimed (Google Maps is very helpful for this one.)
  • Few (if any) employees in the operation other than the founder and/or promoter
  • Background of the principals of the business is mismatched with what the business does (Use Google to find out what kinds of jobs they held previously, and compare it to what they’re supposedly doing now.)
  • Company’s alleged success is related to a recent announcement of some sort, rather than historical financial results (This one is even worse if the information in the announcement can’t be verified, and it appears to just be a PR stunt for the benefit of potential investors.)

As noted above the most common telltale sign of a Ponzi scheme is the high rate of return offered to investors.  You should be suspicious when anyone offers you an investment earning 10% a year or above, particularly in this time of precarious investment opportunities. Most Ponzi schemers are even more obvious than this. They offer 5% or 10% or 15% per month on the investments they’re peddling. Common sense should tell you that this isn’t possible for legitimate investments, but for the very rare situation involving experienced venture capitalists.

The best advice I can offer for someone considering investing in something that could be a Ponzi scheme is to trust your gut. If it seems too good to be true, it most likely is. Don’t worry about missing out on the next great investment. Worry more about losing your hard-earned money to a scammer who is going to run off with every last penny of it.

What if you’ve already been swindled via a Ponzi scheme, and you want to get your money back? First and foremost, understand that it is difficult to get your money back. People running Ponzi schemes don’t typically save a lot of money. They like to spend it.

However, it is possible to recover some money, particularly if the scammers have used the stolen money to buy assets like real estate, cars, and boats. Sometimes money may be hidden in secret accounts, often overseas. They key to recovering money stolen via a Ponzi scheme is tracing the money to find clues about the assets.

A forensic accountant like Tracy Coenen can help find the money.  A detailed tracing of funds through known bank and brokerage accounts (using documentation in the possession of the victims, or documents belonging to the scammers that can be secured through the legal system) may help locate hidden assets. This type of analysis can be complex, particularly since fraudsters like to use many accounts and move money frequently in an effort to avoid detection.  With the help of fraud recovery attorneys, victims may be able to use the legal systems around the world to take possession of assets purchased with stolen money.

Tracy Coenen, CPA, CFF has investigated hundreds of cases of fraud, included cases involving investment fraud, Ponzi schemes, hidden assets, and other financial crimes. She has provided testimony in both state and federal courts, and is available to work on cases worldwide. Attorneys representing victims of fraud can contact Tracy for a confidential consultation by calling her at 312.498.3661 or emailing her at [email protected].

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