Recent news of the alleged $50 billion Ponzi scheme perpetrated by investment advisor Bernard L. Madoff has done nothing to ease the fears of investors who have been annihilated by the stock market over the last couple of months.How does an investment opportunity go from being a legitimate investment vehicle to a pyramid scheme? In this case, it is alleged that Madoff invested the money of clients, but lost it and didn’t want to admit it. Instead of alerting investors to the losses, he used the money of new investors to pay “returns” to the original investors.
This is a classic Ponzi scheme, in which money is collected and spent or lost, and new marks must be recruited to “invest” new cash into the scheme. The pyramid grows, and requires continuously larger “investments” of new money in order to pay existing participants their phony returns. So long as the operator can continue to recruit marks and keep new money flowing in, the pyramid stays afloat.
How does a scheme like this grow to an estimated $50 billion in losses? It’s hard to imagine, but it is alleged that this operation was conducted in secret. Employees say the investment advisory business was run on a secured floor that was separate from the offices of the company’s core business of market making.
Read moreRed Flags Apparent in Alleged Ponzi Scheme