Charles Ponzi, the originator of Ponzi Schemes
According to US financial regulator Securities and Exchange Commission, Ponzi schemes are a kind of pyramid scheme which operate on the “rob Peter to pay Paul” principle.
With the promise of large returns as bait, the fraudster takes in money from new investors and uses it to pay off the earlier investors until no more new recruits can be found and the whole scheme collapses, with the newest investors losing everything.
The ruse is named after Charles Ponzi, a 1920s crook who promised investors in New England a 40pc return on their investment in just 90 days, compared with 5pc in a savings account.
Ponzi had planned to make money by taking advantage of the difference in exchange rates between the dollar and other currencies to buy and sell international mail coupons at a profit.
His scheme was an amazing success, and by May 1920, he had made $420,000 ($5.13 million in 2017 money).
By June 1920, people had invested $2.5 million in Ponzi’s scheme and by July, he was raking in a million dollars per week and rising. By the end of July, he was approaching a million dollars per day.
When the house of cards inevitably collapsed, it turned out he had only ever purchased about $30 worth of the mail coupons on which the scheme was based.
In Bernard ‘Bernie’ Madoff’s case, he told FBI agents he had been paying investors “with money that wasn’t there”. Regulatory filings show he managed money for hedge funds, banks and wealthy individuals.
How Madoff made it happen
Bernard Madoff swindled a host of celebrities before he was arrested
Rich families placed money with wealth managers, hedge funds and private banks
After careful vetting, these professionals chose specialist fund managers. As a consistent performer over decades, Madoff was a favourite choice
Madoff’s popularity lead to specialist funds being set up to raise money to feed directly into Madoff in return for a fee
Although he told them he was investing the money, Madoff used the inflows to pay ‘profits’ back to clients
The financial crisis hit inflows and caused clients to ask for their money back. With no money to pay out, the fraud was exposed.
