LETS TALK ABOUT PONZI SCHEMES

Franklin I. Cueto*

Supposed you were to invest your hard-earned money with a certain company, what would be
your immediate concerns? Perhaps how much return would be earned or how soon the
investment plus interests would be returned? And what if the company did promise a doubleyour-money scheme in such a short period of time, would that address your immediate concerns?
To many, it sure would. In fact, these suckers are born every minute (as P.T. Barnum, or was
it David Hannum, would put it!)
Well, arent you interested to find out where (the heck!) would that company get the money to
pay back your investment plus interests? In other words, does the company have legitimate and
sufficient source of earnings? Because if it does not, the company would most likely pay you by
using the funds to be contributed by investors who would come in later. And those investors, in
turn, would be paid out of the contributions of even later investors, and so on and so forth. With
this scheme, the company would inevitably collapse. Pure common sense? Sure is.
Unfortunately, greed numbs the senses!
But why cast the stones on them? What about the con artists themselves? Well, the occupational
hazards of engaging in Ponzi schemes should haunt them. Apparently, it could cause cancer!
Bato-bato sa langit, ang tamaan ay huwag magagalit!
WHAT ARE PONZI SCHEMES?
The Miriam-Webster dictionary defined a Ponzi scheme as an investment swindle in which
some early investors are paid off with money put up by later ones in order to encourage more and
bigger risks.
The scheme is named after Charles Ponzi, an Italian swindler who migrated to the United States
during the early 1900s. It has been said that Ponzi, at the time, engaged in the buying of an asset
(in the form of international reply coupons) at a lower price in one market (particularly in Italy)
and immediately selling it in a market where the price is higher (that is, in the United States). To
expand his business, Ponzi invited friends to invest and offered them double-your-investment
plans in 90 days. The promised returns were so enticing that investors began mortgaging their
homes or offering their life savings just to be able to invest. Most did not even take their profits,
but reinvested. But unknown to these would-be victims, Ponzi never did exert effort to generate
legitimate earnings as his real agenda was to have the investment money kept flowing in.

CPA-Lawyer-Realtor; Corporate Secretary F.B. Cueto Development Corporation; UB Professor Corporation

Law and Corporate Practice; Former SEC Assistant Commission Secretary/Securities Counsel/Securities Examiner;
MBA (candidate) De La Salle University Manila, College of Business and Economics, Ramon V. Del Rosario Sr.,
Graduate School of Business; UB Law Batch 2001 (Valedictorian); Editor-in-Chief, UB Law Journal (SY 20002001);

Eventually, his business operation began to suffer from financial losses although this situation
did not become apparent because of the accumulation of investments at such an incredible rate.
Not long enough, people became suspicious of Ponzis success. He became the subject of
numerous investigations, with the Boston Post as one of the first institution that exposed his
fraud (for which the Post won a Pulitzer Prize). Ponzis business crashed down, with all
investors practically wiped out.
In the Philippines, the earliest recorded case of Ponzi scheme is the one perpetrated by fertilizer
manufacturer-turned movie producer Sofronio Blando of the Agrix Group of Companies in the
late 1970s. It has been said that Agrix Marketing Inc. and its subsidiary and affiliate
corporations had induced the public to invest funds upon the promise of excessive rates of
interest under schemes the Securities and Exchange Commission had declared, at the time, to be
illegal devices. When the companies suffered from financial losses and failed to pay back its
investors, then President Marcos passed Presidential Decree No. 1717 which created a private
corporation, the New Agrix, Inc., upon which the assets and liabilities of the Agrix Group of
Companies are to be transferred for purposes of rehabilitation and to help the victims recover
their investments. The law, however, was later on declared unconstitutional in the case of
National Development Corporation and New Agrix, Inc. vs. Philippine Veterans Bank (192
SCRA 257) based on the principle that New Agrix, Inc., being neither owned nor controlled by
the government, should have been created only by general and not special law. Incidentally, the
impact caused by the Agrix scam paved the way for the enactment of Presidential Decree No.
1689, a law imposing capital punishment on certain forms of swindling and other frauds
involving rural banks, cooperatives, "samahang nayon(s)", farmers' associations or
corporations/associations operating on funds solicited from the general public.

WHY DO PONZI SCHEMES COLLAPSE?

In the case of People vs. Balasa (G.R. No. 106357, September 3, 1998), the Supreme Court noted
that the progression a Ponzi scheme depends upon is unsustainable. According to the high
tribunal, the pattern of increase in the number of participants in the system explains how it is
able to succeed in the short run and, at the same time, why it must fail in the long run. This game
is difficult to sustain over a long period of time because to continue paying the promised profits
to early investors, the operator needs an ever larger pool of later investors. The idea behind this
type of swindle is that the "con-man" collects his money from his second or third round of
investors and then absconds before anyone else shows up to collect. Necessarily, these schemes
only last weeks, or months at most.
The Balasa case involves Panata Foundation of the Philippines, Inc., a non-stock, non-profit
corporation with principal address at San Miguel, Puerto Princesa, Palawan. It was incorporated
on July 6, 1989. It appeared that the company, during its operation, distributed brochures to
solicit deposits from the public, with promises that the money to be deposited would either be
doubled after 21 days or trebled after 30 days. Initially, few depositors came in and invested
only small amounts as if they were trying to see first whether the foundation would really make

good on its promise. But when the company did pay the interests as represented, not only did
more depositors come in but most of them reinvested and some even added to their initial
investments. At the outset, the foundation's operations proceeded smoothly, as satisfied
investors collected their investments upon maturity. The officers of the foundation even
announced that the money collected had been invested in the stock market. However, in less
than five months from its incorporation, the foundation suddenly stopped its operation. This
prompted the depositors to demand reimbursement of their deposits and when the foundation
failed to deliver, at least sixty-four information, all charging the offense of estafa, as defined in
Presidential Decree No. 1689, were filed against the officers of the foundation. The trial court
convicted all the accused and imposed upon each of them the penalty of life imprisonment. The
Supreme Court affirmed the conviction and ruled that the elements of the crime defined and
penalized by Presidential Decree No. 1689 have been proven beyond reasonable doubt.

ARE PONZI SCHEME AND PYRAMIDING SCHEME ONE AND THE SAME?
In the Balasa case, the Supreme Court stated that, technically speaking, a Ponzi scheme is
different from a Pyramiding scheme.
First, a pyramiding scheme is not illegal per se. An example of a legitimate type of pyramid
operation is that of a multi-level marketing whose primary purpose is to sell a product or service
and not mainly to sell the distributorship itself. In other words, the income is derived primarily
from the sale of products or services (through the payment of commissions) and not from the
recruitment of other persons into the marketing plan. According to the Securities and Exchange
Commission, one distinguishing feature of a multi-level marketing plan is that there is a product
or service of real value that is sold and that the commissions are primarily derived from the
proceeds of the sale of such product or service. The most well-known company associated with
this type of pyramid operation is Amway Corporation. (SEC Advisory Beware of Pyramid
and Ponzi Schemes Masquerading as Legitimate Business, April 18, 2002)
Second, a pyramid sales scheme becomes illegal if it comes within the purview of pyramiding as
defined in Section 53 of R.A. 7394, otherwise known as the Consumer Act of the Philippines, to
wit: x x x sales devices whereby a person, upon condition that he makes an investment, is
granted by the manufacturer or his representative a right to recruit for profit one or more
additional persons who will also be granted such right to recruit upon condition of making
similar investments: Provided, That, the profits of the person employing such a plan are derived
primarily from the recruitment of other persons into the plan rather than from the sale of
consumer products, services and credit; Provided, further, That the limitation on the number of
participants does not change the nature of the plan. Like Ponzi schemes, this type of
Pyramiding is bound to collapse. In the event that new distributors could no longer be recruited,
people in the marketing plan, especially those at the base or lower level of the pyramid, lose the
money they have invested either in the form of purchases of expensive inventory or payment of
so-called enrolment or similar entry fees.
WHAT ARE SOME PONZI SCHEME RED FLAGS?
Many Ponzi schemes share common characteristics. Look for these warning signs:

If it seems too good to be true, it probably is! Cynicism? Not necessarily. Simply be
cautious! Every investment carries with it some degree of risks, and the higher returns
the investment yields, the more risks it naturally involves. Thus, when youre offered an
investment contract promising high returns for zero or very little risks, and youre so
enticed that you really want to venture with it, all Im saying is before you do so, take as
much precautionary measures as possible. Take a look at the scheme, for instance,
offered by the Legacy Group of Companies. In the Permanent Cease and Desist Order
issued by the Securities and Exchange Commission on February 26, 2009, it was
disclosed that the companies enticed the public to invest in various investment
opportunities (Double Your Money Program; Mutual Fund; Pre-Need Buy Back with
Deed of Assignment; Motor Vehicle with Money Back; Maxicore) by offering rates of
interest as high as one hundred percent and that the investment seemed to be risk-free as
the same will be paid through post-dated checks payable on equal monthly and/or
quarterly basis, which were actually issued to the investors upon receipt of their
investments. Needless to say, the erring officers behind these companies have yet to be
proven guilty beyond reasonable doubt but the Department of Justice, in its November
2009 resolution, did recommend their indictment for syndicated estafa under Presidential
Decree No. 1689 in relation to Article 315, paragraph 2(a) of the Revised Penal Code,
after allegedly draining investors money in the estimated amount of P830 million pesos.

Overly consistent returns. The U.S. Securities and Exchange Commission, in an

information-advisory about Ponzi schemes, warned the public to be suspect of an
investment that continues to generate regular, positive returns regardless of overall
market conditions. A good example of an investment scheme that promised positive
returns despite adverse economic condition is the case of Bernard L. Madoff, the founder
of Wall Street Firm: Bernard L. Madoff Investment Securities LLC, and indisputably the
largest Ponzi scheme in history as well as the largest investor fraud committed by a single
person. According to the US-SEC, unlike the promoters of many Ponzi schemes,
Madoff did not promise spectacular short-term investment returns. Instead, his investors
phony account statements showed moderate, but consistently positive returns even
during turbulent market conditions. In March 2009, Madoff pleaded guilty to all the
felonies charged against him. He is currently serving a 150-year sentence in federal
prison.

Unregistered investment contracts. First, investment contracts are defined under Rule
3(1)(G) of the Amended Implementing Rules and Regulations of the Securities
Regulation Code as a contract, transaction or scheme (collectively contract) whereby a
person invests his money in a common enterprise and is led to expect profits primarily
from the efforts of others. The foregoing definition traces its roots from the United
States case of SEC v. Glenn W. Turner Enterprises, Inc. et al. The case established a test
to determine whether a transaction falls within the scope of an "investment contract"
which later became known as the Turner Test. It requires a transaction, contract, or
scheme whereby a person (1) makes an investment of money, (2) in a common enterprise,
(3) with the expectation of profits, (4) to be derived primarily from the efforts of others.
It is a modification of the Howey Test which requires the element that the profits be

derived solely instead of primarily from the efforts of others and which, according to
the 9th Circuit of the US Court of Appeals, if given a strict interpretation, would lead to
unrealistic results.
Second, investment contracts are in the nature of securities. Section 3.1 of the Securities
Regulation Code defined securities as shares, participation or interest in a corporation or
in a commercial enterprise or profit-making venture and evidenced by a certificate,
contract, instrument, whether written or electric in character. It includes: xxx investment
contracts, certificates of interest or participation in a profit sharing agreement,
certificates of deposit for a future subscription.
Third, Section 8, paragraph 8.1 of the Securities Regulation Code mandates that
securities shall not be sold or offered for sale in the Philippines unless said securities are
duly registered by the issuer in accordance with the procedure laid out in the SRC and
without a registration statement duly approved by the SEC. In the case of Power Homes
Unlimited Inc. vs. Securities and Exchange Commission and Noel Manero (G.R. No.
164182, February 26, 2008), the First Division of the Supreme Court held that the
business operation or the scheme of Power Homes constitutes an investment contract that
is in the nature of securities as defined under the Securities Regulation Code. Thus, it
must comply with the registration requirement of the SRC before its sale or offer for sale
or distribution to the public. Further, on the issue of whether or not the Cease and Desist
Order issued by the SEC against Power Homes is proper even without a finding of fraud
(but merely on the ground of failure to register the investment contracts), the Supreme
Court ruled in the affirmative. It stressed that as an investment contract that is a security
under R.A. No. 8799, it must be registered with SEC, otherwise the SEC cannot protect
the investing public from fraudulent securities. The strict regulation of securities is
founded on the premise that the capital markets depend on the investing publics level of
confidence in the system. Take note, however, that the issuance of investment contracts
to fewer than twenty (20) persons in the Philippines during any twelve-month period is
considered an exempt transaction under Section 10.1(k) of the Securities Regulation
Code and, therefore, not subject to the registration requirement under Section 8.1 of the
same Code.
Finally, a corporation has a primary license when it is registered with the SEC as a
private corporation, and may have a secondary license when it is registered with the SEC
as a securities issuer. Do not confuse the primary license with that of the secondary
license. To check whether a corporation has a secondary license to issue securities, you
may verify the same with the SECs Corporation Finance Department or the Market
Regulation Department.
SUPREME COURTS WARNING ON PONZI SCHEMES
I have been invited to speak before groups of investors (of Legacy) during the time when the socalled bubble already burst and Ive seen how emotional, sensitive and, at times, furious these
investors were. In fact there was this Lipa investor (yup, they even came to me in clusters) who,
at the time, cant wait for my powerpoint presentation to end so much so that when it finally did,

she yelled at me as if I duped her or something. I figured, she must have gotten really affected
when I read to them the statement made by the Supreme Court in the Balasa case which I
borrowed and copied verbatim hereunder, and upon which I end this article by way of this SCs
warning:
Totoong walang pagkaubos sa ating daigdig ang mga taong nanlilinlang.
Hindi magkakagayon naman kung walang nagpapalinlang. Dahil sa kanilang
malaking hangarin na magkamal ng kimpal kimpal na kayamanan,
pinapasukan nila ang mga kaduda-dudang alok ng mga mapagsamantala na
kung sila ay mamuhunan ng kaunting salapi, ito ay tutubo ng malaki sa ilang
araw lamang. Kaya't napakaraming mga tao ang nagagantso. Hindi
masasabing mga hangal o dili kaya'y mga maralita na walang gaanong pinagaralan ang mga nabibiktima. Kahit ang mga maykaya at matataas sa ating
lipunan ay napaglalaruan din. Milyun-milyong salapi ang nahuhuthot sa
kanila, hindi ng mga masakim na magnanakaw, kundi ng kanila na ring mga
kasamahan sa tinatawag na "alta sociedad." Mismong mga kaibigan at
kapanatag ng loob ang naguudyok sa kanilang sumali sa mga pakana na
magpapayaman sa kanila. Higit namang nakakaawa kapag ang naloloko ay
iyong nangungutang lamang at nagbabakasakali na ang ilang daan nila ay
magiging libo.
Itong kapasiyahang ito ng Mataas na Hukuman ay nagbababalang muli.
Magpakaingat-ingat ang lahat. Ang naghahangad ng kagitna, isang salop ang
nawawala.
Iyon namang nanlilinlang. Walang gawaing masama na hindi nabubunyag rin.
Totoong mahigpit ang ating batas na pumaparusa sa mga ganyang hindi na
natututo, lalo't higit kung ang mga salarin ay mga sindikato.