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Ponzi scheme

Module: Legal Aspect of Business

Submitted To:

Ms. Subharna Ghosh

Submitted By: Aakash Tantia

Sonali Dhimmar

Priyanka Dhimmar

Yati Patel


A Ponzi scheme is a false contributing trick promising high rates of come back with a little to no
risk. The Ponzi scheme produces returns for more seasoned speculators by getting new financial
specialists. This is like a fraudulent business model in that both depend on utilizing new financial
specialists' assets to pay the prior supporters. For both Ponzi plans and fraudulent business
models, in the long run there isn't sufficient cash to go around, and the plans unwind.

A Ponzi scheme is a venture extortion where customers are guaranteed an extensive benefit at
practically no risk. Organizations that take part in a Ponzi scheme concentrate the greater part of
their vitality into drawing in new customers to make investments. This new wage is utilized to
pay unique financial specialists their profits, set apart as a benefit from an authentic exchange.
Ponzi plans depend on a steady stream of new ventures to keep on providing comes back to more
seasoned speculators. At the point when this stream runs out, the plan goes to pieces.


The primary famous Ponzi scheme was coordinated by a man named Charles Ponzi in 1919. The
postal administration, around then, had created universal answer coupons that enabled a sender
to pre-buy postage and incorporate it in their correspondence. The beneficiary would take the
coupon to a nearby mail station and trade it for the need airmail postage stamps expected to send
an answer.

With the consistent vacillation of postage costs, it was normal for stamps to be more costly in
one nation than another. Ponzi enlisted specialists to buy shoddy global answer coupons in
different nations and send them to him. He would then trade those coupons for stamps that were
more costly than the coupon was initially bought for. The stamps were then sold as a benefit.

This kind of trade is known as an arbitrage, which isn't an illicit practice. Ponzi ended up
noticeably covetous and extended his endeavors. Under the heading of his organization,
Securities Exchange Company, he guaranteed returns of half in 45 days or 100% of every 90
days. Because of his accomplishment in the postage stamp scheme, financial specialists were
promptly pulled in. Rather than really contributing the cash, Ponzi simply redistributed it and
told the speculators they made a benefit. The plan kept going until 1920, when an examination
concerning the Securities Exchange Company was directed.

Steps in the Ponzi schemes

1. Convince a few investors to place money into the investment.

2. After the specified time, return the investment money to the investors plus the specified
interest rate or return.
3. Pointing to the historical success of the investment, convince more investors to place
their money into the system.

4. Repeat steps 1 through 3 a number of times. During step 2 at one of the cycles, break the
pattern. Instead of returning the investment money and paying the promised return,
escape with the money and start a new life

The Structure of a Ponzi scheme:

To better understand Ponzi perpetrators, we first need to look at how a Ponzi scheme is
structured. Ponzi scheme that starts with $100,000 and pays off 20 percent annually. To make the
example more realistic, we will assume that no investor puts in more than $50,000 in the scheme.
We present one scenario for the first four years of the scheme in Figure 1.

Figure 1: The Structure of a Ponzi scheme promising a 20 Percent Return

Funds # of
Year Needed Amounts Raised ($1,000s) Investors
$ $
0 $ 100,000 50.00 50.00 2

$ $ $
1 $ 120,000 40.00 40.00 40.00 3

$ $ $
2 $ 144,000 48.00 48.00 48.00 3

$ $ $ $
3 $ 172,800 43.20 43.20 43.20 43.20 4

$ $ $ $
4 $ 207,360 41.47 41.47 41.47 41.47 $ 41.47 5

Year 0 is today, and $100,000 is needed to start the scheme. As a result, the scheme needs at
least two investors contributing $50,000 each. Given a 20 percent rate of return, the promoter
needs to pay $120,000 total at end of the first year. Therefore, he needs to raise a total of
$120,000 in Year 1 to make those payments. He solicits three investors who contribute $40,000
each. At end of Year 2, the promoter now has to repay those who contributed last year $48,000
each. Therefore, he raises $48,000 from three new investors at the end of Year 2 to make those
payments. These new investors need to be repaid $57,600 each for a total of $172,800 at the end
of Year 3. Therefore, the promoter solicits new investors once again, and collects $43,200 from
four investors this time to make those payments. The sequence goes on like that.

What do we observe? First, the Ponzi promoter pockets the initial $100,000. That's his initial
financial gain from running the scheme. Second, the funding requirement increases at the rate of
(1 + rate of return) every year; that is, it increases geometrically. Third, given finite wealth, more
and more investors are needed over time. For example, two are needed to start the scheme, three
in Years 1 and 2, four in Year 3, five in Year 4, etc. Therefore, the scheme relies on an infinite
supply of capital. However, this is obviously not possible, and that is one reason Ponzi schemes
eventually fail.

Next, in the four-year period displayed in Figure 1, we assume that the promoter is able to attract
new capital as required. What if in Year 1 he can only manage to recruit two investors instead of
three, and the two investors cannot supply the capital needed? The scheme will fail in that year.
This explains why Ponzi schemes are at risk even if only one investor desists.

In Figure 1, the promoter expects the Ponzi scheme to outlast him. To achieve that end, he will
pay a return slightly higher than the opportunity cost of investors' capital, start the scheme later
in his career, or run the scheme where there is an abundance of capital and/or investors. Also, to
avoid suspicion, the promoter does not promise a return too much higher than the opportunity
cost of capital. Given our example, we are slowly gathering the conditions that favor Ponzi
schemes: (1) such schemes are more likely in a boom or asset bubble, (2) they are more likely in
a market with more investors compared to one with fewer, and (3) they are more likely in an
environment where financing is easily available either through excess savings or credit
availability. At the same time, they are likely to be uncovered when the reverse of each happens;
that is, in a recession and/or when investors pull out of the market and/or in a credit squeeze.
This would explain the relatively high number of Ponzi schemes uncovered in 2008 and 2009, a
recessionary period with financial, banking, and credit problems.

Earlier we wrote that the promoter expects the Ponzi scheme to outlive him. However, this is
very unlikely. Ponzi schemes, in real life, are more complex than the one described in Figure 1
and involve far more investors. For example, the Ponzi scheme operated by Bernard Madoff
involved thousands of clients and billions of dollars. His clients included investment
management firms (such as Fairfield Greenwich Advisors, which lost $7.5 billion in the scheme,
and Tremont Group Holdings, which lost $3.3 billion), international banks (Banco Santander of
Spain lost $2.87 billion; Bank Medici of Austria lost $2.1 billion; Fortis of Holland lost $1.35
billion), pension funds, insurance companies, wealthy individuals, and a whole group of diverse
and sophisticated investors. A scheme of that size and reach will sooner or later attract curiosity
and scrutiny, and that is exactly what happened in the case of Madoff.10 Hit by a wave of
redemptions, the scheme becomes unsustainable. When the SEC starts investigating the scheme,
its days are likely numbered, although Madoff managed to survive for many years after the SEC
was first presented with evidence.

What Are the Motivations of a Ponzi Perpetrator?

The main motivation of a Ponzi perpetrator is surely financial. However, it is clear that the
scheme will unravel one day. Therefore, either perpetrators think that day is too far in the future
to be bothered by, are confident they will find a way out, or simply ignore the risk. Mitchell
Zuckoff, a journalism professor at Boston University and author of Ponzi's Scheme: The True
Story of a Financial Legend, says that Ponzi perpetrators are self-delusional.11Ponzi perpetrators
are surely overconfident and skilled at deceiving others. Last but not least, their urge to make
money takes precedence over any risk* considerations, maybe because of their need to finance
lavish lifestyles without regard to possible consequences.

Who Are Ponzi Perpetrators and What Are Their Traits?

A survey conducted by KPMG's Forensic Professionals on corporate fraudsters (i.e., employees

committing white-collar crimes within their organizations), found that fraudsters are most likely
to be males between 36 and 55 years old who act independently and locally, have a finance
background, and are motivated by greed and opportunity.

Bhattacharya lists three critical components of a Ponzi scheme: the perpetrator (1) convinces a
group of people about an investment idea, (2) promises a high rate of return, and (3) builds
credibility by initially delivering on his or her promises.12 We add that the investment idea
frequently sounds sophisticated and complicated. Ponzi perpetrators promise rates of return that
defy economic cycles. They make their first payments as promised, to create trust and to prop up
an ensuing word-of-mouth publicity chain to attract more investors.

To be able to sell a false idea of consistently high returns, it is likely that Ponzi perpetrators are
charismatic salespeople, persuasive and good at successfully closing a sales pitch.

Initially, Ponzi perpetrators focus their attention on targets related to them either socially or
professionally. The way they approach these people is more psychological in nature than factual,
and they exploit the trust between them and people they know. However, after the scheme
evolves, that initial group will not suffice to sustain it, and the door is then opened to outsiders.

Upon receipt of investment funds from the targets, Ponzi perpetrators may issue counterfeit
certificates to show that the investor has contributed. Perpetrators may also produce fake
certificates of securities as collaterals, and they may even fake their own identity as well.

To manage the operation, employees of a Ponzi perpetrator are usually close family members,
relatives, or friends. Employee turnover is very low, and this is important to concealing the
scheme. Some Ponzi schemes are registered in offshore centers where regulation is not strict.

Ponzi promoters are known to be generous donors and regularly contribute to charities,
educational institutions, and political campaigns. The more political connections the perpetrators
have, the more confident they are about continuing their operations without being caught.

What Are the Legal Consequences of Participating in a Ponzi scheme?

At the point when speculators acknowledge they might be casualties of a Ponzi scheme, they
may look for the guidance of a money related consultant or organizer. This area gives data about
the lawful outcomes after a Ponzi scheme is revealed, if a budgetary counselor or organizer is
drawn nearer by a casualty of a false speculation scheme who looks for proficient monetary
guidance. After a Ponzi scheme is found by government controllers, the SEC records a claim
against the Ponzi culprit, and a trustee is then designated to recuperate however much cash as
could be expected to influence installments to loan bosses to and to redistribute any recouped
continues ace rata to investors.17 The trustee will initially focus on the hard resources of the
Ponzi culprit. Next, he or she will endeavor to recover installments made to financial specialists
(independent of whether they knew about the Ponzi scheme). The trustee will likewise consider
taking legitimate activities against other related monetary organizations (counting the Ponzi
culprit's bank) if there is prove they were schemeters or neglected to follow up on warnings of a
progressing extortion scheme.

Thus, it is uncommon that the legitimate results are constrained to the culprit alone. Any
individual/element that supported the plan (alluded to as a "feeder subsidize"), even accidentally,
is in danger. This is particularly obvious when the feeder subsidize gathered cash from others
and neglected to apply due perseverance and additionally neglected to see warnings proposing
extortion was occurring.

The bank the culprit uses to direct exchanges is in danger too. The issue here is that the bank
approached the money related records of a culprit and may have known about abnormal
exercises equivalent to extortion. Similar charges can be collected against a venture bank that
took care of the exercises of a Ponzi culprit; for instance, in the event that it went about as an
intermediary, raised assets, had authority of advantages, arranged speculation accounts, or
approached advertising materials, it could be obligated.

In situations where the culprit made altruistic gifts, the trustee may require that a few or those
gifts be returned after the plan is uncovered, independent of the status of the beneficiary.
Representatives who work at a fence investments blamed for misrepresentation, who are
associated with either contriving with the promoter, or who knew about the extortion are
additionally in danger. The SEC may look for perpetual bans against them working in the
securities business once more. At last, the relatives of the promoter are in danger too, and their
advantages can be solidified and lawfully kept from being exchanged or sold.

In 2009, U.S. President Barack Obama set up an interagency Financial Fraud Enforcement Task
Force that included individuals from the U.S. Branch of Justice, the FBI, the SEC, the U.S.
Postal Inspection Service, the Internal Revenue Service Criminal Investigation unit, the U.S.
Item Futures Trading Commission, the Federal Trade Commission, the U.S. Mystery Service, the
National Association of Attorneys General, and a wide scope of government and state

organizations and specialists to explore and arraign budgetary violations under the code
"Operation Broken Trust." By December 2010, Operation Broken Trust had accomplished the
outcomes in Table 3.

Table 3: Operation Broken Trust Statistics for August 16–December 1, 2010

Panel A: Criminal Cases


Cases 231

Defendants 343

Arrests 64

Info/Indictments 158

Convictions 104

Sentencings 87

Estimated Loss Amount $8,384,150,054

Estimated Victims 120,381

Panel B: Civil Cases

Civil Enforcement Actions 60

Defendants 189

Estimated Loss Amount $2,134,681,524

Estimated Victims 23,566

Source: FBI Press Release, “Financial Fraud Enforcement Task Force Announces Results of
Largest-Ever Nationwide Operation Targeting Investment Fraud,” December 6, 2010, accessed at

Table 3 demonstrates that Operation Broken Trust included 231 criminal cases and 60 common
requirement activities. Eighty-seven litigants have been condemned to jail. More than 120,000
individuals were swindled of near $8 billion in the 231 criminal cases. The plans explored
incorporate Ponzi plans, fondness fakes, prime bank/high return venture tricks, outside trade
cheats, business opportunity fakes, and other comparative plans. The team keeps up a site at to keep speculators and the overall population educated about venture tricks

Regulating Ponzi Schemes

The SEC, as the primary controller of the money related markets, is accepting all penalties for
neglecting to recognize Ponzi plans. In any case, we alert that numerous such plans once in a
while begin as an enrolled business, subsequently keeping away from identification by
controllers. Subsequently, it is far-fetched that controllers can stop Ponzi conspires in their
beginning periods.

Ponzi promoters find a way to guarantee data about their plan isn't spilled to the SEC. Above all
else, they keep their operations little regarding HR. They utilize individuals they can trust who
are probably not going to reprimand them even subsequent to clearing out. Second, Ponzi
promoters distribute little data about their operations. This absence of data makes it difficult to
reveal their deceitful exercises. They likewise request that their speculators not uncover anything
to controllers as the guaranteed exceptional yields will be difficult to accomplish under an
administrative guard dog. They abuse the trust of their customers, and the last are hesitant to
approach and uncover them. Regardless of the possibility that the customers find the plan, they
turn out to be more worried about recovering their speculations than stressing over the
authenticity with which it is done. Ponzi promoters every now and again set up associations with
high-positioning lawmakers and powerful financial specialists and take part in generous
gatherings to profit by their security. The fact of the matter is the promoter strives to dodge
identification by the SEC and different controllers.

It is additionally now and then conceivable that the promoter is running a Ponzi plot close by a
real business. Or, on the other hand maybe the promoter is maintaining an honest to goodness
business, but since it loses cash, begins a Ponzi plan to cover those misfortunes. Clearly, in these
circumstances, the SEC is probably not going to identify the extortion at a beginning period.

Numerous Ponzi plans (not any semblance of big-time administrators like Bernard Madoff and
Alan Stanford) are little in estimate, including only a couple of financial specialists. The cost of
examining these little plans may weigh vigorously on the SEC's assets. Given the SEC's asset
limitations in addition to a ceaseless examination list, its way to deal with researching Ponzi
plans is more probable receptive than proactive. In these conditions, the SEC would rather focus
its endeavors on bigger cheats including a bigger pool of financial specialists have suggestions
for the contributing group on the loose. The SEC's "detail framework," which monitors its

recorded cases and may shape the reason for motivations and prizes, can support snappy hit cases
over more troublesome ones.

For the SEC to make a superior showing with regards to with policing Ponzi plans, it needs more
staff masters, a greater spending plan, a more slender association, less organization, and better
speculator training. As Khuzami and Walsh affirmed before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs on September 10, 2009, "The ... Report follows the SEC's
disappointment with Madoff to weaknesses in various regions, including deficient ability,
preparing, background and supervision by administration; insufficient inward correspondence
and coordination among and inside different SEC divisions; inadequacies in investigative
arranging and prioritization; absence of complete on leads; and inadequate resources."20

Because of the Bernard Madoff's plan and the money related emergency of 2008, the Dodd-
Frank Wall Street Reform and Consumer Protection Act became effective in July 2011 to get
control over budgetary cheats and secure purchasers. It fortifies oversight and enables controllers
to forcefully seek after monetary misrepresentation. The law straightforwardly targets Ponzi
plans, offers assurance to and remunerates informants who give data that outcomes in a
requirement activity by the SEC, and enables and distributes more assets to the foundation to
take action against such plans.

Following the section of the Dodd-Frank monetary enactment, the SEC presented the informant
abundance program. Under the program, a representative who reports extortion to the SEC can
net under specific conditions as much as 30 percent of the punishments and assets recouped from
the misrepresentation culprit by the SEC. Among others, the law additionally builds up a solitary
without toll number as a buyer hotline to report issues with budgetary items and administrations,
requires mutual funds and private value counselors to enroll with the SEC, and sets up more
prominent state supervision.

Some scams in India through Ponzi schemes:

Size of the
Name of the Scam (Rs. in
Company crore) Remarks
The company promised Rs. 4,000 monthly
income of an initial investment of Rs.
Speak Asia 2,500 11,000.

The company promised investors 27 times

Gold Sukh 200 return in 18 months.

RM of Citibank, promised clients 2-3%
return every month. He forged SEBI
circulars & bank statements to convince
Citibank 300 clients.

The company promised Rs. 1.72 lakh on an

Abhinav Gold 100 investment of Rs. 6,000 in 26 months.
It offers a return of 20% per month for up to
six months and the principal amount
Stock Guru 1,000 invested is returned in the next six months.

How to Identify Ponzi Schemes?

Ponzi scheme "red flags"

Many Ponzi schemes share common characteristics.

• High venture comes back with practically no hazard. Each venture conveys some level of
hazard, and speculations yielding higher returns normally include more hazard. Be very
suspicious of any "ensured" venture opportunity.

• Overly predictable returns. Speculation esteems have a tendency to go here and there after
some time, particularly those offering possibly significant yields. Be suspect of a venture that
keeps on producing customary, positive returns paying little mind to general economic situations.

• Unregistered ventures. Ponzi schemes regularly include speculations that have not been enlisted
with the SEC or with state controllers. Enrollment is essential since it gives financial specialists
access to key data about the organization's administration, items, administrations, and funds.

• Unlicensed venders. Government and state securities laws require venture experts and their
organizations to be authorized or enlisted. Most Ponzi plans include unlicensed people or
unregistered firms.

• Secretive as well as unpredictable systems. Maintaining a strategic distance from speculations

you don't comprehend, or for which you can't get finish data, is a decent dependable guideline.

• Issues with printed material. Try not to acknowledge pardons with respect to why you can't
survey data around an interest in composing. Likewise, account proclamation blunders and
irregularities might be signs that assets are not being contributed as guaranteed.

• Difficulty accepting installments. Be suspicious on the off chance that you don't get an
installment or experience issues getting the money for out your venture. Remember that Ponzi

scheme promoters routinely urge members to "move over" ventures and here and there guarantee
returns offering significantly higher profits for the sum moved over.

The most effective method to Protect against Ponzi Schemes:

• Beware of guarantees of improbable returns. This is maybe the simplest approach to recognize
a Ponzi trick. Any genuine speculation includes chance. Assurances of unreasonably significant
yields are an unmistakable cautioning sign. In any case, conveying reliable 10 percent returns for
a considerable length of time, as Madoff indicated to do, is unreasonable as well, if certainly
feasible. "Pipe dream" ought to be viewed as a warning.

• Diversify – everything. Try not to put all of your investments tied up on one place. Expand
your advantages as well as your cash administrators, accounts, and monetary foundations.
Spreading your cash around will restrain your presentation to the money related issues of any
one organization. Casualties in the Madoff case who were monetarily steady after the trick were
the ones who contributed just a level of their advantages with Madoff, not as long as they can
remember investment funds.

• Don't depend on notoriety or verbal exchange alone – comprehend your speculation. On

specialists are specialists at building systems of trust, influencing speculators to think they are
getting an "inside" track on a hot venture. A large number of Madoff's casualties contributed in
light of the fact that individuals they knew and put stock in, for example, companions and even
relatives, urged them to do as such. In the event that somebody gives you an "inside" tip, don't
simply hand over your cash.

• Verify the venture points of interest. Make point by point inquiries about the speculations and
those offering the ventures, and find clear and direct solutions previously you contribute. In the
Madoff case, customers were informed that the speculation system was restrictive and would not
be uncovered. On the off chance that the ventures are not disclosed to you in detail, leave. In the
event that you don't comprehend a venture, don't contribute.

• Auditors. Check the reviewer, or request that your money related consultant check the inspector
of any reserve or organization for you. Examiners sign and ensure monetary articulations of
organizations and speculation stores. Financial specialists depend on these review reports since
evaluators are subject for errors. A true blue venture organization overseeing multi-billion
dollars of benefits under administration would utilize a trustworthy, broadly known reviewing
firm. In the Madoff case, with over $50 billion in indicated stores, the way that the inspector was
obscure, hardtop-find and had just three implied representatives in charge of investigating such a
broad portfolio ought to have been a warning to financial specialists.

• Background Check. Check with your state/common securities controller to decide whether the
people and firms offering the venture are legitimately enrolled with your state/area. Keep in
mind that, anybody offering a security must be enrolled. In the event that the promoter says he's
absolved, catch up with your controller to affirm the claim. You can likewise check the
promoter's dissension history when you call.

• Report extortion. In case you're a casualty of a Ponzi scheme, call your state/common securities
controller. Neighborhood securities controllers can explore the issue and your call may help
other people from being defrauded by a similar trick.


Observing against Ponzi plans should best be embraced by all around educated individual
speculators, since history demonstrates that the SEC recognizes most plans simply after
considerable mischief against financial specialists is executed. On the off chance that financial
specialists don't address or take after their reserve directors intently, they are conceivably
encouraging a deceitful Ponzi culprit. Consequently, it is up to financial specialists to do their
due constancy when settling on any sort of venture choice, particularly when a prominent
speculation counsel is advancing securities not enlisted or recorded on ordinary trades or for
which constrained open data is accessible.

In the occasion budgetary guides are drawn closer by present or forthcoming customers with
worries about deceitful venture plans, we have given an agenda in Table 2 that could help
monetary experts when offering exhortation to a customer who might consider contributing cash,
or who may have just contributed cash, in a Ponzi scheme. Ponzi culprits will most likely
dependably exist, however their prosperity relies upon discovering customers willing to put
resources into their plans, and the better educated and taught speculators and budgetary
counselors turn into, the more outlandish they will progress toward becoming casualties of
money related extortionists like Bernard Madoff.