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What is a Ponzi scheme?

If you face federal charges in New York for securities fraud, this represents a highly serious matter. If convicted, you could receive a life sentence in federal prison plus a fine of many hundreds of thousands of dollars.

Money.com explains that financial fraud charges can cover a wide variety of specific crimes. One of the most notorious, however, is the Ponzi scheme, named for Charles Ponzi, a 1920s’ Italian immigrant who perpetrated a scheme involving international reply coupons.

The original Ponzi scheme

Prior to the advent of technology that allows people around the world to communicate with each other via email and cellphones, the only way someone had to keep in touch with his or her international friends or family members was via snail mail. In the 1920s, many letter senders enclosed an international reply coupon, a voucher for return postage.

These coupons formed the basis of Ponzi’s scheme. He bought large quantities of them in foreign countries where they cost less than in the United States. He then resold these coupons to his victims, promising them a 50 percent return on their “investment” within three months.

One of the hallmarks of any Ponzi scheme is that the initial investors do, in fact, make money. The farther down the investment chain any particular investor finds himself or herself, however, the less likelihood that (s)he will make a profit and the more likelihood that (s)he will lose his or her entire investment.

In Ponzi’s case, the problem quickly became the cost of running his business and supplying sufficient quantities of coupons to an ever-growing number of investors. Almost immediately, he began paying his original investors with the money he obtained from his second tier of investors rather than from coupon profits. Then he paid the second-tier investors with third-tier money, supposedly ad infinitum.

However, his false infinity quickly collapsed and the Feds busted him within a year. One of the clues in their investigation was the fact that only about 27,000 international reply coupons existed worldwide, but Ponzi’s supposed coupon sales represented over 160 million such coupons.

Later Ponzi schemers

Unfortunately, the allure of get-rich-quick schemes always attracts a surprisingly large number of people, even those who possess reasonable financial sophistication. Many schemers have followed in Ponzi’s wake. The most notorious schemer in recent years was Bernie Madoff, a highly respected NASDAQ trader with a hugely successful brokerage business. He ran his scheme for over 20 years before the Feds convicted him and sent him to federal prison for 150 years.

While this information is not legal advice, it can help you understand Ponzi schemes and the consequences thereof.

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