Ponzi scheme

For schemes that promise rewards based on enrolling ever larger numbers of people, see Pyramid scheme.

Charles Ponzi, the namesake of the scheme, in 1920

A Ponzi scheme (/ˈpɒnzi/, Italian: [ˈpontsi]) is a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors.[1] Named after Italian businessman Charles Ponzi, this type of scheme misleads investors by either falsely suggesting that profits are derived from legitimate business activities (whereas the business activities are non-existent), or by exaggerating the extent and profitability of the legitimate business activities, leveraging new investments to fabricate or supplement these profits. A Ponzi scheme can maintain the illusion of a sustainable business as long as investors continue to contribute new funds, and as long as most of the investors do not demand full repayment or lose faith in the non-existent assets they are purported to own.

Some of the first recorded incidents to meet the modern definition of the Ponzi scheme were carried out from 1869 to 1872 by Adele Spitzeder in Germany and by Sarah Howe in the United States in the 1880s through the "Ladies' Deposit". Howe offered a solely female clientele an 8% monthly interest rate and then stole the money that the women had invested. She was eventually discovered and served three years in prison.[2] The Ponzi scheme was also previously described in novels; Charles Dickens's 1844 novel Martin Chuzzlewit and his 1857 novel Little Dorrit both feature such a scheme.[3]

In the 1920s, Charles Ponzi carried out this scheme and became well known throughout the United States because of the huge amount of money that he took in.[4] His original scheme was purportedly based on the legitimate arbitrage of international reply coupons for postage stamps, but he soon began diverting new investors' money to make payments to earlier investors and to himself.[5] Unlike earlier similar schemes, Ponzi's gained considerable press coverage both within the United States and internationally both while it was being perpetrated and after it collapsed – this notoriety eventually led to the type of scheme being named after him.[6]

  1. ^ Cite error: The named reference Investor.gov was invoked but never defined (see the help page).
  2. ^ Zuckoff, Mitchell. Ponzi's Scheme: The True Story of a Financial Legend. Random House: New York, 2005. (ISBN 1-4000-6039-7)
  3. ^ Markopolos, Harry; Casey, Frank (2010), No One Would Listen: A True Financial Thriller, John Wiley and Sons, p. 50, ISBN 978-0-470-55373-2
  4. ^ "Ponzi Schemes". US Social Security Administration. Archived from the original on 1 October 2004. Retrieved 24 December 2008.
  5. ^ "Ponzi Schemes – Frequently Asked Questions". U.S Securities and Exchange Commission. U.S. Securities and Exchange Commission. Archived from the original on 26 June 2012. Retrieved 23 June 2012.
  6. ^ Peck, Sarah (2010), Investment Ethics, John Wiley and Sons, p. 5, ISBN 978-0-470-43453-6