The Madoff situation was a variation of the classic Ponzi scheme. Named after Charles Ponzi, this scam depends on constantly obtaining new investors and new sources of money.
The first investors are paid from money from the second wave, the second wave paid by a third group and so on.
The original Ponzi operated in the U.S. in the 1920s and he took money from people on the strength of international trade stamps then in use. He was caught after he diverted money to his own use and couldn’t pay investors.
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Madoff’s situation was similar, but much bigger at almost $65 billion by the last estimate. He created a Wall Street investment firm named after himself. He obtained money from big rollers and famous individuals and funds kept rolling in. He paid high returns and gradually became more popular. Of course, the plan had to fail as he took more money out for himself and paid fewer
people.
Instead of buying investments for his clients, he stuck the money in his own bank account or used it to purchase luxury items for him and his family.
Ultimately, his own sons, who worked in the business, turned him in when it turned out the business wasn’t paying returns to customers but was paying big bonuses to employees. He was arrested, admitted to the Ponzi scheme and received jail time totalling 150 years, with no parole.
Why don’t Ponzi schemes work?
These frauds all have similar characteristics. The main person behind them has the appearance of success, affluence and credibility. He or she has attracted wealthy or noteworthy clients and has the trappings of wealth, power and success.
These people promise their investors huge returns on investment within a short period and initially deliver such returns.
Often terms are used that sound great but don’t actually mean anything. They often also promise consistent or guaranteed returns and initially deliver.
The problem arises when more and more income is required to keep up with the returns being paid, given that there is no real investment and also that the ringleader is taking money out for himself.
The scheme collapses or the police investigate and charge someone just before the house of cards falls apart.
These frauds are happening in Canada. Last month, Milowe Brost was charged in Calgary. He is presumed innocent and nothing has yet been proven in a court of law. Nevertheless, thousands of Canadians lose money every year to unscrupulous and dishonest promoters of investment schemes that have the appearance of legitimacy but are outright frauds.
The bottom line is if it sounds too good to be true, it likely is. Don’t go looking for the quick buck and if you do, only invest money that you can afford to lose. Such investments are at best speculative and at worst crooked.
Rick Danyliuk is a practising lawyer in Saskatoon with McDougall Gauley LLP. He also has experience in teaching and writing about legal issues. His columns are intended as general advice only. Individuals are encouraged to seek other opinions and/or personal counsel when dealing with legal matters.
