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Indiana Securities Division

Securities Division > Indiana MoneyWise > Investing 101 > Mortgages 101 > Articles > Protect Your Pocket Series - Ponzi Schemes Protect Your Pocket Series

Understanding and Avoiding Ponzi Schemes

(originally published January 2009)

When you hear about people getting tricked or conned out of their money, it can be easy to sit back and think, “I would never fall for that,” or “I’m too smart to get scammed.” However, as details continue to unravel in the alleged $50 billion Ponzi scheme perpetrated by Bernard Madoff, people across the nation are recognizing a harsh reality: anyone can become a target of fraud.

Madoff, a former chairman of the Nasdaq Stock Market, owned and operated an investment advisory firm and also managed a high-profile hedge fund. Hedge funds are portfolios of investments that often carry a lot of risk, but aim to generate high returns. These funds are typically set up as private investment partnerships that usually require an initial investment of between $250,000 and $1 million.

Well known and widely respected in the industry, Madoff had more than 100 charities, businesses and individuals investing in his hedge fund. He later confessed to his employees that the fund and his firm were all part of a big Ponzi scheme.

The term Ponzi scheme comes from a scam operated by Charles Ponzi in the early 1900s that bilked investors out of millions. Ponzi recruited investors by promising high returns within a short period of time. He was able to pay returns to initial investors with the money he collected from new investors, making it seem like his nonexistent business was legitimate and doing well.

Ponzi schemes typically fall apart when the fraudster does not have enough money to pay returns to investors. This was the case with Madoff as he struggled in early December to fulfill requests from his clients to redeem $7 billion from the hedge fund. The total estimated amount lost by Madoff’s investors is $50 billion, with some individual investors losing their entire life savings and some charities losing significant portions of their endowments.

In the wake of this significant scam, here are several tips for protecting yourself against Ponzi schemes:

  • Never rely solely on the testimony of others. Just because someone else made money doesn’t mean you will or that the investment is legitimate.

  • Be skeptical of promises of high returns. One red flag in the Madoff case was that his hedge fund generated consistently high returns, even when the market fluctuated. Promises of high returns are typically too good to be true.

  • Investigate before you invest. Use the searchable databases on www.IndianaInvestmentWatch.com or call 1-800-233-8791 to make sure an investment advisory firm is registered with either the Indiana Securities Division or the Securities and Exchange Commission. You can also contact the Securities Division to make sure an investment is registered.

  • Get written information. Every investment opportunity should have a prospectus that outlines the details of the investment. Once you enter an investment, be sure to closely examine your financial statements for suspicious activity.

Another thing to consider: Ponzi schemes often coincide with affinity fraud – where fraudsters exploit an existing level of trust and friendship. Affinity fraud typically takes place in religious and/or ethnic communities. Several of Madoff’s investors were prominent members of the Jewish community, as he was himself.

If you feel you have been the victim of a Ponzi scheme or investment fraud, report it to the Indiana Securities Division by calling 1-800-223-8791 or file a complaint online at www.IndianaInvestmentWatch.com.

Related Information:

- Search databases

- Contact the Securities Division