Typically Ponzi scheme require an initial investment and promises above average returns. They use vague verbal guise such as “hedge future trading”, “high-yield investment programs”, or “offshore investment” to describe their income strategy.
By Sanjenbam Jugeshwor Singh
A Ponzi scheme is a fraudulent investing scam promising high rates of returns with little risk to investors. The Ponzi scheme generates returns for early investors by acquiring new investors. This is similar to a pyramid scheme in that both are based on using new investors ‘funds to pay the earlier backers. Both Ponzi scheme and Pyramid scheme eventually bottom out when the flood of new investors dries up and there isn’t enough money to go around. At that point, schemes unravel. A Ponzi scheme is an investment fraud in which clients are promised a large profit at little or no risk. Companies that engage in a Ponzi scheme focus all of their energy into attracting new clients to make investment. This new income is used to pay original investors their returns marked as a profit from a legitimate transection. Ponzi schemes rely on a constant flow of new investment to continue to provide returns to older investors. When this flow runs out, the scheme falls apart.
Ponzi scheme is named after a swindler named names Charles Ponzi, who orchestrated the first one in 1919. The postal service at that time had developed international reply coupons that allowed a sender to pre-purchase postage and include it in their correspondence. The receiver would take the coupon to a local post office and exchange it for the priority airmail postage stamps needed to send a reply. The constant fluctuation of postage prices meant that it was common for stamps to be more expensive in one country than another. Ponzi hired agents to purchase cheap international reply coupons in other countries and send them to him. He would then exchange those coupons for stamps that were more expensive than the coupon was originally purchased for. The stamps were then sold at a profit. This type of exchange is known as “arbitrage” which is not an illegal practice. But Ponzi became greedy and expanded his efforts. Under the heading of his company, Securities Exchange Company, he promised of 50% in 45 days or 100% in 90 days. Due to his success in the postage stamp scheme, investors were immediately attracted. Instead of actually investing money Ponzi just redistributed it and told the investors they made profit. The scheme lasted until August 1920 when “The Boston Post” began investigating the Securities Exchange Company. As a result of newspaper’s investigation, Ponzi was arrested by federal authorities on 12th August 1920 and charged with several counts of mail fraud.
Typically Ponzi scheme require an initial investment and promises above average returns. They use vague verbal guise such as “hedge future trading”, “high-yield investment programs”, or “offshore investment” to describe their income strategy. It is common for the operator to take advantage of a lack of investor knowledge or competence or sometimes claim to use a proprietary secrete investment strategy to avoid giving information about the scheme. The basic premise of a Ponzi scheme is “to rob Peter to pay Paul”. Initially, the operator pays high returns to attract investors and entice current investors to invest more money. When other investors begins to participate a cascade effect begins. The schemer pays a returns to initial investors from the investment of new participants, rather than from genuine profits. Often high returns encourage investors to leave their money in the scheme, so that the operator does not actually have to pay very much to investors. The operator simply sends statements showing how much they have earned; which maintains the deception that the scheme is an investment with high returns. Investors within a Ponzi scheme may even face difficulties when trying to get their money out of the investment. Operator also try to minimize withdrawals by offering new plans to investors when money cannot be withdrawn for a certain period of time in exchange for higher returns. The operator sees new cash flows as investors cannot transfer money. If a few investors do wish to withdraw their money in accordance with the terms allowed, their requests are usually promptly processed, which gives the illusion to all other investors that the fund is solvent and financially sound.
Ponzi schemes sometimes begin as legitimate investment vehicles, such as hedge fund that can easily degenerate into a Ponzi type scheme if they unexpectedly lose money or fail to legitimately earn the returns expected. The operator fabricate false returns or produce fraudulent audit reports instead of admitting their failure to meet expectations, and the operation is then considered a Ponzi scheme. If a Ponzi scheme is not stopped by authorities, it usually falls apart because of: the operator vanishes, taking all the remaining investment money; since the scheme requires a continual stream of investments to fund higher returns, if the number of new investors slow down, the scheme collapses as the operator can no longer pay the promised returns (the higher the returns, the greater the risk of Ponzi scheme collapsing). Such liquidity crisis often trigger panics ,as more people start asking for money, similar to a bank run. Actual losses are extremely difficult to calculate. The amount that investors thought they had were never attainable in the first place. The wide gap between “money in and fictitious gains” make it virtually impossible to know how much was lost in any Ponzi scheme. A pyramid scheme is also a form of fraud similar in some ways to Ponzi scheme, relying as it does on a mistaken belief in a non-existent financial reality including the hope of an extremely high rate of returns.
Modi Government passed a bill to ban unregulated deposit schemes. The bill will help tackle the menace of illicit deposit-taking activities in the country which at present are exploiting regulatory gaps and lack of strict administrative measures to dupe gullible people of their hard earned savings. It also seeks to amend the three Laws i.e. the Reserve Bank of India Act 1934; the Securities and Exchange Board of India (SEBI) Act 1992 and the Multi-State co-operative Societies Act 2002. The recent and present buzz about financial fraud in Manipur by an Organisation is a Ponzi scheme as described by financial experts. If it is true, then what could be the fate of investors is a big question. Not only this, it is also reported that many such Ponzi operators are operating in Manipur right now & spreading like an epidemic. As suggested by the financial experts and financial planners, we need to know the financial literacy and awareness to check heavy losses of our hard-earned money which had been taken place many times before also. At the same time government should regulate the non-banking financial Institutions operating in Manipur to prevent undue loss of people’s hard-earned money.
(Sanjenbam Jugeshwor Singh is Asst Prof, JCRE Global College, Babupara, Imphal. He can be reached at firstname.lastname@example.org)Ponzi schemes in Manipur