Trick or Treat: The Top 5 Ponzi Schemes of All Time

Investing

by Susan Lyon

Trick or treat?  While Ponzi Schemes may at first sound like treats, they are soon found out to be tricks.  For many gullible investors, an “investment opportunity of a lifetime” was promised to be a treat, but it turned out to be a terrible trick in the form of a Ponzi Scheme instead.

So for Halloween we decided to investigate something very spooky and frightening to us here at NerdWallet: the scariest Ponzi Schemes of all time.  What were they, who ran them, and how did they get away with it for so long before being found out?

Frights of Finance: What is a Ponzi Scheme?

A Ponzi Scheme is a fraud disguised as a legitimate investment opportunity.  Specifically, the SEC notes that this type of fraud is characterized as an:

“Investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors.”

In short, there are no actual profits being earned.  The criminal promises investors high returns, which are then paid out by the new money coming in from other investors rather than from the legitimate source of earnings that was promised.  This prevents or delays the scheme from being found out, at least at first, because at first investors are placated and seem to be seeing the fruits of their investment.  Ponzi Schemes are named after Charles Ponzi, the famed con artist of the 1920s detailed below, who found an intricate way to pay off old investors with new cash inflows while really running at a loss and racking up debt the entire time.

Still looking for a good Halloween costume?  If you’re looking to dress up as a ‘Fright of Finance’ this Halloween, these people might be an inspiration to you (and check out NerdWallet’s Top 10 Nerdiest Costumes list too).

We now present to you the Top 5 Worst Ponzi Schemes in history (since Ponzi) as measured not just by the vast sums of money lost, but also by their staggering audacity, nerve, and even creativity at times.

1. The Original Ponzi Scheme: Postage Gone Awry (1920)

Charles Ponzi, an Italian businessman turned con artist, found that the post-war inflation of the post World War One era was the perfect thing to take advantage of.  With a history in smuggling and gambling, he quickly learned he could buy up international reply coupons (a type of postage stamp) cheaply in Italy and exchange them for U.S. stamps of higher value, thus profiting from the net difference in value (arbitrage: not illegal in itself).  He mailed money to relatives in Italy to purchase more cheap stamps to send to America to redeem for more.

But the stamps ran into bureaucracy and he wasn’t able to exchange them as hoped – this didn’t stop Ponzi from taking investor money.

He began to promise investors 100% profits in 90 days and he then began ramping up his operation by promising vast returns to those willing to invest, hiring agents to collect more and more investor money.  He was soon bringing in cash by the millions, but he was only able to pay off old investors with the new money coming in.  Unbeknownst to most, he was operating at a net loss, and local authorities started to get suspicious.

After media, bank and Massachusetts state investigations resulted in a front-page story about his criminal past and current $7 million in debt, he was arrested for mail fraud.  He brought down 6 local banks and $20 million in investor money (over $225 million in today’s money) in the process.

2. Bernie Madoff: Half a Century of “Beating” the Markets (2008)

Think a Ponzi Scheme couldn’t happen in this day and age?  Not so fast.  Madoff’s scheme collapsed in 2008, with investor losses amounting to $18 billion and overall losses in the $65 billion range.  Ouch.  Madoff operated by promising investors a long term way to beat the market, rather than outrageous short term profits; this made it seem more legitimate to them over time.

The most frightening fact?  Madoff’s scheme went on for nearly 50 years undiscovered, despite multiple whistleblowers’ tips to the government, before he was eventually turned in by his own sons.  Bernard L. Madoff Investment Securities LLC was founded in 1960 and was in operation until Madoff’s arrest in 2008

The SEC even launched an investigation to figure out how Madoff’s scheme was able to continue on for so long.  Enjoy those 150 years in jail, Bernie.

3.  The Kubus Scheme: The Beauty of Rotten Milk (1984)

The South African entrepreneur Adriaan Nieuwoudt decided to market his grandmother’s milk-based cultures, promising investors a wildly successful skincare product based on this proprietary ingredient.  It sounds pretty quaint to us.

The problem?  No beauty product was ever actually sold.  He was selling off the dried plant “activator” used to create the milk cultures to other investors, who then each had to grow the cultures and mail them back.  These very same cultures were promptly then ground up and resold as activators all over again, to a new batch of gullible investors.

Kubus also brought his “activator kits” business to the U.S. but it was eventually declared an illegal lottery by the South African government and shut down.

4. MMM’s Pyramid Scheme: To Russia, With Love (1994 and 2011)

In the first years of post-communist Russia, financial regulations were ambiguous (and largely unenforced) so everything was fair game. Sergei Mavrodi, sometimes referred to as “Russia’s Bernie Madoff,” ran MMM as it grew into the country’s best-known investment firm at the time.  So when it started offering in the realm of 2,000% returns annually with no minimum investment, Russians rushed to sign up.

The wildest part?  Mavrodi went to jail in 2003 and was released in 2007, only to soon start another similar scheme nicknamed ‘MMM-2011’ while also expanding his operations to India with what was called ‘MMM India.’  These operations were shut down earlier in 2012, but he outright referred to them publicly as pyramid schemes on his blog, as Russia’s legal system was not equipped to penalize such financial structures.

If Russian financial markets seem a little sketchy to you, this is one of the reasons why they’re so notorious.  One of the largest Ponzi Schemes of all times, the 1994 scheme was kept under wraps and we still only have general estimates of how many people and funds were affected by it.

5.  Haitian cooperatives: The GDP Destroyers (2001)

In Haiti in the early 2000s, thousands of Haitians used up their savings investing in cooperatives that promised unheard of 10% to 15% monthly returns.

At first these co-ops maintained a veil of legitimacy because salespeople promised they were “government-backed” and Haitian pop stars served as spokespeople for the cause.  But sadly it soon became clear these cooperatives, initially praised as “the people’s capitalism,” were not being properly regulated and criminals were escaping with the invested money.  Families across Haiti lost their homes, cars, and life savings in what seemed at first like a legitimate ‘get rich quick’ scheme.

The various cooperative scams that swept Haiti in this timeframe stole around $240 million – perhaps not a lot by international standards, but this was the equivalent of about 60% of Haiti’s GDP at the time.  It truly hurt the country’s entire economy, already struggling.

Trick or Treaters Beware: Watch Out For Ponzi Scheme Red Flags

Always beware of any investment group offering high returns with promised low or no risk.  As we all know, any high returns investing opportunity also carries high risk – that’s how it works.  It is sometimes unclear whether the Ponzi Scheme was the investor’s original intention, but everyday consumers must be careful nonetheless.

The SEC notes that if you think you’ve stumbled across a Ponzi Scheme you can become a whistleblower too: contact the SEC by phone at (800) 732-0330 or online at http://www.sec.gov/complaint.shtml.

The moral to the story: get rich quick schemes rarely pan out as advertised upfront.  Take it from us: trick or treat is a much better activity on Halloween than it is the rest of the year.