All you wanted to know about Ponzi schemes

A week ago, the President of India signed into law a new ordinance giving SEBI more powers to crack down on Ponzi schemes. The move brings into focus the need to check investment schemes designed to part savers from their money — from the SpeakAsia scam in India, to Bernie Madoff’s hedge fund in the US. Such frauds are called Ponzi schemes.

A Ponzi can be any scheme in which the returns to promised to older investors are paid from the money collected from new investors, and not actual profits from the investments. Ponzi schemes were named after Charles Ponzi, a clerk in Boston who, almost a century ago, duped thousands of investors into speculating on phenomenal returns from the humble postage stamp.

Those running a Ponzi scheme reel in their first set of investors by introducing them to a great opportunity. They may even pay up the fanciful returns out of their personal funds. But once investors begin to bite, they build a house of cards, using money from the stream of new entrants, to pay the older patrons. Even if profits are made from the investments, more often than not, the scheme operators siphon it off to private accounts. As long as new investors are willing to sign up, the Ponzi scheme works. But when the flow of fresh money dwindles, the house of cards collapses.

Because it is one of the easiest ways to lose your money. Take last year’s Saradha scam, which was built along Ponzi lines. This illegal ‘chit’ scheme promised returns of 15 to 50 per cent.

Attempts to regulate Ponzi schemes in India have taken the form of SEBI’s ‘collective investment scheme’ regulations. By law, any scheme that amasses more than ₹100 crore requires SEBI’s permission. But several such schemes have simply gone ahead and raised money without SEBI’s nod

Now, what the ordinance does is to allow SEBI to take action where it comes across an illegal collective investment scheme. To apprehend Ponzi scheme perpetrators, the watchdog can comb through phone records and conduct search-and-seizure operations.

Ponzi schemes can take many forms, from your informal neighbourhood ‘fund’ that pools money from friends, to pyramid marketing schemes.

And often enough, it’s cold comfort when these fraudsters are brought to book.

Usually, those who orchestrate a ponzi scheme don’t have the cash to pay back investors, leave alone offer any return. So when schemes fall to pieces, even if regulators appear on the scene, your money is not going to make its way back into your bank.

Watch out for tell-tale signs. High returns is one, especially if they are promised to be consistently high, no matter what the market conditions are. No regulatory stamp of approval, minimal documentation, no information about where the returns will come from and outlandish investment avenues are other hints that a scheme is a potential sinkhole.

Don’t let someone else make off with your savings and live it up in the Bahamas. If an investment offers unbelievably great returns, it’s equally unbelievable that you will get back your capital.

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