Generally, a Ponzi Scheme is a form of investment fraud where the investment manager falsifies investment returns and uses new investor money to pay existing investors.
Example Ponzi Scheme
John is a hedge fund manager who raises $1,000,000 from Adam. John invests the funds into some speculative stocks and loses $100,000, so the account’s value is now $900,000. John lies to Adam about the fund’s return on investment (ROI) and tells him the stocks are doing well and his account is up 6%, so Adam thinks the account value is $1,060,000.
Adam wants to redeem his full investment plus the profits for $1,060,000; however, John only has $900,000 available because he lied to Adam about the investment performance. For John to deliver the $1,060,000, he must find a way to cover the shortfall of $160,000 ($1,060,000 minus $900,000).
John approaches a new investor, Brian, and persuades Brian to invest $500,000 into his fund. John uses $160,000 of Brian’s $500,000 investment to give to Adam. The Ponzi Scheme has started…
Famous Ponzi Schemes
- Bernie Madoff. Formerly the president of Bernard L. Madoff Investment Securities LLC, a company that conducted a $64 billion Ponzi Scheme that ultimately collapsed in 2008.
- R. Allen Stanford. Formerly the founder, chairman, and Chief Executive Officer (CEO) of Stanford Financial Group, a company that conducted a $7 billion Ponzi Scheme that ultimately collapsed in 2009.
- Tom Petters. Formerly the founder and CEO of Petters Group Worldwide, a company that conducted a $3.65 billion Ponzi scheme that ultimately collapsed in 2008.