Charles Ponzi - Father of Ponzi Schemes

 Have you ever heard of the phrase "Ponzi Schemes"? If you have ever heard these words, you should know about Charles Ponzi, on whose name this phrase was coined. 

Who is Charles Ponzi?

— The Phoenix (@3011_ajit) December 20, 2022

Charles Ponzi was an Italian by birth. His birth name was Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi. Carlo Ponzi became Charles Ponzi after migrating to the US in 1903. He did some small jobs till 1907 and moved to Montreal, Canada. 

He started working with a bank in Montreal, Canada and forged the signatures of customers in the bank. He got caught in 1909 and spent two years in jail. In 1911, after being released from jail he indulged in smuggling illegal Italian immigrants from Canada to the US. He was caught again, this time by the US authorities, and spent another two years in jail. 

After his release from jail, he moved to Boston where he got married to an Italian-American in 1918. In Boston, he did several small works and eventually failed in all of them before becoming the master scammer and ultimately the name of a particular type of fraud after him.

Before jumping into the details of his fraud, let me introduce you to International Reply Coupons (IRC) issued by the Universal Postal Union in 1906. Universal Postal union is a union of countries that issued IRC for the purpose of using them as common postal stamps. The IRCs can be purchased in one member country with that country's currency and can exchange in any member country with their currency or postage stamps. Being convenient for exchange, European immigrants in the US used to purchase them in the US and send them to European member countries for their family members to redeem them and pay for the postage for replies.

What has this to do with Charles Ponzi? The answer lies in how he manipulated the system of IRC to amass money from people.

How did he do that? His plan was simple. In 1920, he started an investment plan and said that he will purchase the IRCs in the US and redeem them in Europe, lend the money in Europe for higher interest rates, and exchange them again for USD when the payments are due. He promised to double the money in just 90 days. 

People believed the plan (out of greed to earn easy money) and invested millions of dollars in the scheme. By July 1920, the scheme was able to collect $2.5 million. It was estimated around 75% of the Boston police also invested in the scheme.

With huge monies flowing in, Ponzi started living a luxurious lifestyle. As the lifestyle of Ponzi changed in a very short span, it raised a few eyebrows and started raising suspicions about his investment plan.

On July 26th, 1920, Richard Grozier, the editor of The Boston Post raised his suspicion about a paid article printed in their newspaper about the Ponzi scheme on July 24th. He contacted Clarence Barron, a financial journalist. 

Barron started observing the activities of Ponzi and found that Ponzi was not even investing his money.

This is a revelation, Right! Then how was Ponzi able to make the payments to the investors?

The modus operandi of Ponzi was quite simple. He took the investments from one person and started paying for his earlier investors. As more and more people started investing, he got more money than his payables and he didn't face a cash crunch as the investment swelled. 

Barron found a fundamental flaw in the scheme during his investigation. He estimated the postal coupons to be purchased by Ponzi if he actually invested in the scheme as promised to be 160 million coupons and then contacted the United States Post Office. The United States Post Office stated that there were no such bulk purchases either in the US or in any other member country.

Meanwhile, the Boston Post started a series of articles posing serious questions about how Ponzi was able to make so many returns on his investments. This triggered some investors and they disinvested from the scheme. Since Ponzi was getting more investors he didn't find it difficult to pay the amount and he even convinced some investors to leave their money with him.

But in a span of one month, by August 9th, the bank accounts of Ponzi were running in overdraft. Meanwhile, Daniel Gallagher, a district attorney in Massachusetts appointed Edwin Pride as an auditor for the Securities Exchange Company (Company founded by Ponzi). 

On August 11th, 1920, Edwin Pride revealed the audit report and declared that Ponzi has debts of up to $7 million dollars and was insolvent. This triggered the investors and the demand for withdrawals was hyped in a day. 

On August 12th, Ponzi declared insolvency and surrendered. It was estimated that the investors in the scheme got only 30 cents for every dollar invested and the overall losses were up to $20 million dollars if the interests are considered.

If we observe the overall scheme, it was a simple fraud. Ponzi took money from Mr. Y and paid Mr. X without making any real investments. This was repeated many times.

From then onwards, the world has witnessed many such investment schemes which promised high returns but ended up as frauds and they were called "Ponzi Schemes".

I just don't want to waste your time reading about a fraudster. So, here are some tips to identify the "Ponzi Schemes":

1. Very high interest rates on deposits or very high returns on investments are clear red flags - Generally, a specific type of investment gives a specific percentage of return. It is better to take the interest rates on fixed deposits as standard and measure the returns or interests on investments on the scale of fixed deposit interest rates. Each investment class will give approximately a certain percentage of return higher than the bank fixed deposit based on the risk perspective of the investment. If any investment plan by any company is promising very high returns than other industry players in the same class of investments, it is better to avoid such plans. Most of the time they end up as Ponzi schemes.

2. Unregulated Investments - Never invest in any unregulated investments. So, what are unregulated investments? These are the investments made with unregistered firms or with individuals, generally with friends, relatives, or neighbors. You might have faith in the person with whom you are investing, but any unforeseen event can compromise the whole investment. Even though there are methods to claim the investment, most of the time, the court cases take years and decades to settle. 

3. Read all investment-related documents - Just question yourself about how many times you read the complete terms and conditions of the insurance policy you made? If you haven't read the documents, at least read them now. If you don't find time to read the entire document, don't forget to take the important terms and conditions from the investment advisor in writing. Read them and then decide. If it is a loan, check for the interest rates, foreclosure terms, penalties for delays, and treatment of collateral in the event of non-payment.

These are the important things that I follow and suggest. If you have more tips, please feel free to comment, spread the knowledge, and save at least a few from financial fraud. After all, it is our hard-earned money we are trying to save from fraudsters.