The Ponzi Scheme is a type of fraudulent investment operation that is characterized by the payment of high returns to previous investors coming from the money paid by new investors rather than sourcing it from legitimate business profits. It is considered as a form of a pyramid scheme that has defrauded many people of their investments with the allure of promises of high returns and profits being offered by such schemes.

History

The Ponzi scheme was named after Charles Ponzi, an Italian immigrant in the US during the early 1900’s. Although the original scheme wasn’t developed by Ponzi himself, his fraudulent operation took in so much money that it was the first scheme of its kind to became quite known throughout the United States.

Charles Ponzi Scheme

The Charles Ponzi operation consisted of buying and selling IRC’s or international reply coupons. The purpose of the IRC is to allow a letter sender from one country to send it to another person and use it as postage for a letter reply.

The IRC’s could be exchanged for stamps in the country where it is redeemed. There were usually differences between the price of stamps from one country to another. The differences in values offer an opportunity of profit.

From this principle, Charles Ponzi began to look for investors during the early months of 1920 in order to fund his operation of buying cheap IRC’s from Italy and then sending them to the US and exchanged for higher valued stamps that can then be sold.

Ponzi claimed that the potential profit from this operation was in the excess of an incredible 400 percent after taxes and deducted expenses. Ponzi attracted many friends and associates to invest in the operation by offering a 50 percent return of investment within 45 days.

Scheme Success

During the course of the operation, many people invested and were initially paid off as promised. As the word spread about the profitable venture, investment came in at an ever increasing rate. Ponzi began to hire agents to get more and more investors into the scheme and paid them handsomely for the task.

Scheme Collapse

In a matter of months Charles Ponzi had made millions out of the increasing investors wanting to join in the scheme. By July of 1920, Ponzi was making about US$250,000 a day, quite a large sum at that time. The scheme seem to work efficiently as long as more and more new investors keep on coming. People were continually paid, some even did not cash on their profits and instead reinvested their earnings in order to get higher returns.

But then stories of suspicion surrounding the investment operation started to spread. People began questioning how the scheme managed to offer such high profit margins to its investors. Eventually the scheme, was discovered and had defrauded investors of tens of millions of dollars. Charles Ponzi was charged and in November of 1920, pleaded guilty to mail fraud and was imprisoned.