Ponzi Scheme

The organiser promises steady, above-market returns with little risk and often claims a secret strategy. In reality there is little or no real investment. Early investors receive their promised payments, which are funded by deposits from later ones, so they spread the word and bring in more money. The scheme needs a constant flow of new funds and falls apart when recruitment slows, or when many investors ask for their money back at once, often during a market downturn. It does not depend on investors recruiting others, which separates it from a pyramid scheme. It is named after Charles Ponzi, who ran a postal-coupon scheme around 1920. Regulators spot these cases when a fund reports smooth returns through a market fall yet cannot explain where the money is held.

A fund manager promises clients 12% a year regardless of market conditions. He pays interest to existing clients from the deposits of new ones and sends glossy statements showing growth. After a market fall, many clients ask to withdraw their money in the same month. There is not enough cash to meet the requests. The fund freezes withdrawals, and an investigation finds that most of the assets reported never existed.