Ponzi Schemes

What is a Ponzi Scheme?

A Ponzi scheme is a fraud designed to give investors the impression that an investment is profitable. In a Ponzi scheme, the fraudster pays early investors with money that is thought to be profits from the business. But it is actually money from the investor's own principal investment dollars or the pooled investment dollars of subsequent investors. As new investment dollars are paid out to previous investors, the fraudster seeks more investors to fund the “payments” being made.

Sometimes Ponzi schemes are perpetrated to cover business or investment losses, but sometimes Ponzi schemes are perpetrated to cover the misuse or theft of investor funds. Either way, Ponzi schemes constitute securities fraud under the Utah Uniform Securities Act and federal securities laws.

ALL Ponzi Schemes Collapse

Since Ponzi schemes need an ever-increasing supply of new investors to maintain payments to prior investors (and possibly support the fraudster’s lifestyle), all Ponzi schemes ultimately collapse as the fraudster will eventually fail to find enough new investors to cover the payments to all prior investors.

Once the Ponzi scheme has collapsed, recovering funds can be extremely difficult—especially if all the funds were paid out to earlier investors.

Utah Ponzi Schemes

While large Ponzi schemes have made the news in recent years (e.g. Madoff, Stanford, Petters), Utah sees its own share of Ponzi schemes.

Often these Ponzi schemes are sold under the guise of a seemingly profitable business. Some common business ventures that have been found to be Ponzi schemes include:

"Flipping" distressed homes
Payday loan companies
Hard money lending
Factoring of accounts receivable
Developing properties
Forex trading
Purchasing viaticals
Removing soil contaminates

This is not to say that all these businesses are inherently Ponzi schemes, but any business raising money and making payments to investors could be running a Ponzi scheme. To ensure that you do not invest in a Ponzi scheme, you should investigate any investment opportunity before investing.

Another common characteristic of Utah Ponzi schemes is the use of Affinity Fraud to lure investors. Affinity Fraud is when someone abuses the membership or association with an identifiable group (e.g. religions, ethnicities, professions) for the purpose of building trust in the legitimacy of the investment. The blind trust created by affinity fraud prevents investors from asking the basic questions about the investment opportunity and the company or individual offering the investment.

2018 - Precious Metals Ponzi Scheme in Utah

Concerns

Registration Concerns

Any person or company that seeks to pool investor money has created a security and must be:

properly registered under Utah law;
exempt from registration under Utah law; or
be a federal covered security notice filed in Utah.

In most cases, promoters running Ponzi schemes fail to properly follow securities laws and offer unregistered securities to Utah investors, which is a violation of the law.

Licensing Concerns

If the underlying business of the offering is an investment fund whereby a fund manager makes investment decisions with the pooled monies, the manager is often required to license as an investment adviser. When a fund manager licenses as an investment adviser, additional information about the advisert can offer help to prospective investors seeking to research the fund. Licensing as an investment adviser also ensures that the manager’s fees will not exceed industry standards without proper disclosure.

Additionally, if a third party is compensated for introducing the issuer and investor, that third party needs to be licensed as an issuer-agent, broker-dealer agent, or investment adviser representative depending on the specific arrangements.

Due Diligence

Since Ponzi schemes typically occur in private securities transactions, the burden is on the investor to ensure their investment is legitimate. To assist you in performing the due diligence so that you do not invest in a Ponzi scheme, you may contact the Division's Licensing section or use the Division’s online resources.

Key Questions to Ask the Issuer, Promoter, or Salesperson Before Investing

Companies raise capital through debt or equity financing. You may be issued an equity interest (e.g. partnership interest, stock, or interest in a limited liability company) for your investment and may receive dividends or a share of profits. Your investment may also be a loan, or debt, to the company (e.g. promissory note, bond) that is to be repaid according to certain terms that may include payments of interest. Debt may also be secured or unsecured.

To help you perform the proper due diligence before investing, you should be provided a private placement memorandum, private offering memorandum, or some other document that fully details information about the fund, including managers, financials, track record, investment strategy or business plan, and the risks associated with that strategy or plan. Like a mutual fund’s prospectus, a hedge fund’s disclosure document should be substantial in length (typically 30 to 60 pages).

With pooled investor dollars, the managers of the company may invest in many types of investments each of which carry their own particular risks. If the company will make investments with investor dollars, it is acting as an investment fund and the fund manager needs to license as an investment adviser. Additionally, the fund should disclose in writing the types of investments it will make and the risks associated with those investments.

Every industry has its specific challenges, so the question is not only whether the business plan or investment strategy is solid, but also whether the managers have the expertise and skill to execute the plan or strategy. While experience is not a requirement, it is definitely something to consider. The experience of all principals of the company (or investment fund) should be fully detailed in the disclosure document.

Before investing you should research the company and its management. The first step may be a simple internet search to find any information. You may contact the Division of Securities to see if the company or its managers have any derogatory information. You may also use the Division's resource tool and also search with other regulators, such as the Utah Division of Real Estate or Utah Department of Insurance. Greater due diligence may require looking for any court records for criminal or civil matters.

Key Questions to Ask Yourself Before Investing

Is this investment too good to be true?
Do I understand the investment?
Why does the company need my money?
Can I afford to lose my investment?
Have I spent sufficient time researching the company and its managers?

About Charles Ponzi

Charles Ponzi was an Italian-born con man. In 1920, Ponzi became infamous for defrauding New Jersey and New England citizens out of millions of dollars. Ponzi promised investors at least 40 percent return in 90 days on their investment that he claimed would be used to purchase discounted International Postal Reply Coupons. He said the coupons could be exchanged for stamps in the United States and the stamps could be sold at a substantial profit. Early investors were paid as promised and the news of Ponzi’s investment spread quickly, creating a seemingly endless stream of investors. Ponzi’s scheme was exposed by a Boston newspaper and law enforcement. The investigation revealed Ponzi made no real effort to purchase postal reply coupons. Ponzi was charged with mail fraud and was in and out of prison several times before being deported. Ponzi died in 1949, destitute.