Ponzi Schemes Are Highly Illegal

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A Ponzi scheme could yield even worse results for investors, because it does not pay out any commissions at all. This can have disastrous consequences, as exemplified by Charles Ponzi’s infamous fraud in the 1920’s. Charles Ponzi, an engaging ex-convict, promised the Italian-American community of South Boston that he would give them a 50 percent return on their money in just 45 to 90 days.(5) Mr. Ponzi claimed that he could pay such a high rate of return because he could earn 400 percent by trading and redeeming postal reply coupons. These coupons had been established under the Universal Postal Convention to enable a person in one country to pre-pay the return postage on a package or letter sent back from another country. For a short time after World War I, fluctuations in currency exchange rates did create a disparity between the cost and redemption value of postal reply coupons among various countries. However, Mr. Ponzi discovered that he could only make a few cents per coupon and that handling large volumes of coupons cost more than they were worth. He stopped redeeming any coupons but continued to collect investors’ money. When he actually paid a 50 percent return to some early investors, his reputation soared and more money flowed in from around the country. Mr. Ponzi bought a stylish house in the best part of town and purchased a large minority interest in his local bank, the Hanover Trust Company.

Eventually his scheme began to unravel, bringing ruin to the bank and thousands of investors. When Mr. Ponzi began to overdraw his accounts at Hanover Trust, the Massachusetts Banking Commissioner ordered Hanover Trust to stop honoring Ponzi’s checks. The bank refused and even issued back-dated certificates of deposit to cover Mr. Ponzi’s overdrafts. A few days later, the Banking Commission took over Hanover Trust, and Mr. Ponzi was arrested for mail fraud. In the end, Charles Ponzi owed investors over $6 million, an enormous sum of money for that time. He was convicted of fraud in both state and federal court and served ten years in prison.

Law Enforcement Partners

The legacy of Mr. Ponzi lives on as pyramid and Ponzi schemes continue to plague us and challenge the law enforcement community. Fortunately, in the U.S., the Federal Trade Commission is just one among many agencies that have the authority to file suit to stop this type of fraud. The Securities and Exchange Commission also pursues these schemes, obtaining injunctions against so-called “financial distribution networks” which in fact sell unregistered “securities.”(7) The U.S. Department of Justice, in collaboration with investigative agencies like the FBI and the U.S. Postal Inspection Service, prosecutes pyramid schemes criminally for mail fraud, securities fraud, tax fraud, and money laundering.