Friday’s Fraud – Ponzi Schemes: Don’t Believe the Unbelievable

By Benjamin Stubbs, Spring 2014 Student Intern

chasingThis week’s tip: be more like Alice than the Queen. In Lewis Carroll’s Through the Looking Glass, when the Queen asked Alice to consider that the Queen was over a hundred years old, Alice tells the Queen that there was no use trying to consider that because “one can’t believe impossible things.” The Queen responded that she had “sometimes … believed as many as six impossible things before breakfast.”

Coming in third on NASAA’s list of most common investment frauds of 2013 are high-yield investments and Ponzi schemes, which are often used to defraud investors because they are chasing high returns and are tricked by promises of “unbelievably high rates of returns.” The simplest way to avoid such scams: don’t believe unbelievable things, no matter how much money someone promises you.

What are High-Yield Investments and Ponzi Schemes?

According to FINRA, high-yield investment programs (HYIPs) are unregistered investments—not registered with the Securities Exchange Commission (the SEC)—that are sold by unlicensed individuals—people not licensed with FINRA. HYIPs are usually offered with a promise of “high, unsustainable rates of return—20, 30, 100 or more percent per day” and a guarantee of little to no risk. Many HYIPs are operated as Ponzi schemes.

The SEC defines a Ponzi scheme as “an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors.” This means that the person running the scheme will promise high returns to a group of individuals and convince them to give him or her their money. Then the person will find other individuals to invest in the scheme and use funds from the second pool of investors to pay “returns” to the initial investors.

In FINRA’s words, Ponzi schemes use “payments from today’s recruits to pay ‘interest payments’ to yesterday’s investors or ‘referral’ fees to those who recruit new members.” Because the “returns” are not actually returns, however, as the SEC explains, Ponzi schemes need new investments consistently and collapse when new recruits are few or when too many investors want to cash out. So, even if the investment does pay as promised for a while, that doesn’t mean it’s a valid investment. If returns are consistently extraordinarily high, something is probably wrong.

How can you spot a high-yield investment program or Ponzi scheme?

unsureFINRA and the SEC give good tips on spotting and avoiding HIYPs. Perhaps the biggest red flags are promises of high returns with very little risk and returns that are too good to be true. Ask the person to explain how the investment produces such good returns and how the person can be so sure. If the answer is secretive, unclear or just too complex, be skeptical because these are signs that the investment may be a scam.

Always be careful with unregistered investments, and don’t invest with unlicensed sellers. Find information on the person offering you the investments by asking the person if he or she is registered and then confirming by conducting a BrokerCheck on the person. As FINRA says, “Ask and check.” Check out the SEC’s and FINRA’s webpages to see all of their tips and red flags.

Further, even if you’re good with social media and the latest technology, be wary of any investments offered through social media. A few years ago, FINRA issued a warning explaining that con artists who run HYIPs “are experts at using social media … to lure investors and create the illusion of social consensus that these investments are legitimate.” This is only a form of a peer pressure, and you shouldn’t let peer pressure influence how you invest your money.

Don’t believe impossible things.

Don’t believe or overlook unbelievable promises. Many people fall prey to HYIPs because they believe people who promise to multiply their money quickly and regularly. To avoid falling prey to an HYIP, be like Alice. If someone makes you a promise that seems too good to be true, it probably isn’t true. Instead of believing the promise and investing with that person, tell him or her that you simply can’t believe impossible things.

If you think you may have already fallen prey to one of these schemes, contact our clinic and we’ll see if we can help. Remember to check back in next week to pick up another tip from the past that could help you save for your future.