The modus operandi of a ponzi scheme; Red flags for prevention

Feb 04, 2019

Introduction

Fraudulent investments always promise higher rate of return which is mostly above the industry prevailing rate to sweeten the pot. The high rate of return is used as bait in order to entice prospective clients/customers/investors. However, the scheme offers reasonable guaranteed above-market rate, so as not to make it suspicious or attract attention.

Ponzi scheme is named after the popular Carlo Charles Ponzi who in the 1920s used an investment vehicle to take advantage of a weakening foreign currency. He purchased international postal coupons overseas to be redeemed for US postage stamps, and then he sold them off for a profit. However, over a period, it gradually became very difficult to sustain the profit due to the huge burden involved in redeeming these coupons.

Charles Ponzi instead of abandoning this unsustainable investment product rebranded and pitched a new investment product to potential investors. The new products promised a rate of return of 50% on the investment in 45 days or double the investment amount in 90days. Ponzi advised investors that he would achieve such returns through a “network of international agents,” they would purchase the postal reply coupons on his behalf. He withheld further details of how he would achieve such returns “due to competitive reasons.” In reality, Ponzi was merely paying off early investors with new investors’ funds while making no new purchases of postal reply coupons.

Ponzi schemes are dependent on new investors to pay earlier investors; by definition they are mathematically doomed to fail. Ponzi schemes are not sustainable because eventually it reaches a point at which there are no newer investors in existence to fund investment returns and returns of capital to existing investors.

The Red Flags and Warning Signs

  • Fraudulent investment schemes always promise high interest rate on your investment.
  • As a basic aspect of human nature, fraudulent schemes thrive on investor greed. It is important to point out that fraudulent investment schemes do not need gullible or unsophisticated investors only to leverage greed. In most cases, investors are well educated and financially prudent individuals or organizations. What is important is the ability and creativity to build the illusion of above-market or guaranteed returns to entice people or organizations to reinvest for even higher returns.
  • There is an assurance of consistency in paying the interest component on the investment.
  • The risk associated to the investment product is mostly not disclosed to the investor.
  • The investment process and procedure is mostly not well documented and agreement of contract is mostly on a one-page sheet.
  • Investment agents/managers mostly use the attractive high interest rate above what the market is offering as selling tool.
  • In most cases, the individual or executives behind the fraudulent scheme portray believable credibility enough to convince the initial investors to leave their money with him.

Impact on the Economy

These fraudulent schemes mostly focus on potential victims who share a common bond, such as faith group, social club, and professions, to build especially trust. History proves that, this affinity fraud links has been the key factor to the success of most such fraudulent schemes across the globe.

  • The impact of fraudulent schemes is far beyond what hits the investors who loses all his money. The public trust and confidence in the financial system would be affected, especially institutions that are doing legitimate business.
  • Investors lose confidence in the financial system and move their investments out of the banks/institutions to safety. 
  • Financial institutions lose funds which could be made available to the private sector for economic growth due to locked up or fraudulent investment schemes.
  • The trust shocks to individual who lose their investment have long lasting effects on their mind and may affect the investment culture in the country.

Prevention by the Regulators and Citizens

  • Regulators should enforce their oversight responsibilities and collaborate more to enhance coordination amongst them. This would make it easy to clampdown on these fraudulent investment schemes.
  • Industry watchdogs should collaborate more with all other stakeholders especially the media for information on suspicious investment schemes in the communities.
  • Regulators should carry out regular monitoring of the operations of financial and non-financial institutions operating in the country.
  • Policies for incentivizing and protecting whistleblowers must be enhanced to make it easy for citizens to collaborate with the industry watchdogs. This is because it’s difficult for authorities to find out all the remote corners such schemes are operated.
  • Deepen financial literacy at all levels of education and local communities. This will sensitize citizens on the right questions to ask when making investment decisions.

Conclusion

Fraudulent investments schemes have some common characteristics that run through them all, the promise of high rate of return above the offering market rate, guaranteed returns and concealing of investment risk from the investor. Several fraudulent investments schemes have occurred in Ghana, some examples of these are R5 and Pyram Ghana, MMM Ghana, Savanna Gold Ltd, US Tilapia, DKM and God is Love and Menzgold etc. These investment schemes have something in common which is the offering of higher rate of return and guaranteed return.

It is very important that every individual seeks investment advice or consult professionals with experience before signing on to any investment scheme. Proper due diligence must be carried out on any non-financial investment institution/investment bank before dealing with them. 

 

©Jerry.J.AFOLABI is a Financial & Economic expert who believes that ordinary people can do extraordinary things when given opportunity. He is a Change Maker with the ability of easily getting people to get things done for the good of humanity. Email; This email address is being protected from spambots. You need JavaScript enabled to view it./0541238987

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