Ponzi schemes

Dividends but no real investment

One of the simplest yet most effective investment scams is the ponzi scheme. The promoter promises investors a return on investment and says it is secure, but there is no real 'investment'.

The promoter convinces people to invest with their scheme. They then use the money deposited by early investors to pay the first 'dividend' until investors feel comfortable and decide to invest more. Some investors then encourage their family and friends to join. Eventually the scheme falls apart because the promoter starts to spend the money too quickly or the pool of investors dries up.

Here are tips on how to pick a ponzi scheme from a real investment.

Warning signs of a ponzi scheme

  • The rate of return is sometimes suspiciously high (maybe as high as 10% per month or 120% per year)  - but it can also be just the usual rate of return
  • The person who tries to recruit you is someone you think is trustworthy, like a neighbour or someone in your church or community group
  • The recruiter may have already invested in the scheme and received great dividends

Read ASIC's media releases about the conviction of ponzi operator Chartwell Enterprises, and a penalty and ban issued to ponzi 'mastermind' David Hobbs

Case study: Maria invests through a friend

Couple On Park BenchFirst-time investors Maria and Jason borrowed $70,000 to invest in the overseas money market after a recommendation by their friend of 40 years, Steve.

Steve told them their investment would involve no risk at all, as it was guaranteed by the Bank of America. He said they could withdraw their capital at any time after the first 12 months. The return promised on the investment was fantastic (26% per year on their initial investment). Steve helped the couple arrange to borrow the $70,000 they would invest.

But the scheme was not real - they were caught up in a ponzi scheme. Part of the money they and other early investors deposited was used to pay their first dividend cheques. When the money for dividends dried up, Steve said that it was due to the interference of ASIC. This was one of many false stories fed to the investors by Steve, to keep them onside.

Jason and Maria were angry with ASIC as they thought the organisation was ruining their chances of making money from their investment. They wanted to believe Steve, as they didn't want to think they had lost all their money, and he was an old friend.

When the truth eventually came out that the scheme wasn't real, Maria and Jason, along with the other investors, assisted ASIC's investigation and prosecution of Steve and his business partner -- who spent more than 2 years in jail.

Maria and Jason lost their $70,000 and ended up having to pay off the loan. When Jason's mother died, his inheritance was completely swallowed up by the $70,000 debt plus interest. 

Jason and Maria are now very wary, and warn others to get a second opinion from a licensed financial adviser before investing in anything.

This is a true story - only the names of the investors have been changed at their request.

Where do ponzi schemes operate?

Operators of unlawful investment schemes sometimes target community groups, like churches, to find victims. In some cases, members of the community group innocently encourage others to put money into the illegal scheme.

This means that when the scheme collapses, not only do the investors lose their money, but relationships break down between friends, neighbours or community group members.

Ponzi schemes targeting Thai communities

ASIC Victorian Regional Commissioner Warren Day talks to SBS about how members of the Australian Thai community are falling victim to Ponzi scams operated through Facebook.

Warren Day interview on SBS (23 mins)

How long can the scheme last?

If the promoter of the scheme is disciplined about how much money is left in the account to pay 'dividends', the scam can go on for many years. Ponzi schemes only require a few people in their early stages to be successful.

How ponzi schemes work

An example of how a ponzi scheme works is shown in the table below. In January, the promoter convinces Katie to invest $100,000 in his scheme. The promoter then pays Katie $10,000 each month using Katie's own money.

As Katie receives $10,000 each month she doesn't suspect anything is wrong, and happily recruits friends and work colleagues to invest, too. After 3 months, Katie's neighbour Adam decides to invest $100,000 after hearing about Katie's great returns.

After both Katie and Adam have invested their savings, the returns continue to come in April. But in May they don't hear anything from the promoter. They try to contact him but his number has been disconnected.

The promoter has taken off leaving two devastated people in his wake. Katie lost $70,000 and Adam lost $90,000. The promoter got $160,000 out of the scheme.

This is example has only two victims but in reality these schemes can have dozens or even hundreds of victims.

Katie and Adam invest in a ponzi scheme

Month Katie Adam
January Invests $100,000 -
February $10,000 returned -
March $10,000 returned Invests $100,000
April $10,000 returned $10,000 returned
May No contact No contact

The power of a Ponzi scheme

In this episode we take you behind the scenes of a Ponzi scheme where unbelievably good returns are offered to investors, the scheme operator seems to be trustworthy - but it's all smoke and mirrors.
ASIC investigators Kaan Finney and David McArthur explain how Ponzi schemes work, how operators attract investors, how ASIC investigates and shuts down these schemes and most importantly, how can you can avoid getting caught up in a scheme.

Katie: I'm Katie Davis-Hall-Watson and welcome to the official podcast of the Australian Securities and Investments Commission. Today we'll take you behind the scenes of an investment scam called a ponzi scheme with ASIC investigators Kaan Finney and David McArthur. Welcome David and welcome Kaan.

David/Kaan:  Hi Katie. Hi Katie

Katie:  So David, can you tell us what is a Ponzi scheme and how does it work?

David:  It's an investment scam where the promoter convinces people to invest in the scheme. Money is deposited by early investors and used to pay the first round of returns. However, new money invested is used to pay older returns to investors. People are led to believe there is an investment because of this when often there actually is no investment at all or the investment is not what they think it is.

It's like a washing machine and money goes round and round. New money comes in to pay old investors. They put their money in and they see the initial returns and they're very good, so people are given confidence to keep investing or keep their money in the investment.

We've seen returns very high, promised very high in these schemes, as much as 10 per cent a month. Which is obviously very high so if you put in $10,000 in a month you'd get back $1000, so that's obviously an obscenely high return.

Katie:  So Kaan, tell me where does the name 'Ponzi' actually come from?

Kaan: Well this is an interesting story Katie, it comes from Charles Ponzi who ran exactly the scheme that David just spoke about back in the 1920s and he thought he had actually found, theoretically, a way to make money whereby he was buying effectively postage stamps from Europe and then he was able to sell them in the United States and make a small profit, only somewhere in a few cents in the dollar on the postage stamps that he sold. But he convinced everyone, a lot of people, that this was a way that he could make significant returns for them, so a lot of people started tipping money into his scheme and he started paying people; new investors out of old investors' money. And really built up what would, in today's terms be, millions of dollars' worth of investors and then was able to buy into banks and when the whole thing collapsed, he almost brought down a number of banks in the United States.

Katie:  So Kann, in the cases you've investigated, how do people get caught up in these schemes?

Kaan: Well Katie I think the word that comes to mind is 'trust'. People just have trust in the ponzi operator and the ponzi operators exploit that trust and take advantage of those people's good nature in terms of getting money out of them. And they convince them that they've discovered, the ponzi operator has discovered a secret way to make money and Dave and I always say, you have to think if someone's discovered a secret way to make money, why would they be giving it away to other people. And they will target particular communities to get deep into that community and exploit that trust within the community.

Katie:  So how do they build up that trust with a community?

Kaan: Well often they will use family and friends to spread the word. And there's nothing better than a recommendation from a family or friend, even just for a holiday trip, but it's the same with investments. So, people think, well if my friends invested and they're getting returns, I want to get in on this action as well and they feel like they are missing out if they don't get in on the action.

But you know we see people who try to do the right thing every now and then. So in one case we saw a guy who only invested a small amount initially to make sure the scheme actually worked, sort of $10,000 and then he built that up over the next 6 to 8 months and invested $30,000 and then $90,000 and eventually he tipped all of his money in - almost $400,000 and the scheme collapsed a couple of months later and he lost everything.

Katie:  So, can you tell us about a ponzi scheme you've investigated and take us through the case?

David: Sure. So, one case we've investigated was a ponzi scheme operator called Sunny Madhoji, in Brisbane, in Queensland. He was ultimately charged with 55 counts of fraud. This was a joint investigation with the Queensland Police. He was convicted in 2016 and sentenced to over 7 years imprisonment. He was also banned for life from providing financial advice by ASIC.

Interestingly he was actually a licensed adviser. He was only licensed to deal in wholesale products. His strategy involved trading in shares for a pool of clients. Now he marketed himself as a very successful share trader and mathematical genius, which he used, apparently to do his trading. He started losing money he was trading for people. To cover his tracks he started taking money from other people's accounts to put into the accounts he needed to, to honour redemptions. This obviously caused a lot of problems and the scheme ultimately imploded which caused the loss of over $3 million in losses to clients.

Strangely enough he didn't actually profit financially himself. It was only his reputation that he wanted to secure so he was stealing money from other clients and moving it around to make sure that his reputation remained intact.

The clients in this matter agreed to allow Madhoji to have complete access to their funds so that he could trade at his discretion. This was obviously a highly aggressive and risky format and not a format that would be recommended by any retail financial adviser.

Katie:  Kaan, why does ASIC take on these cases like this?

Kaan:  Well ASIC wants to maintain trust and integrity in the financial services system and we often find that these schemes have a financial services element. The operator is saying that they are investing into foreign exchange or into equities, those sorts of things so there is that financial services element. And we like to take strong enforcement action to both punish the offenders and deter other ponzi scheme operators.

We also like to, where we can, obviously, grab hold of whatever assets are remaining so there can be some return to investors but this can be difficult because often, by the time it's reported to ASIC a lot of the assets are gone so we encourage people where they think something's not right to report it to ASIC as early as possible so that we can look at it.

These are often complex investigations however, and that means we have people, the ponzi operator, trying to deceive both us and the investors. And so, they can be lengthy investigations.

Katie:  So Kaan what are the penalties for running a ponzi scheme?

Kaan:  Well there are criminal offences that can be committed if a person runs a ponzi scheme because effectively they are just committing fraud against the investors and some of the penalties for fraud are up to 14 years.

Recently some of the other offences under the Corporations Act, the penalties have been increased and the Courts certainly take a dim view of people who engage in this sort of behaviour.

Katie:  So, David, what should investors look out for to avoid getting caught up?

David:  You always have to ask yourself, 'Is this too good to be true?' It probably is. You need to do good due diligence. Firstly you need to check that they have an Australian Financial Services Licence with ASIC. You need to really look at the company and make sure the word of the operator and your friends is not just what you are going on. Despite the fact that we all know a personal recommendation from a friend is very persuasive, but we need to look into that and be sure we are getting what we think we are.

It's important to realise that a professional website, persuasive-looking materials and documents, doesn't necessarily mean that the company is legitimate. You need to ask yourself: 'What do you really know about that company and the people running it'? If you are entrusting someone with your hard-earned savings you need to be really sure that it is what you think it is.

Katie:  So Kaan, what other tips do you have for people to avoid getting caught up in ponzi schemes?

Kaan: Well we always recommend you deal with a licensed financial adviser and you can check whether they are licensed and what products they can advise on, on our Financial Advisers Register. But if you are offered an investment opportunity from someone you trust, a family member or a friend, then go out and get that advice from someone who is independent and who is licensed and authorised to provide advice and see what they say about the investment opportunity.

Katie:  Thanks so much Kaan and David, thanks for speaking to us today on the podcast.

There are more practical tips on how to avoid ponzi schemes and other types of investment scams on ASIC's MoneySmart website or you can subscribe to our media releases to find out about the latest matters we are investigating here at ASIC.

And if you have feedback on this podcast, we'd love to hear your thoughts. Send us a tweet to @ASICmedia

 

What to do if you have invested in a ponzi scheme

  1. Stop investing any more money
  2. Check if the company is on our list of companies you should not deal with
  3. Check the company's licence number on ASIC Connect's Professional Registers.
  4. Report the scam to ASIC

ASIC may be able to prosecute the ponzi scheme operators if they are operating in Australia. ASIC may also be able to issue an alert about the scheme. You should also warn your family and friends, to stop them from becoming victims.

The biggest telltale sign of a ponzi scheme is the suspiciously high rate of return. That old saying applies here: if it sounds too good to be true, it probably is.

Before you invest in any scheme, do independent checks to see how the returns are really going to be made. Don't just trust the word of the person selling you the scheme.


Related links


Last updated: 21 May 2019