Money Matters
5:00 am
Tue October 15, 2013

Could You Fall for a Ponzi Scheme?

If a financial adviser offers you a quick way to double your money, should you go for it?

Hold on to your wallet! The bigger the promised return, the more skeptical you should be.

On this week’s Money Matters, Greg Heberlein looks at Ponzi schemes and how to avoid them.

Charlatans have a number of ways to separate people from their money. The Ponzi scheme has been a popular method for over 100 years.

Ponzi comes from Charles Ponzi, a charismatic man who in just a year duped investors out of $20 million in the early 20th century.  

His tactic: promise investors enormous returns—a doubling of your money in 90 days, then recruit new investors to pay off the old investors. 

Ponzi was in and out of jail several times before he was deported in 1934. He concocted numerous scams in his lifetime. 

How was that possible? 

He had a silver tongue.

In one of several trials regarding the $20 million, two juries failed to convict Ponzi because of his spellbinding oratorical skills. But he couldn’t evade jail the third time. So the term Ponzi scheme became the name applied to scams where the cash from newcomers is used to repay earlier investors.

The biggest Ponzi scheme ever was conducted by New York investment manager Bernie Madoff

In 20 years ending in 2008, Madoff bilked more than $17 billion from nearly 5,000 investors. He's now serving a 150-year prison sentence.

The Pacific Northwest is no safer than other regions. At least three Ponzi schemes have been detected in Washington and Oregon in the past several years.

The biggest ever in this region was the work of Darren Berg

Berg was an investment manager who persuaded individuals into putting money into his business of buying and selling mortgages. 

In Berg’s case, there was an actual business at the outset. But in 2008, when the real estate market began a steep decline, Berg was in trouble. So the money he then raised was used to repay earlier participants. 

Berg was arrested in 2010. His scheme affected more than 500 individuals. The losses exceeded $100 million. He's serving an 18-year sentence.

It’s easy to say that with a little homework, the savvy investor could avoid such a rat hole. 

But it’s not that easy. 

By all accounts, Berg—and many before him—was suave and easily able to capture your confidence. Berg was so good that two prominent investment companies were taken in. That suggests the odds of fooling a non-professional were pretty good.

An irony in the Ponzi business: early investors can come out whole (however, eventually the bankruptcy court will go after those ill-gotten gains). But many of those early investors, thrilled with their extraordinary returns, reinvest their cash and often lose it all when the scheme collapses.

The ways to avoid such a disaster are complex, which is why Ponzi schemes work in the first place. 

Potential investors must do everything they can to make certain the financial adviser is legitimate, to dig as deep as possible into the person’s background, and to be especially wary about exotic or obscure proposals. 

Sadly, older people, who are investing their retirement savings, are especially susceptible. Nearly half of all complaints regarding the financial industry come from those aged 65 and over.

Buyer beware! 

If the deal sounds too good to be true, it likely is.