Ponzi Schemes and HYIPs – Free Money Traps

With the collapse of Bernard Madoff’s 50 billion dollar investment fund, Ponzi schemes are very much in the news. Recently, the FPA investigated CRE Capitol Corporation and the TradeLite HYIP, both of which turned out to be Ponzi schemes. I’ve covered some of this before in my article about managed forex, but since so many people have lost so much money to both classic Ponzi schemes and HYIPS, I thought this style of scam deserved a more in-depth analysis.

Be aware that not every managed forex fraud is a Ponzi scheme. Both Atwood & James and LegendTrader just found different ways to steal money directly from investors without following the typical plan of a Ponzi scheme.

So, what exactly is a Ponzi scheme?

A Ponzi scheme is an investment that provides returns to investors from deposits, not from investing. In a typical Ponzi scheme, investors are promised a fixed rate of return (usually fairly high) allegedly from some form of high return investment. The original scheme was devised by Charles Ponzi and was based on a legal method (at that time) of using international postal reply coupons. The problem was that there weren’t enough of those coupons in existence to cover all the investment money that poured in. Modern Ponzi schemes claim to make returns based on a number of different investment plans, with forex becoming more and more prominent.

When the first person invests, the company makes very sure the investor gets paid his returns in a timely fashion and encourages him/her to tell friends and family about the investment. For example, if Investor 1 invests $10,000 dollars with PonziFx Investments (fake company name – example only) and is promised a 10% monthly return from their “expertly” run investments. If the scammers keep their overhead costs down, they can pay $1000 per month to Investor 1 for almost 10 months without doing any work at all.

This would seem like a foolish way to scam people, but the scammers have a plan. Whether by advertising or just by encouraging Investor 1 to tell friends and family, they get more investors. Everyone is now making a huge return on their investments. Investor 1 is so pleased, that he might take out a 2nd mortgage and max out his credit cards. Now he places a total of $200,000 with the company. He can now quit his day job and collect $20,000 a month. Of course, he’s a nice guy and tells everyone he knows so they can all share in his success. Some are skeptical, but it’s hard to keep doing the 9-5 thing when 3 of your relatives and 5 of your neighbors have all quit their jobs and are making huge amounts of money with no effort.

Incentives to recruit new people can be monetary (cash bonuses and/or higher interest for the investor who recruits others) or more personal. I don’t know about you, but I’d love to be able to tell my family and friends, “Put your life savings with this company and all your financial worries will be solved forever.” if there really was a company that could always return 5% a month or more per month every month, under all market conditions with no drawdown ever. Wow! I’d be the great fiscal hero to everyone who would listen. This is part of how people get drawn in. People want to believe that they’ve found the perfect solution to all their money problems. Sometimes, they are cautious and just put in a little money to test it out. Once they get a few payments, it’s easy to justify borrowing money at a low interest rate to invest it at a high rate of return.

A well run Ponzi can become huge (current world record – $50 billion), but at some point, it has to end. Either the supply of new investors runs out or the authorities step in – assuming the scammers haven’t already decided just to grab the money and leave town beforehand.

Ponzi Warning Signs

1. Many large promises are made about the skill of the traders or the special trading or investing method (could be forex, could be anything), but details are scarce. Trading statements (if any) are unlikely to give information on what brokerage was used to place the trades. Attempts to get details will be gently deflected. Any serious attempt to get details is likely to result in the scammer threatening to not let the potential investor take part in the investment plan.

2. A web search for the people in charge of the company reveals little or nothing about them, despite claims of having long and successful careers managing other people’s money. Worse yet, the search may show some civil and criminal legal difficulties, but these will be explained away as “misunderstandings” by people who didn’t understand the business. Most of the positive info available is by word of mouth from friends or relatives who have invested.

3. The company will often try to claim that it has a long and solid history, often on Wall Street. There might be a virtual office in New York. There may or may not even be a very nice local office. Asking for information about registrations with the CFTC, NFA, BBB, local, or state authorities will be turned aside, either with excuses about how this isn’t necessary, or with threats to keep anyone who would not take the investment seriously won’t be allowed to invest.

4. An investor who wants to take some time to consider the investment will often be pressured to place money as soon as possible. Of course a legitimate investment manager will want your business soon in order to collect commissions, but excessive pressure to invest now can mean that the scammer is getting short on cash to pay off prior investors or else is getting ready to run off and wants as much money as possible before disappearing.

A serious investor needs to apply logic. Any legitimate company will be very happy to provide information about which regulators, government agencies, and business groups they belong to. Anyone who asks for your money and says that you aren’t entitled to get a full disclosure about the company and how the investments will be handled is either a criminal or a crazy person who thinks that normal rules of investing don’t apply. Anyone who threatens not to accept your investment money if you require basic information about the company is a criminal. The company my IRA is with sends me way too much info about my investments and they are happy to answer any question I have by email or phone. Investment companies should want to give you info, not hide it. Any serious managed investment company that claims to have a long, solid track record will be easy to look up online. Lack of bad information is not the same as the presence of good information. Just because your Aunt Mildred has been getting 10% per month for 6 months is no reason to throw all of your money in without researching the company first.

One special note about the Madoff case. He got a lot of very big names to invest in his scam. He even managed to slide under the CFTC’s radar many times when they checked his company (yes, he really was registered with the CFTC). The reason he got away with it for so long is that he only offered 10% per year. This made his company seem a lot less suspicious, so many investors as well as investigators didn’t examine his books as closely as they should have. Still, some smarter investors who checked things out closely did avoid getting involved.

One other thing about Ponzi schemes. Those who get in early and who don’t add to their investment can end up with a significant profit. So, do you think it’s ok if you got in early enough to have recovered your initial investment and made a profit? Think again. In the Madoff case, the authorities are working to recover any profits made by early investors to help partially repay the losses of later investors. Just because an investor didn’t know it was a criminal enterprise doesn’t mean that the investor can profit at the expense of others. Also, there’s almost no way to predict when a Ponzi will collapse, so trying to invest with the plan to profit before the scheme fails is dangerous and foolhardy. Knowingly taking part in such a scheme can also attract quite a bit of attention from the authorities and other investors after the scheme falls apart.

Free Money from HYIPS?

HYIP stands for High Yield Investment Plan. I can’t prove that they are all Ponzi scams, but am willing to bet that at least 99% of them are. Some HYIPS have FAQs claiming that they aren’t HYIPS, so let me explain some of the more obvious warning signs that something is a HYIP.

HYIP Warning Signs

1. The website will often go on and on about the company having a large team of experts in a wide variety of fields, but when you check the services offered, it’s usually just a set of 2-5 “Plans” paying interest in a daily/weekly/monthly basis for anywhere from a few days to 12 months. Sometimes the interest rate is fixed, sometimes it’s listed as a maximum or minimum. It’s always far more interest than can be had from any legitimate investment. The alleged investment can be just about anything, but forex is very commonly listed. Some of them have names like Real Online Forex, but are just real online scams.

2. A very steep increase in daily/weekly/monthly return as the amount of investment increases. I’d expect to make a little more interest with a legitimate account manager if I place $100,000 instead of $1000, but not somewhere between 2 and 10 times as much. Many also pay investors a percentage to bring in other investors.

3. They usually only accept deposits via one or more e-currencies (Liberty Reserve, e-Gold, StrictPay, etc.), not check, credit card, wire transfer, or anything else easily traceable. Those few that do offer wire transfer almost never have the money sent to a bank in a country with strict regulations. I’m completely in favor of offering a variety of methods to fund and get paid back on investments, but when all of the funding methods are virtually untraceable, this is not a good sign.

4. Minimum investment amounts are typically very low – almost always under $100 and sometimes as little as $1. This is done to lure people in and pay them some huge percentage of profit in order to convince them to invest larger amounts and tell their friends about it. Some people have lost hundreds of thousands when a HYIP disappears.

5. There is usually little or no contact info on the website. Contact is typically only by a web form or an email address. This might be fine for a low-cost or free service, but not for some place that claims to be investing significant amounts of your money.

Try to think about this logically. Some of these HYIPS promise over 5% interest per week. Take a moment to do the math. Even uncompounded, that’s over $250% per year (5%, 52 times). Compounded weekly, that would be over 1000% per year. If this was all there was to investing, why isn’t anyone talking about how great it is in the financial news? These things are very easy to find on the web, so they aren’t secrets. Do you really think there’s a service that gives away virtually unlimited free money with little or no risk? If these really work, why didn’t Bernie Madoff just place a small percentage of the money he had into them and fix the problem he has paying off his investors?

Some people play what I call HYIP games. There are HYIP rating sites that tell if HYIPs are paying out to investors or not. Some of these sites are honest, but many are owned by the HYIP companies and are completely fake. Those who play HYIP games look for sites that are fairly new and are currently paying out while trying to lure more people in. They invest modest amounts and try to recover their initial investments as quickly as possible. They leave some money in and try to get as much as they can from the HYIP before it collapses and takes all the remaining money. Sometimes they lose everything, but they can make enough on the profitable ones to have at least a chance of coming out ahead. Personally, I consider this to be unethical. Every dollar placed with a Ponzi scheme makes it possible for that scheme to continue a little longer and steal more money from more people. Those people looking for that “golden moment” to put money in, grab some cash, and get out with a significant profit are only assisting the criminals and taking money from others who still are falling for these scams.

Take action and save yourself from these scams

In conclusion, keep your eyes open, ask a LOT of questions before placing even 1 dollar with a company that you suspect might be running a Ponzi scheme. Don’t let a desire for high returns cloud your judgment. Don’t place any money with anything even resembling a HYIP, and be very cautious before turning your money over to a person or company that claims to be able to produce stable high returns.

I’ve said this before and I’ll repeat it here. Do some serious research before placing money with an account manager. There are people out there who will spend more time checking out the features of a new TV or stereo system than looking into an account manager or investment funds manger before handing over their life savings. If it takes you a whole month to check out a company, the worst thing that happens is that you’ve lost one month of lucrative returns. If the company turns out to be a scam, you’ve given up nothing and saved all of your money. If you don’t have the time or skill to investigate, spend some money and pay someone to do it for you. You may end up spending a couple thousand dollars, but could save your entire life savings, your home, and more.

It’s your money. Invest it wisely. Learn to trade for yourself or else do the research needed to find a suitable investment plan. Most of these scams are easy to avoid if you know what to look for.