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Securities Lawyer Jonathan Kurta
By: Jonathan Kurta Author

Red Flags of a Ponzi Scheme: What the SEC Wants Investors to Know  

“Ponzi schemes” are familiar headline fodder, but do you know the warning signs for this type of investment fraud? Ponzi schemes are investment scams that steal money from investors under the guise of an impressive, sure-fire investment strategy. However, instead of investing the money in legitimate investments, the conman simply uses the money to pay previous investors, presenting the stolen money as a return on their investment. In the meantime, the conman keeps plenty of investors’ money for himself. 

Since Charles Ponzi’s infamous scam in the 1920s, Ponzi schemes have flourished. According to The Wall Street Journal, in 2019, six huge cryptocurrency Ponzi schemes were responsible for 90% of money stolen through illicit transactions. Ponzi schemes draw in investors with the scammer’s favorite formula: a promise of immense wealth, accrued in a short amount of time, with no risk to the investor’s capital. 

How Do Ponzi Schemes Work? 

All scammers need to start their Ponzi scheme is a reliable stream of new investors. The Ponzi scheme might also double as an affinity scheme, in which a scammer preys on investors from their ethnic or religious group. People more often trust members of their own community, adding to the scammer’s credibility. 

Ponzi schemes are always doomed to fail. Even if the SEC doesn’t immediately catch on, the scheme will eventually run out of people to dupe. Then, new investments dry up, and the payments to investors suddenly stop. At that point, investors get suspicious and demand their money back. Then, the scheme begins to unravel. 

Bernie Madoff Ponzi Scheme 

Since December 2008, Bernie Madoff’s name has been synonymous with Ponzi schemes. At the time of his arrest, he had stolen billions of dollars from tens of thousands of investors—one of the biggest Ponzi schemes in history, spanning approximately 17 years. Investors are still recovering from their enormous losses. 

Ponzi schemes did not die with Bernie Madoff. The SEC regularly announces allegations that seemingly legitimate investment opportunities served only to line the pockets of their promoters. 

The History of the Ponzi Scheme  

Ponzi schemes take their name from Charles Ponzi, an Italian immigrant who started his scheme in Boston, Massachusetts, in 1919. While Ponzi did not technically invent this type of scam, the sensational media coverage of his fraud gave the swindle its name.

Charles Ponzi told his first investors that he would pay them approximately $150 for every $100 they lent him, every 45 days. Ponzi told investors he could generate this incredible 50% return using arbitrage. 

Arbitrage is a trading instrument that seeks to profit from pricing inefficiencies of certain assets. Traders simultaneously buy and sell an asset, allowing the trader to make money from the often minuscule differences in price. Charles Ponzi claimed to use arbitrage to take advantage of price differences in international postal coupons by buying postal coupons in foreign countries and redeeming them in the U.S. for a profit. (The exchanges for postal coupons were set by treaties and did not factor in exchange rates.) 

One Boston Post headline read: “DOUBLES THE MONEY WITHIN THREE MONTHS; 50 Per Cent Interest Paid in 45 Days by Ponzi—Has Thousands of Investors.” While his scheme lasted, Charles Ponzi lived in the lap of luxury. This is another hallmark of a Ponzi scheme — perpetrators spend lavishly while awaiting the inevitable demise of their scam.

Ponzi paid his first set of investors their 50% returns on time, adding an air of legitimacy to the scheme. But the U.S. Postal Department officials knew that Ponzi could not be making as much money as he claimed. There simply were not enough international postage coupons in existence to generate such massive returns. One financial writer pointed out this flaw, suggesting that the returns that Ponzi claimed to generate were impossible in such a short timeframe. Charles Ponzi successfully sued the writer for libel and won $500,000—a major discouragement for any future whistleblowers. 

Eventually, a federal investigation caught up with him, and in 1921, Charles Ponzi pled guilty to mail fraud. He served more than ten years in prison. Like Madoff decades later, Ponzi maintained that his scheme could have worked under the right circumstances. 

Ponzi Scheme Red Flags 

The SEC highlights the following Ponzi scheme characteristics: 

  • Huge returns with low risk. Ponzi schemes almost always offer a huge return with seemingly little risk. This should always raise an investor’s suspicion because higher than average returns always come with increased risk. 
  • Guaranteed returns. There are no “guarantees” in investing. Guaranteed returns signal that something is not right. 
  • Unregistered securities. Legitimate companies register investments with the SEC. Before investing, look up a security on the SEC Edgar database
  • Secret strategies. When the Post Office pointed out that Charles Ponzi could not make returns for investors using postage coupons, he became more secretive about how he actually made money, saying, “My secret is how to cash the coupons. I do not tell it to anyone. Let the United States find it out, if it can.”
  • Problems cashing out. Because of the nature of the Ponzi scheme, scammers do not want investors taking their money out of the business. They may take a long time to fulfill a cash out request, or they might persuade an investor to leave their money alone by promising even bigger returns at a later date. 
  • Novel investments. Ponzi schemes often use the latest hot investment as their hook for investors. Today, many new Ponzi scheme cases involve cryptocurrencies. 

Ponzi Scheme: Cryptocurrencies 

As the SEC stated in a recent investor alert, cryptocurrencies are a hotbed for Ponzi schemes because “Potential investors are often less skeptical of an investment opportunity when assessing something novel, new or ‘cutting-edge.’” We have all heard stories about Bitcoin millionaires, lending some credibility to the idea that an investment in cryptocurrency could come with incredible profits. 

A recent cryptocurrency Ponzi scheme ripped off investors who wanted to make money from a seemingly plausible strategy–using arbitrage to exploit Bitcoin pricing inefficiencies. (Sound familiar?) In 2016, a federal court sentenced Trenton Shavers to 18 months in prison following the reveal of his Bitcoin Ponzi scheme, the first documented of its kind. According to The Wall Street Journal, at one point, Shavers owned 7% of all Bitcoin in circulation. Shavers’ scheme bore several classic hallmarks of a Ponzi scheme: 

  • Shavers promised investors astonishingly high returns of 7% per week on their Bitcoin investments. 
  • The SEC complaint states that Shavers claimed to be using arbitrage, and providing large sums of Bitcoin to individuals who wanted to purchase Bitcoin quickly and in large quantities. Shavers claimed the return came from the exchange rate of Bitcoin to cash. 
  • Instead of providing Bitcoin to clients, Shavers used the money for his personal expenses and attempts at day trading, which lost money. 

Since then, massive cryptocurrency Ponzi schemes like PlusToken have followed similar scripts, promising investors returns of 10% to 40%. PlusToken is one of the largest cryptocurrency scams to date—before it collapsed in 2019, it raked in approximately $2 billion. As an added pyramid scheme bonus, PlusToken promised increased returns for participants who recruited more investors.

Ponzi Schemes vs. Pyramid Schemes: What’s the Difference?

Ponzi schemes and pyramid schemes rely on the continuous recruitment of new investors to keep going. But while a Ponzi scheme manager might encourage new investors to recommend this exciting new investment to their friends and family, they do not offer commissions to their investors for bringing in new recruits. Pyramid schemes make money by providing participants with a monetary incentive to recruit new participants.

Are All Ponzi Schemes Illegal? 

Anyone facing Ponzi scheme criminal charges could face jail time, disgorgement (an order to repay ripped-off investors), and fines. 

Some perfectly legal investments have characteristics in common with Ponzi schemes. Investors should be wary of partnership agreements that allow for dividends to be paid using new investments, according to an article from The Wall Street Journal entitled “Look Out for Ponzi Schemes, Including the Legal Ones.” Private placements might also include language that allows for investments to go toward managers’ personal expenses, a characteristic that may seem uncomfortably similar to a Ponzi scheme’s operations.

Brokers should provide clear information on how an investor’s money will be spent. If investors believe their broker misled them, they should contact a securities attorney for a case evaluation.

How to Get Out of a Pyramid Scheme 

Investors who bought into a Ponzi scheme should consider their legal options. It may be that their brokerage firm failed to supervise their representative broker. Investors have been able to recover lost funds, for example, following allegations that Oppenheimer failed to supervise a broker who allegedly operated a Ponzi scheme using connections through his work at Oppenheimer. He even transferred money to his Horizon Private Equity III scam from Oppenheimer accounts. 

In some cases, investors have successfully recovered money through “clawback lawsuits.” Clawback lawsuits have allowed Madoff investors to recoup money from banks that funneled investors’ money to Madoff, as well as from early investors whose “profits” were really just payments from subsequent investors. 

Contact Kurta Law if you believe you may have suffered losses as a result of a Ponzi scheme. Our securities attorneys can help you gather the information you need to prove your case to the Financial Industry Regulatory Authority. Investors who suspect they may be involved in a Ponzi scheme should also report the scheme to the FBI or the SEC.


Securities Lawyer Jonathan Kurta
Written by: Jonathan Kurta

Jonathan Kurta is an accomplished securities attorney and a founding partner at Kurta Law.