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Cape Town - Ponzi or pyramid schemes use the money of new investors to pay old investors and sooner or later it will collapse. Here’s more about how to recognise one and not to get caught.
Whatever we would love to believe, there really is no quick way to get rich. Wealth is generated by hard work and good investment over a long period of time.
South African consumers have been exposed to numerous ‘get rich quick’ schemes over the decades. These range from the Kubus culture scheme of the 1980s to the doomed-to-fail pyramid schemes of the 1990s that saw ‘victims’ clamouring to get friends and family involved, to the more complicated, but equally flawed, Ponzi schemes that have dominated recent headlines.
Who was Ponzi?
Ponzi schemes were named after Charles Ponzi who operated an ‘investment’ scheme in Boston in the 1920s. He told his ‘investors’ that he could make huge returns for them by buying and re-selling international postal-reply coupons; but he did exactly the opposite. The unsuspecting public (some 30 000 individuals) parted with more than $8m over seven months before the scheme collapsed in a heap and they lost all their cash.
The common feature of a ‘get rich quick’ scheme is a promise of an unrealistic return while the common emotions driving a consumer’s decision to participate in such schemes include desperation, greed and the fear of missing out.
“One of the saddest things about local scams is that they often lure in the old and vulnerable who are desperate to supplement declining retirement incomes due to the current low interest rate environment,” says Justus van Pletzen, the CEO of the Financial Intermediaries Association of Southern Africa.
How Ponzi schemes attract investors
The mere promise of a great return is enough to lure some consumers to part with their hard-earned cash; but the perfect Ponzi must do two more things. First, it must be able to demonstrate that the unrealistic return is being achieved and second, it must have a clever explanation as to how the scheme generates so much more return than mainstream asset managers or banks.
Ponzi – like every Ponzi scheme creator since – realised that the best way to market his scheme was by word of mouth and that positive word of mouth was guaranteed if a handful of ‘investors’ made money. The secret to a successful Ponzi is therefore to make sure that some of the participants are handsomely rewarded – and boast about their windfall.
Another trick is to create a believable ‘hook’ or story that explains the massive returns on offer. The Tannenbaum Ponzi – rumoured to have cost wealthy South Africans around R13bn – convinced participants that they were earning money by buying chemicals and on-selling these to pharmaceutical manufacturers at huge mark-ups. The scam was backed up by authentic-looking documents and a network of connected and high net worth individuals who unwittingly (and sometimes knowingly) encouraged their peers to join.
How to recognise a Ponzi scheme
Here are some signs that you’re dealing with a possible Ponzi scheme, and should look to invest elsewhere:
* If you need to join some sort of club or programme (usually at a fairly substantial cost) and are then promised that you will be paid commission for every person you bring onto the scheme.
* The scheme promises enormous returns on your investment – much bigger than you would get in any other investment scheme at the bank or through a real broker.
* The promises of a life of luxury are hard to resist and scheme organisers rely on people’s greed and desire for easy cash to make them fall for the sales talk.
* Sometimes scheme organisers will provide a list of names of well-known wealthy people who have already invested with them. This probably isn’t true, and if it were, shouldn’t they be protecting their clients’ confidentiality?
* Any mention of a miracle product or cure should make you run a mile. If it really worked, the pharmaceutical companies would have cashed in on it decades before.
* Get out quickly if you are required to buy some product or tool before being able to join the scheme -you are being fleeced.
* The promise of guaranteed returns should make you sit up. All investments carry a risk, even if you invest it in the nearest bank. There are no guarantees in the world of finance.
* Don’t believe first-hand stories of successful investors – they are most probably being paid by the company. In Ponzi schemes the first few investors often do make money, but by the time your everyday investor becomes part of the scheme, those days are long over.
* Ponzi schemes often pressurise potential clients by claiming there is a cut-off point for joining, or by not giving you enough time to read the small print and make up your mind in a leisurely fashion.
* They are also known for making you feel ashamed or stupid if you don’t join and they are not shy to lay on the emotional pressure, especially if you have attended the presentation with your partner.
* Check the financial credentials of any company, broker or investor before giving them your money. Ask to see registration certificates and check if they are real.
* Be extremely wary if someone can’t answer your questions, or claims that it is too complicated to explain.
* If you are having difficulties receiving payments, you should be suspicious. The list of excuses is long: the money is tied up in a 60-day call account in China, or it can only be paid out when both directors have signed etc.
* Beware of people who work through existing social networks, such as churches and professional organisations. They often abuse the trust people have in the leaders of these organisations to promote their schemes.
* Claims that the programme has been endorsed by XYZ bank or government department or the tax man should be viewed with suspicion. Ask for proof and check with the relevant department.
* Ask yourself one question: if these people have found the short cut to untold riches, why are they interested in my cash?
Why do Ponzi schemes collapse?
The short answer is that they simply run out of money. They pay old investors with the money of new investors. That’s also how they pay their operating costs. There is no product or no real investment. And at some point the pool of new investors simply dries up and everything collapses.
When Ponzi schemes go under – and they always do – the crooks that operate them are quick to blame the regulatory authorities for the financial losses that consumers suffer. They argue that the scheme would have been just fine if the regulator had kept its ‘hands’ off. Ironically the consumers end up badmouthing the very regulator that has stepped in to minimise their losses.
Ponzi schemes appeal to consumers regardless of their class or education, with the rich and the poor, the educated and the uneducated all falling for these scams almost daily, according to Van Pletzen.
The FIA’s message to South African consumers is to realise that there is no magic fix to poverty – to accept that there is no way to create money out of thin air – and to understand that the only way to become wealthy is through hard work and sensible saving over a long period of time.
(Partially based on a media release of the Financial Intermediaries Association of Southern Africa (FIA)14 May 2015)
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