What is a Ponzi Scheme?
Any fraudulent or scam investment operation in which the operator, an organization or an individual, pays returns to the investors not from the profit they make but from the new capital paid to the operator by some new investors is known as a Ponzi scheme. Generally, the operators lure investors on the promises of giving higher returns than on other investments. The promised returns are either
unusually higher or consistent. In order to maintain the scheme and perpetuate high returns, it is vital that the flow of capital from new investors remains in an ever increasing mode. These schemes are generally commenced as legitimate investment vehicles. People plotting Ponzi schemes target investors who lack competence and knowledge.
How Ponzi Schemes Operate?
Let us understand how a Ponzi scheme actually operates. At first, an operator will promote an investment plan in manner that the investors find it attractive. The benefit of high returns is promised and a setup is created to show how such abnormally high returns will be achieved. To keep luring more investors as well as to urge current investors to put in more capital they will pay out high returns. As many new investors will start to participate, it will lead to cascade effect. Then the operator pays the return to the initial investors from the capital being invested by the new investors rather than from the profits the operator is making. Also, as the investors are receiving higher returns, they tend to leave their money in the scheme. Thus, the operator has to just send a statement showing them the money they are making, thereby, maintaining the deception.
The operator works on reducing withdrawal of capital by investors, too. This is done by offering them new, attractive plans. Thus, their money gets frozen for a long period. New capital keeps coming as the investors can’t transfer their funds from one plan to the other. To maintain the illusion of a solvent fund, the operator quickly processes the request of withdraw if emphasized by an investor as per the terms. Unless stopped by the authorities, Ponzi schemes eventually fall out. The risks involved are high. Initially, as an investor your money gets frozen in a particular plan for a very long duration. And eventually the promoter/operator is going to dupe you and run away with all the capital. This can prove detrimental to your bank balance and may leave you broke. Such schemes are very meticulously planned and are hence, a little difficult to determine. Thus, it is always recommended to do a thorough financial analysis of the company before investing in any of its plans. Also, think carefully before you reinvest in further schemes being offered by the company.
Biggest Ponzi Scams Cases
Two popular Ponzi schemes were the Sahara and Amway cases. Sahara Company was involved in raising funds through illegal means. Two of the Sahara Group companies issued OFCD(Optionally Fully Convertible Debentures))s in order to raise capital from about 3 Crore investors. The scheme sounded genuine but it was kept obscure enough to prevent investors from scrutinizing it. The companies also encouraged its investors to reinvest their capital in other new schemes as well. A reasonable financial analysis of the Sahara Group is difficult to make, as little financial information about them is accessible to the public. Thus, it became easier to keep the investors away from detecting the deception. When the case came into light through SEBI, the company was asked by court order to make a repayment of more than INR 24,000 Crore to its investors.
The Amway case involved luring investors into a plan where easy money was promised. The investors were to get as many new people into the plan as possible thereby leading to circulation of illegal money. It was also reported that the company was violating the Prize Chits and Money Circulation Schemes Act. It was found that the company was charging ten-fold the actual cost of the product. The scheme was such that nobody was actually interested in selling their products. The money being made by the distributors was actually the money acquired from new distributors who were charged with a certain amount of commission for joining Amway’s MLM scheme. No legitimate business activity was being actually carried out. Some arrests were made when the scam blew out.
Saradha Chit Fund Scam Case:
Saradha Group involved in such ponzi and collapsed last year after collecting small deposits and promising payouts of land or cash, with interest rates as high as 24%. The firm defaulted on thousands of deals, and 1.74 million customers saw their savings vanish.It raised political temperature in West Bengal as few ruling politician were also found involved in this scam.
Also Read Top 10 Corruption Scams in India