What is a Ponzi Scheme?

A Ponzi scheme is a deception in which people are enticed into investing money in exchange for the promise of unusually high returns within a short period of time, with earlier investors being paid off from the cash extracted from later investors. The person operating the scheme puts all of his efforts into attracting new investors, since new ones are needed to maintain an increasing inflow of cash. One action taken to attract the more skeptical investors is to pay out promised returns to early investors, which spreads the word that the operation is legitimate. In fact, their initial good fortune in being paid the advertised returns may lead early investors to re-invest in the scheme, along with their friends and family.

The deception eventually collapses when the stream of incoming cash flows declines below the amount of outgoing cash flows. The person originating the deception typically disappears with all remaining cash shortly before the scheme would have collapsed anyways. The scheme is named after Charles Ponzi, who operated such a deception in the 1919-1920 time period, bilking more than $15 million out of investors.

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A Ponzi scheme may be in operation when one or more of the following indicators are present:

A promise of high returns
A continuing stream of reported earnings, irrespective of market conditions
Difficulty extracting money from the operation, especially after it has been operating for some time
Investment strategies that are described as secret
A lack of registration with the Securities and Exchange Commission