David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.

We have all heard the term “Ponzi Scheme” in relation to Bernie Madoff and other investment scams, but just what is Ponzi Scheme, and how can you avoid being a victim of such a fraud?

The term “Ponzi Scheme,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation and fraud deterrence programs in the Delaware Valley, can be traced back to Charles Ponzi, an early 20th century Italian immigrant.

Interestingly, Ponzi didn’t even come up with the concept that bears his name, but instead, learned it from an early employer – a Canadian bank – that was using a similar scheme. Ponzi merely copied the ruse and used on a grander scale.

In 1919, Ponzi discovered money could be made using International Reply Coupons (IRCs), which were used to cover the cost of postage from one country to another.  Ponzi learned IRCs could be purchased cheaply in Italy and other European countries, and could be exchanged, said Certified Fraud Examiner Anderson, for U. S. postage stamps of a higher value. These then could be sold to the U. S. Postal Service or others. At the time, this was a completely legal way to make a profit.

However, Ponzi lacked the funds to make a significant profit from IRCs. To work around this, he set up a company to raise funds.  He promised investors a 50 percent return on their investment in 45 days, and delivered on that promise.  Based upon this initial success, Ponzi created another company to promote his scheme.

Initial investors also saw this significant return on their investment, and word about Ponzi’s investment returns spread like wildfire. Initial amounts invested with Ponzi’s company were $1,800 in the first month, $3,200 in the second month, $20,000 in the third month, and another $2.5 million in the next three months.  By the end of the seventh month, Anderson said, people were investing $1 million per day with Ponzi.

Ponzi was so busy handling new investments that he never got around to implementing his legal scheme to use IRCs.  Instead, he was paying off earlier investors with funds received from later investors.  Ponzi also realized early on that his IRC scheme was impractical to implement.

For example, just to produce profits for the first month investors – those who provided him with $1,800 — Ponzi would have had to purchase more than 50,000 IRCs in Italy and have them shipped to the U.S. for exchange and resale of the U.S. postage stamps.  For the $1,000,000 a day he was taking in by the end of the seventh month, he would have had to purchase approximately 28 million IRCs a day and have them shipped to the U.S. for exchange and resale of the U.S. postage stamps.

Of course, no one was really thinking about this.  Instead they were thrilled about the tremendous profits they were making on their investments and, instead of withdrawing their investments and profits, many were reinvesting these with Ponzi. This only added more fuel to the fire. When a financial writer wrote an article suggesting there was no way Ponzi could effectuate his scheme, Ponzi sued the writer for libel and won – at that time, the burden of proof was on the writer and the paper that published the article.

Things began to unravel for Ponzi during the eighth month of his scheme.  The noted financial journalist Charles Barron, who headed Dow Jones & Company, began to examine Ponzi’s scheme.  He quickly noticed that, based upon the investments received by Ponzi, Ponzi would have had to have purchased and exchanged more than 160 million IRCs.  However, the U. S Post Office reported that only about 27,000 IRCs had been exchanged, including IRCs purchased by other people for actual postage exchange, not millions upon millions.

Furthermore, Barron performed an analysis that showed the cost of purchasing an IRC, bringing it to the U. S., exchanging it for U. S. postage stamps, and selling those stamps would be more than the profit differential that could be realized from the IRC.

By the middle of the eighth month of his scheme, government officials had stepped in and audited Ponzi’s books, which along with newspaper reports revealed that Ponzi had less than $4 million in assets remaining from almost $25 million in invested funds.  Ponzi surrendered to authorities.  His investors ended up receiving less than 30 cents on the dollar.  Ponzi pleaded guilty to fraud less than eleven months after his scheme began, and was sent to prison.

As a footnote, after getting out of prison, Ponzi went to Florida and began selling swampland to investors, promising them a 200 percent profit in just 60 days.  He was convicted for this fraud and served additional prison time.

As can be seen from the foregoing narratives, Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation and fraud deterrence programs in the Delaware Valley, said a Ponzi Scheme generally consists of these characteristics:

• An initial required investment for which the fraudster promises or guarantees significantly higher investment profits than the investor can obtain elsewhere.
  • In Ponzi’s case, he was offering a 50 percent profit in 45 days while most banks were paying 5 percent interest per year;
  • In Bernie Madoff’s case, regular returns, even in years when the stock market was significantly down;
• A vague or highly complex description of the basis by which the profits will be realized.
  • In Ponzi’s case, the overseas purchase and exchange in the U. S. of IRCs;
  • In Madoff’s case, a complex proprietary stock and option trading strategy;
• A seemingly legitimate investment vehicle.
  • In Ponzi’s case, IRCs;
  • In Madoff’s case, stock and option trades;
• The impracticality of the actual investment methodology.
  • In Ponzi’s case, the need to purchase, ship and exchange millions upon millions of IRCs;
  • In Madoff’s case, the huge volumes of stock and option trades that would have been required to produce the claimed profits;
• Payoffs of early investors at the rates promised or guaranteed, but only from the funds provided by later investors; and, finally;
• The use of secrecy, threats, and influence to silence detractors.
  • In Ponzi’s case, his libel suit, among others;
  • In Madoff’s case, a threatened refusal to allow a potential investor to invest with him if that investor asked too many questions.

Any investment opportunity featuring these kinds of characteristics should be carefully vetted so you can avoid becoming the victim of a Ponzi Scheme.

If you suspect you have been offered, or might have accepted, an investment deal that contains some of these features, you might walk to speak with a Certified Fraud Examiner from an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley.  A Certified Fraud Examiner can examine the deal and determine if you are working with a latter-day Ponzi or Madoff.

Please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com if you require the services of a Certified Fraud Examiner or any other forensic accounting services in Philadelphia and the Delaware Valley.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.