Reading about the whole Bernie Madoff billion-dollar Ponzi scheme made me think: How can you protect yourself from putting your money into a Ponzi scheme?
The best way to avoid being taken by a confidence scheme, although not guaranteed, is to get inside the mind of a Ponzi-Scheme manager. Find out how they run their business and then you can more easily see the warning signs.
A Ponzi scheme, named for underground financier Charles Ponzi, is simply using money from new investors to pay off previous investors, sort of like the Social Security system without the press and the AARP to back it up.
To get your Ponzi scheme running, you should do the following:
Offer nearly-impossible returns to new investors.
The less astute Ponzi schemers will usually offer extremely high rates of return, but they often attract attention and get discovered quickly. Madoff’s rate of return was small–8 percent or so–but it was so consistently 8 percent that alarm flags should have been raised.
Hide behind social connections.
Madoff was a member of the financial establishment and he worked them over more than he did his investors.
Make sure you are the custodian of your investors’ funds.
You’ll need to issue false statements. To do that, you should be the custodian of your investors accounts. A simpler way to explain it, according to the Brett Arends of the Wall Street Journal:
“If your adviser manages your investments, but the funds are actually held at, say, Charles Schwab or Fidelity, it’s almost impossible for him or her to run a Ponzi scheme.”
Make sure you pick investors who don’t insist on transparency. If they insist on information, baffle them with B.S. by citing the level of “trust” you have with your investors. Or, simply fill them with a mind-dulling array of investment statistics and number-crunching.
Finally, insist on picking investors for your scheme that don’t want to play a role in their own wealth-generation. Even though independent investors are busier than ever, technology, like Automated Trading systems, are making it easier for them to be independent of financial managers.
As this technology grows, we hope Ponzi scheme managers find it more difficult to dupe new investors.