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PONZI Schemes : Beware

Plus ca change, plus c’est la meme chose, goes a French phrase, meaning the more things change, the more they remain the same’. This holds true in the case of Ponzi schemes as well.

Every few years a new one hits the market. Initial investors make money and the latter ones lose money.

Of late a international entity has been in the news and is being investigated by various regulatory agencies of the government, including the ministry of corporate affairs. Several investor protection groups have alleged that the company is nothing but another Ponzi scheme.

What is Ponzi Scheme ?

Charles Ponzi, an Italian immigrant to the United States of America, promised this to investors way back in 1919. Born in Parma, Italy, in 1882, Ponzi, landed in the US in 1903.

In August 1919, in the process of issuing an export magazine, Ponzi realised that a huge arbitrage opportunity existed. Ponzi made an offer to a person in Spain requesting him to subscribe to an export magazine he planned to launch.

The subscriber sent Ponzi an international postal reply coupon, which could be exchanged at the local post office, for American stamps, needed to dispatch the magazine to Spain.

The coupon in Spain cost the equivalent of one cent in American currency. In America when Ponzi exchanged the coupon, he got six cents worth of stamps. Sensing the arbitrage opportunity, Ponzi decided to float an investment scheme.

Ponzi promised investors that he could double their money in 90 days. Money started pouring in as no other investments in the market at that point in time offered such high returns.

Once the money had been collected, Ponzi planned to convert American dollars into foreign currency, buy international postal reply coupons from various countries, convert them into American stamps and sell them for a huge profit.

The idea was brilliant. But Ponzi had not taken into account the difficulties involved in dealing with various postal organisations around the world, along with other problems involved in transferring and converting currency. Nevertheless, the investors got attracted to the huge returns the scheme promised.

At its peak, the scheme had 40,000 investors who had invested around $15 million in the scheme. Meanwhile, Ponzi had started living an extravagant life blowing up the money investors brought in.

On July 26, 1920, the Boston Post ran a story questioning the legitimacy of the scheme. Within a few hours, angry depositors lined up at Ponzi’s door, demanding their money back.

Ponzi asked his staff to settle their obligations. The anger subsided, but not for long. On August 10, 1920, the scheme collapsed. The auditors, the newspapers and the banks declared that Ponzi was definitely bankrupt.
It was revealed that only two stamps had been actually purchased. Money brought in by the new investors was used to pay off old investors.

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