This week’s article is about the trouble you can get into for investing in investments that are too good to be true. They are otherwise known as “Ponzi Schemes.” Ponzi schemes are usually clouded by a promise of a legitimate investment. A Ponzi scheme is where a person promises you a guaranteed significant return on an investment that far exceeds the normal market rates. The person then repays you for your investment with other investors’ money. They are bound to fail.
The most famous Ponzi scheme of all time is the Madoff scheme that sucked in a Major League Baseball team, among others, for millions of dollars of liability. What team owed millions? There are also other Ponzi schemes in Florida that you may have heard of: (1) Pearlman; (2) Beau Diamond; (3) Botfly.
First we will discuss what to look for before you accidently invest in a Ponzi scheme, second we will discuss what red flags to look for, and third what liability you may have if you invest in a Ponzi scheme whether you knew it or not.
BEFORE YOU INVEST:
RULE 1: If it seems to good to be true, it probably is. You must do your due diligence first and foremost. I must repeat this over and over and over: IF IT SOUNDS TOO GOOD TO BE TRUE, DO NOT INVEST!
You do your due diligence. Research the company, the person running the company, the type of investment and run it by your accountant and your lawyer. Do not forget to run it by your parents, spouse, and other trusted friends.
If it is a “Forex” or a foreign exchange business, read the first two paragraphs above at least five more times. A “Forex” investment is the most common type of smoke for a Ponzi scheme.
Make sure you educate yourself. Buy a book on the investment or attend lectures or seminars on the specific type of investment. Make sure the lectures and seminars are by people other than the person or business you are considering investing with.
Check with your financial advisor that the rates are reasonable. If the rate of return is above the market average for common investments, then you may have a problem. There are guaranteed investment returns such as government bonds and so forth. However, if you are investing in a Forex, there is no way you can be guaranteed a return. Why? Because the person you trusted your money with is not guaranteed a return. Big gains can be achieved in the Forex market. So can big losses. You should ask yourself whether a person can guarantee extreme gains when they are just as likely to suffer major losses.
Here are some huge RED flags that you are investing in a Ponzi scheme:
1. You are guaranteed a specific rate of return that is above the average. In other words, if the bank is giving 2 percent, and a CD is giving 2.5 percent, why are you guaranteed 10 percent?
2. You are told that you will receive a commission (kickback) for referring other investors.
3. You are told that you will receive bonuses or incentives for not taking your profits. If someone is running a Ponzi scheme, they do not want you to take your money out. That could collapse the Ponzi scheme. So they will offer you incentives to not withdraw your profits when you receive them.
4. The company does not provide the proper tax forms for the profits made (although some Ponzi scheme companies will issue IRS documents…until they are caught).
All Ponzi schemes fold at some point. It is a broken business model. At some point the beneficiary of the Ponzi scheme runs out of investors and cannot pay back the investors. They all collapse. So what happens to you, Mr. or Mrs./Ms. Investor?
First, you can be sued for every dime you earned for your investment even if you did nothing wrong or thought it was legitimate. The most common person to sue you is a receiver of the Ponzi scheme company or a trustee in a federal court of law. This means that an attorney or law firm will seek you out, among thousands of other investors, to see how much money that person can collect.
Second, if you knew or should have known that you invested in a Ponzi scheme, you will have to repay all the money back. The receiver or trustee does not care how you pay it back. If they prevail, they can garnish your wages, your bank account, and take your property. The presumption to the courts is that your investment – as innocent as you thought it was – was fraudulent. Fair or not, that is law right now.
Protect yourself: Stick with your financial advisor, attorney, and banker. Underlying theory: If the investment is too good to be true, it is!