Tired of hearing the constant call for 2 people to join the latest “out of this world” money-making venture? Firstline’s Risk Manager in London takes a logical and strategic look at the reason why so many Trinbagonians are falling prey to unregulated financial schemes that will only hurt their wallet in the end.
In the first of a four-part series of blog entries we take a look at Ponzi and Pyramid Schemes.
This article is a 8 min read.
Ponzi and Pyramid schemes are currently being heavily marketed in Trinidad and Tobago using social media, virtual meeting platforms, WhatsApp and the exploitation of social clubs and gatherings.
Such schemes are unregulated, and any money invested in them is not covered by any form of Statutory Deposit Insurance Scheme or Statutory Compensation Fund.
Yet people are being seduced into making investments.
In part this can be explained by COVID-19.
Because of financial difficulties arising from the shutdown of the economy compounded by the twin problem of low oil and gas prices together with perceived poor returns on products offered by traditional regulated financial institutions many have reached a watershed moment.
Tired of “scrunting” to save money to jump start their dreams – perhaps a deposit for a house, a dream holiday, a new car, this list is as endless as the potential for the mind to dream of something that is simply “better” than what we have now – investors choose to jump start their dreams by investing in a product that offers the potential for unbelievable returns.
Seduction is a powerful tool. Because that is the problem in a nutshell.
The returns are unbelievable because the returns don’t exist.
The message is therefore simple.
When the scheme busts, you will lose!
At Firstline, we are experts at creating, growing, and maintaining wealth in Trinidad and Tobago.
With some of our staff working for over 4 decades in the financial industry, in addition to the success stories, they have witnessed many a person’s finances rise and fall or stagnate, and there are specific actions taken by those who keep their finances rising over their life, compared to those who were not as proactive.
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A Ponzi scheme in its simplest form can be defined as an illegal business practice in which new investors’ money is used to make payments to earlier investors.
New investors are enticed by the promise of unbelievably high returns.
Everyone involved in promoting the Ponzi Scheme pretends to represent a legitimate organization, but little or no commercial activity takes place.
Ponzi schemes usually unravel when the operators decide to keep all the proceeds for themselves or when the number of new investors declines (mathematically this is certain to happen) and dividends can no longer be paid to investors.
Ponzi Schemes usually run for a short period of time, but this is not always the case.
Bernie Madoff, the New York Financier who literally “Madoff” with US$65 billion of investors’ funds managed to successfully operate a Ponzi Scheme for at least seventeen years before the financial crash of 2007 led to a liquidity crisis in his investment firm and ultimately the Ponzi Scheme collapsed around him.
In accounting terms, money paid to Ponzi investors is described as income – but in reality – it amounts to a distribution of capital contributed by later investors.
A pyramid scheme is a fraudulent scheme for making money based on recruiting an ever-increasing number of investors.
The initial promoters of the pyramid recruit investors, who in turn recruit more investors, and so on. These types of schemes are referred to as pyramids because at each new level the number of investors increases. The small number of promoters at top require a large base of later investors to support the scheme by providing returns that are used to pay earlier investors.
The reality is that Ponzi and Pyramid schemes are similar because they share common characteristics based upon one common concept – the desire to dupe unsuspecting investors (the “mark”) by the promise of extraordinary returns way above anything available on the market offered by regulated businesses like banks and non-banking financial institutions.
Both Ponzi and Pyramid schemes are self-sustaining but only if cash outflows can be matched by new cash inflows.
With Ponzi Schemes investors give money to a portfolio manager. When the investor wants the money back, they are paid from funds paid in by incoming investors. In other words, there is no attempt to make investments to generate returns sufficient to repay the investor or to pay the advertised returns.
With a Pyramid Scheme the creator of the scheme recruits’ investors who in turn recruit other investors and so on. Late joining investors pay the person who recruited them for the right to participate or sell a certain product.
Possible indicators of Ponzi Schemes include the following:
There is a pressure to reinvest. For a Ponzi schemes to survive more than a short while investors must be convinced to reinvest their profits rather than withdraw their capital.
Of course, the above should not be considered as a definitive list of all potential red flags and readers should also be aware of the following additional red flags.
Tomorrow we continue our narrative with the second part of our four-part series of blog entries looking at Ponzi and Pyramid Schemes
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