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How Ponzi Schemes Work

Bernard Madoff's and Allen Stanford's Ponzi Schemes
Bernie Madoff pulled off a wildly successful Ponzi scheme before things started to unravel and he fessed up in 2008.
Bernie Madoff pulled off a wildly successful Ponzi scheme before things started to unravel and he fessed up in 2008.
Jason DeCrow/Associated Press


In December 2008, Bernard Madoff revealed that the asset management arm of his firm, Bernard L. Madoff Investment Securities, was "just one big lie" [source: Henriques]. In what he described as a Ponzi scheme, it's estimated he took his investors for a cool $65 billion over the course of nearly two decades. And he didn't just con fat-cat billionaires and celebrities (such as Zsa Zsa Gabor, Kevin Bacon and Steven Spielberg); humbler individual investors, banks and even charities lost money in the scheme [source: WSJ, Sunday Times]. The scheme wasn't revealed until Madoff himself confessed his crimes. In March 2009, Madoff pled guilty to the charges against him, and he was sentenced to 150 years in prison the following June [source: Edwards].

One reason that Madoff was so successful was that he was a highly respected, well-established and esteemed financial expert -- his reputation was bolstered by the fact that he helped found the NASDAQ stock exchange and served a term as its chair. What's more, at the same time he was running his scheme, he was also running a legitimate business [source: Appelbaum]. He earned his investors' trust because whenever they requested a withdrawal, Madoff's investment company got their money to them promptly. In addition, unlike other Ponzi schemers, he didn't tempt investors with unbelievable returns. He reported moderate (albeit, suspiciously consistent) returns to his investors.

It's not unusual for tip-offs such as these to help authorities build a case and eventually expose a Ponzi scheme [source: Scannell]. However, in the Madoff case, the Securities and Exchange Commission (SEC) failed to come up with any smoking gun, which might've been as straightforward as making Madoff provide proof of his holdings [source: Appelbaum]. According to some sources, any examinations the SEC conducted fell drastically short [source: Moyer]. Madoff himself later said he was "astonished" that the SEC failed to catch him [source: Katz].

While investors were still reeling from the fallout from the Madoff case, another Ponzi scheme led by Texas billionaire banker Allen Stanford was broken. Like Madoff's scheme, Stanford's dwarfed most other Ponzi schemes; he managed to accumulate $8 billion over a decade from the sale of fraudulent certificates of deposit (CDs) in his bank in Antigua [source: Creswell and Krauss]. Unlike Madoff, however, Stanford attracted investors through interest rates that were too good to be true. Also unlike Madoff, Stanford's cohorts in the scheme -- all officers in his bank -- were also indicted.

In the wake of the Madoff and Stanford Ponzi schemes, the SEC has stepped up investment regulation and fraud detection measures. It's unlikely that it will be able to rid the world of Ponzi schemes entirely. So if Ponzi schemes still abound, you should know what to look for.

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