Ponzi schemes: What they are and how to spot them
By Anne-Marie Brennan, Policy & Standards Analyst 8 March 2019 2 min read
If it sounds too good to be true, it probably is
Did you know that the prefix con in con-man is short for confidence? Smooth talking grifters scam people out of their life savings by earning their trust and promising guaranteed results. Ponzi schemes are one such confidence scheme that can have devastating effects on its victims. We wonder how anyone could fall for a sales pitch that guarantees such consistently high returns with such little risk, but for those living on a fixed income, these pitches can be dangerously attractive because these fraudsters are so adept at telling people what they want to hear.
What exactly is a Ponzi scheme?
But what is a Ponzi scheme exactly and what are the red flags you, as an investor, should be aware of? Basically, a Ponzi scheme is a fraudulent investment that uses money provided by new investors to pay dividends to older investors. There are no legitimate business activities or profit from actual trading, just money coming in and money going out. The key for Ponzi operators is to keep recruiting new money to pay the older investors. Eventually the pyramid becomes so unstable, it collapses but by then the damage to hundreds of investors is done.
How to spot a Ponzi scheme
When you are looking at an investment, there are a few things to remember that may help you avoid being sucked into a Ponzi scheme1.
- Are the returns abnormally high or unusually consistent? Beware of investments that offer short-term returns that are either abnormally high or unusually consistent. Markets are unpredictable and fluctuate daily which make consistently high returns unlikely.
- Watch out for business models where the investing process is ‘confidential’ or is overly complicated and vague. Be wary of investing money in a business where you don’t understand how profits are generated.
- Take the time to research any foreign investment products. Often times, Ponzi schemes rely on the fact that investors are too busy or too far away from an investment to conduct proper due diligence.
- Ask about sales commission structure. High commissions are generally unsustainable so if your investment advisor is getting say 15% on a $100,000.00 investment, it might be a Ponzi scheme.
- Risk free investments do not exist! No matter what you invest in, there is an element of risk. In situations like this, if it seems to good to be true, it is. Take your money and find a new investment.
What to do if you come across a Ponzi scheme
Should you find yourself in a situation that seems suspicious, you can report potential Ponzi schemes to the Alberta Securities Commission, the Canada Anti-Fraud Centre, the Competition Bureau of Canada or the RCMP.
For more information about fraud, types of scams and helpful ideas for protecting yourself, take a look at the Alberta Securities Commission Checkfirst webpage.
1Chng, V. “5 red flags to spot a Ponzi scheme.” The Fifth Person. Retrieved March 14, 2018. https://fifthperson.com/5-red-flags-to-spot-a-ponzi-scheme/