turn of the century Boston, an Italian Immigrant named Carlo
"Charles" Ponzi established the Securities Exchange
Company. Ponzi offered investors a choice between a fifty
percent return on a 45 day investment and a 100% return on
a 90 day investment. Ponzi claimed that this return on investment
was possible due to his unique understanding of the international
postal reply coupon system; by international agreement, postal
reply coupons were recognized by all countries but the cost
of these coupons varied dramatically from country to country
depending upon their economy.
Although true in principal (an IPRC that cost a penny in Germany
cost a nickel in the US), Ponzi was fully aware that the scheme
did not work in actual practice because of importation restrictions.
Nevertheless, the story sounded good.
Investors did receive the interest on their investments that
they were promised and the investments poured in. This was
not a revenue generating business enterprise supported by
investors; there was no underlying business whatsoever. This
was an investment generating scheme that relied entirely upon
today’s investors to meet the obligations due to those
who had invested 45 days previously.
A Ponzi scheme’s indebtedness increases as a function
of geometric progression; however, the enterprise generates
income so long as the pool of investment capital increases
faster than the debt accrued. The reason that these schemes
are illegal is that, as is the case with their pyramid cousin,
they are mathematically doomed to collapse.
Due to the fact that there is no source of revenue other than
the investment pool used to pay debt, the “Classic Ponzi
Scheme" will be immediately exposed in any audit. According
to generally accepted accounting procedures (GAAP), any Ponzi
scheme is insolvent from the moment of its inception and becomes
increasingly insolvent each day that it is in operation.
essence of a Ponzi Scheme is investment. The Ponzi operator
typically represents that he has some sort of "system"
that is either incredibly complex, or a proprietary secret.
His system makes it possible for him to pay incredible rates
of return. The elaborate office, exquisitely tailored suits,
involvement with the church, and generosity toward charitable
organizations are all classic window dressing.
schemes do not decline and fall; they are typically hugely
successful until they collapse. Everyone is making money,
everyone who wants their money out gets paid, and everyone
is happy until the regulators shut it down or something precipitates
a run on the bank.
closing, I want to alert you to the fact that it may not always
be clear that a debtor was in fact operating a Ponzi Scheme
and I have been involved in cases where over zealous prosecutors
applied this label to legitimate businessmen who became hopelessly
overextended, made poor business decisions and pursued fiscal
strategies that were totally unrealistic in hindsight.
reality is, in their efforts to stay afloat, people in this
position often continue to borrow money, incur future obligations
to meet today’s bills and use the funds invested today
to satisfy today’s debts. Rather than give up, admit
defeat and abandon their dreams, honest people with no intent
to defraud may very well continue to borrow from Peter to
pay Paul long after it should have been obvious that they
were hopelessly insolvent. There is a profound difference
between a desperate businessman who makes poor decisions and
a Ponzi operator.
Ponzi Scheme, by definition, is a scheme and artifice to defraud
that was insolvent from its inception. See Scholes v. Lehmann,
56 F.3d at 755; Merrill v. Abbott (In re Independent Clearing
House Co.), 77 B.R. 843, 871 (D. Utah 1987); In re Taubman,
160 B.R. 964, 978 (Bankr. S.D. Ohio 1993); Martino v. Edison
Worldwide Capital (In re Randy), 189 B.R. 425, 441 (Bankr.
N.D. Ill. 1995); Emerson v. Maples (In re Mark Benskin &
Co.), 161 B.R. 644, 650 (Bankr. W.D. Tenn. 1993) and Dicello
v. Jenkins (In re International Loan Network, Inc.), 160 B.R.
1, 12 n.15 (Bankr. D.C. 1993)
questions and suggestions.