Ponzi schemes are a type of investment fraud in which investors are promised artificially high rates of return with little or no risk. Original investors and the perpetrators of the fraud are paid off by funds from later investors, but there is little or no actual business activity that produces revenue. The scheme generates funds for previous investors so long as there is a consistent flow of funds from new investors. This gives the impression that the earlier investments drastically increased in value in a short period of time. The scheme inevitably collapses when too many investors demand redemption or when the scheme fails to attract a sufficient number of new investments. The Ponzi scheme is named after Charles Ponzi, who in the 1920 defrauded thousands of investors in Boston.
Ponzi schemes continuously pose threats to investors, often resulting in billions lost every year in the United States, and given the nature of the scheme, legal remedies for victims often cannot compensate for the lost investments. Ponzi schemes pose major challenges for victims and investment authorities because the schemes involve many broken laws across multiple levels of government and often hundreds of victims with differing interests. Enforcement against the schemers can be made by individuals and governments with potential civil and criminal remedies for charges like securities fraud, fraudulent transfer, and disgorgement.
Many legal difficulties arise in determining which funds a bankruptcy trustee and court can access and who receives which part of the funds. There is not enough funds to pay all the investors their principal back and some investors may have already received profits from the enterprise. Often, profits can be taken from investors to compensate for principal lost by other investors. The more challenging issue is determining whether investors and other parties involved in managing the scheme should have done more in preventing the scheme and therefore should lose principal and fees already received. Another issue arises in determining what assets of the individuals orchestrating the scheme may be taken, especially regarding what assets they have given to others like family members may be retrieved. The laws governing these bankruptcy, fraud, and securities matters vary greatly across federal and state laws and involve case specific inquiries into the relationships and rights involved in the cases.
[Last updated in March of 2022 by the Wex Definitions Team]