Taking Care of Mom and Dad: Ponzi Schemes
The dot.com bubble of the 1990s struck many people as a big, economy-wide swindle. In truth, the investment mania gave cover to real crooks. (Again, crooks like confusion.) There was an increase in the number of financial scams reported all around the United States -- and that boom lasted after the dot.com bubble had burst.
The most common investment swindle of the 1990s and 2000s was the Ponzi scheme -- another old-fashioned fraud.
A Ponzi scheme isn't complicated, mechanically. The perpetrator collects money from investors, promising huge returns in a matter of months or weeks. Then, he has to do one of two things:
1) return a portion of the money as profit while convincing investors to keep their principle (which is dwindling fast) invested; or
2) recruit new investors, whose money is used to produce the promised windfall to the earlier ones.
Finding the second level of investors is the hard part of the scheme. Once those investors are recruited, the scheme often drives its own growth -- so,word-of-mouth publicityis essential to a scheme's success. When word of early profits spreads, new investors pour in, allowing the swindler to pay off the earlier investors.
The schemes may yield returns for those who start them or join early on. As long as there are enough people to support the next level, the previous one is safe. In financial circles, this is known as the "greater fool" theory. As long as you find someone willing to take your place in the scheme -- a greater fool -- the fact that you were a fool to invest doesn't matter. (This may remind some readers of the "dot.com bubble" in technology investments that happened during the late 1990s.)
Investment swindles rely on trust. Of the key factors that allow Ponzi schemes to flourish, misplaced trust is most important. It's the point on which burned investors -- once they learn they've lost money -- most often blame themselves. Invariably, the person will offer some version of "I can't believe I trusted that crook..."
Telephones, television, computers and the Internet have shattered the traditional sense of social proportion and created an encouraging environment for swindlers. People don't trust their neighbors but believe they have a personal relationship with Oprah Winfrey or Hillary Clinton.
Swindlers thrive on the inability of some investors to tell the difference between a friend and an acquaintance. This is particularly true in business circles, where the networking mentality often confuses business cards in a Rolodex with time-tested relationships.
Many smart swindlers have the same characteristics and tricks of the basic telephone scammer, including:
- they're courteous;
- they sound concerned about your parents' well-being;
- they listen to your parents'complaints;
- they flatter;
- they try to be a surrogate son or long-lost friend;
- they offer some financial advice; and
- they promise that they can get a better return on your parents' money
Then they take your parents' money.
Personal charisma is a swindler's best tool. But your parents can turn that tool against him. Warn them that there are recurring signs that a swindler is hoping to bank on his charisma. These include:
- the swindler talks about you a lot -- but in general and psychological terms ("you're being decisive," "you're taking control of your life," "you're investing in yourself");
- if your parents ask financial questions about the investment, the swindler responds in cliches and philosophical or psychological abstractions;
- the swindler describes himself as an "idea man" or "vi-sionary" -- anyone to whom your parents give money needs to pay attention to details;
- the swindler talks a lot about emotional matters, such as fear, joy, happiness and love;
- the swindler talks about talking, saying that he doesn't understand what you mean...or asks if you understand what he's saying; and
- the swindler answers questions with questions ("What are you saying?" "How can I make you happy?" or "Are you saying you want your money back?").
Charismatic swindlers will often try to turn facts on their heads. In some cases, crooks at the center of crumbling schemes -- and under investigation by the SEC or the FBI -- are able to convince investors that the Feds are the villains.
Swindles are an unavoidable part of a capitalistic economy (and probably every other kind of economy, too). But the basic features of their schemes remain relatively simple.
- They place themselves in the context of legitimate opera-tions -- whether country club, church or auction Web site.
- They promise big, guaranteed profits...with no risk.
- They use the jargon of technology or psychology...and hope that you don't ask too many questions about details.
- They talk about what you can do with all of the money you make, rather than the mechanics of their deals.
- They count on their personal charm or charisma to divert detailed questions or comments that you have.
Your parents can avoid these traps by taking a few basic precautions when they're thinking of investing or lending money:
- make sure of someone's identity before giving them money...and don't let connections blur who's who;
- whenever possible, transfer money through disinterested third-parties and -- if possible -- escrow accounts;
- no matter how high-tech a business might be, keep a paper trail of documents related to any investment;
- don't be afraid to admit not understanding the details of an investment...and trust enough to hesitate and ask more questions; and
- be wary of any seller or borrower who doesn't answer questions simply and directly.
Scams can fool even the smartest or most intuitive person. They're designed to do that. So, tell your parents to keep that in mind when they hear about a sweetheart deal or surefire bet. There is no reward without risk; and the higher the reward, the greater the risk.
