A “Ponzi scheme” is a complicated kind of financial fraud that, after it inevitably implodes and gets disclosed, can result in major criminal prosecutions not to mention decades in prison.
A Ponzi scheme is defined by the U.S. Securities and Exchange Commission as:
“an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors to create the false appearance that investors are profiting from a legitimate business.”
These types of fraud are named after Charles Ponzi who utilized the method in the 1920’s to bilk thousands of trusting investors.
Perhaps the most notable perpetrator of Ponzi schemes in recent history is Bernie Madoff, who is serving a 150-year long sentence for orchestrating the biggest Ponzi scheme in U.S. history. He caused investors to lose $65 billion dollars. His lengthy prison term illustrates the gravity with which prosecutors and lawmakers treat such financial offenses.
People suspected of running a Ponzi scheme face various criminal charges on both state and federal levels, including:
- Mail fraud
- Wire fraud
- Theft
- Tax fraud
- Money laundering
- Securities fraud
- Business records fraud
Similar to Ponzi schemes are “pyramid schemes,” which are also called “endless chain” schemes. This is where participants try to generate money by recruiting other participants into the scheme without having to ever make or sell anything. Whatever money that is brought in from new recruits is used to pay off the earlier recruits. Pyramid scheme participant face the above charges as well as charges under California Penal Code Section 327, which makes it a crime to engage in:
any scheme for the disposal or distribution of property whereby a participant pays a valuable consideration for the chance to receive compensation for introducing one or more additional persons into participation in the scheme or for the chance to receive compensation when a person introduced by the participant introduces a new participant.
Violating Section 327 is punishable by imprisonment in a county jail not exceeding one year or in state prison for 16 months, two, or three years. (For Nevada law, see our article, “What are Ponzi Schemes in Nevada?“)
