Ponzi schemes: Lure of making a fast buck continues

History has taught us that ponzi schemes are not restricted by asset classes. They come in various forms and have taken into their fold the animal world (the emu scam), and even the plant kingdom (teak plantations). 

Old wine new bottle

Irrespective of the innovative nature of such schemes, the story is always the same — promise of very high returns, where the returns get paid initially, and advertisement via word-of-mouth until new investments stop and the scheme crashes for want of fresh money to pay existing investors.

 The general notion is that people succumb to ponzi schemes due to lack of widespread and formal financial and banking systems. And yet, large cities with organised systems are not lagging behind, when it comes to being conned by ponzi schemes.

Few years ago, the notorious case of a bank relationship manager committing fraudulent acts with high-net-worth clients, including promoters of a large auto company and venture capitalists, was by no means due to the lack of a formal financial system.

Here is how you could save yourself:

 Complex strategy: Ponzi schemes are routed through businesses that appear complex and often work in multi-tiers, sometimes taking the structure of multi-level marketing (MLM) agencies. Therefore, it is first important to understand the nature of business or investment strategy. If somebody is trying to sell you a product or idea that you do not understand, it is not your fault. It is likely that the idea is a weak or dubious one. Walk away.
Even if the business appears promising, remember, retail investors are not angel investors, who provide finance to budding businesses that hold plenty of promises and no assets.

 High ‘guaranteed’ returns in a short span: High returns mean high risk. This especially holds good if returns are promised in a short period of time. Take the Gold Sukh case, where the promoter promised 150 per cent returns in 18 months. A fixed deposit would take over 10 years (at nine per cent) to deliver that. Even gold did not deliver such returns in that period.

Now, that does not mean that one cannot earn 20-30 per cent in equities or mutual funds. The fact is nobody guarantees that a stock would deliver ‘X’ returns as they are linked to markets. Also, there is an underlying core business of a company involved in all this.

Hence, making a quick back-of-the-envelope calculation to check if such returns are feasible at all in relation to regular products available in the market, will go a long way. There can be no other recipe for disaster than the self-styled ‘pooled’ schemes.

 Regulations governing the scheme: Large returns mean larger risks that require extensive information and verification before you invest. The first step towards such verification is knowing what regulates the investment. It could be the RBI or Sebi, or simply the Companies Act. You should also know if the firm has authorisation to borrow from the public.

For instance, an NBFC must be registered with the RBI and also have authorisation to collect deposits from the public. Direct equities and mutual funds are governed by Sebi laws, while insurance by the IRDAI. Chit funds, on the other hand, are mostly governed by state laws  and have less redressal mechanisms. Ensure that there is a lifeguard before stepping into deep waters.

 High initial investment: As ponzi schemes seldom have their own capital, they would depend on investors to invest a good sum in the beginning. Gold Sukh had three such plans of Rs 23,000, Rs 1.2 lakh and Rs 6 lakh.

Be wary of committing large sums in schemes outside the ambit of the regular organised financial system.

 Euphoria: Do not go by the high returns that a friend just received from a ‘too good to be true’ firm. That’s how a ponzi operates.

Economist Robert Schiller’s definition of ponzi scheme says, “It (ponzi scheme) creates a false perception of high returns for initial investors by distributing to them money brought in by subsequent investors. Initial investor response to the scheme tends to be weak, but as successive rounds of high returns generate excitement, the story becomes increasingly believable and exciting to investors. Finally, the scheme collapses when new investors are not prepared to enter the scheme.”

Scams, time and again, bring to light that there is no such thing as quick money. For retail investors, the only recipe to build wealth is — making regular investments in regulated systems, taking calculated risks, and seeking the help of qualified people in case advice.

(The author is head, Mutual Fund Research, at FundsIndia.com.)