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Table of Contents

Executive summary 3

1.0 Introduction 3

1.1 Background and purpose of study. 3

2.0 How Ponzi and Pyramid schemes differ. 4

2.1 Illegality. 4

2.2 Types of products schemers offer. 5

2.3 The structure of the scheme. 5

2.3 Active verses passive. 5

3.0 The similarities between Ponzi and pyramid schemes. 6

3.1 Unregistered investments 6

3.2 Schemers operation. 6

3.3 Transfer of money from one person to another. 6

4.0 Why white collar criminals carry out their schemes for long than similar types of fraud. 7

4.1 The depth of the Ponzi schemes. 7

4.2 Smart, ambitious and well-educated. 7

4.3 Highly successful 8

4.4 Seemed trustworthy 8

5.0 Remedies of large scale frauds. 9

5.1 Legitimate adviser. 9

5.2 Dig deep. 9

5.3 The security and Exchange Commission. 9

5.4. Education. 10

6.0 Conclusion. 10

7.0 References 11

Executive summary

It is a study of two frauds of a century that are the Ponzi and pyramid schemes. The work focuses on how the schemes were conducted by schemers to make money. The purpose of the study is to study and analyze how the schemes get money from people, how they differ and their similarities. Most importantly is how they differ as most individuals cannot differentiate between the two. It is therefore, very important to distinguish between the two. Additionally, they have some similarities that are very close for one to differentiate. The similarities are also stated clearly to clear any doubts. The study is explorative in nature as it explores all the aspects of these schemes. The white-collar criminals or rather schemers establish themselves as trustworthy as respectable figures. As a result many investors didn’t think twice to invest their money into the schemes. In the long run, schemes collapse and the investors lose their investments in return. Victims of these frauds trust the clients and believe there are sufficient balances and checks to certify that an operation is legitimate. For example, Bernard Madoff was a well educated and experiences individual in the position of respectability, responsibility, power and trust. He abused his trust for personal gains. Schemers of both the Ponzi and pyramid fraud schemes used promises and deception to carry out their scams. The study also comes up with the recommendations that should be done to curb such large scale fraud from happening in future.

1.0 Introduction

1.1 Background and purpose of study.

There are two main frauds of the century in the world. One is the Ponzi scheme which became a front page headline in December 2008. It was never realized by the average consumer for decades until the rise of a prominent respected securities trader Bernard Madoff. He admitted to have been operating a Ponzi scheme for than a decade. Also, the chairman and CEO of Petters worldwide named Tom Petters was also arrested for alleged Ponzi scheme in October of the same year. During the same year, R.Allen a respected financier was also detained for the same scheme that cost investors seven billion dollars. A Ponzi scheme is therefore a type of crime that occurs when a criminal allegedly takes money from new investors to pay earning for existing investors. The money is never invested as expected and, in the long run when the scheme collapses for one reason or another, the new investors usually lose their investment. Another fraud is the pyramid scheme which is illegal. However, they are hard to detect. They occur when there are no sustainable investments or legitimate products to sell. Just like the Ponzi schemes, the pyramid also collapses faster because it requires increased potential participants to sustain it. A pyramid offers an opportunity for individuals to make money through effort. It is usually a form of business, product opportunity or an investment. It works in a manner that the first person recruited in turn recruits more people. The process of recruiting more people has a financial reward. The key aspect in a pyramid scheme is that people pay to get involved. Each new member joins a group that is believed to be a legitimate opportunity to get good returns. Unfortunately, this is how criminals or rather fraudsters get money.

2.0 How Ponzi and Pyramid schemes differ.

2.1 Illegality.

The aspect of legality is one of the reasons for the difference between the schemes (Nolasco, Vaughn &Del Carmen, 2013). Being legal means it is accepted by law. The reason it is legal is that it starts a s a legitimate business. A legitimate business is a registered operation is protected by law. They are protected under some acts of the relevant constitution that stipulate their duties, objectives and purpose. It is after it becomes fraudulent that it stops being a legitimate business. It is at his point that it starts to operate under fraud lent terms. But initially, it starts as a legal business. They occasionally begin by investing on investors’ contributions to make profits and pay returns to the same investors. The business then becomes a Ponzi scheme when it no longer make investments and therefore pays returns to its investors using the capital paid by new investors. With time, the scheme collapses and the new investors lose their capital. On the contrary, the pyramid scheme is illegal. It is not allowed in most countries and regions including Australia. It is not recognized by law as a type of business and any individual found to be running such business will held accountable by law. The fact that it seldom involves the sale of products and services without a value makes it illegal. It compels new members to join the scheme and solicit money from them because it does not involve the creation of goods and services.

2.2 Types of products schemers offer.

The basic difference between the two schemers is the type of products they offer to their clients. Ponzi schemes offer fraud lent investment management services based on false promises. Basically, inventors contribute money to the scheme and they are promised high returns after a certain period of time. When the time to pay returns to investors, they are paid using the funds contributed by new investors. The manager who is in charge of the scheme is controlling the entire operation. They only transfer funds from one client to another and forgo the expected investment activities. On the other hand, the pyramid scheme offers a false investment opportunity to a recruiter. The person who recruits more people into the scheme is promised an opportunity such as selling a particular product (Del Carmen & Rolando, 2013).

2.3 The structure of the scheme.

The two schemes can be differentiating based on their structures. Ponzi is structured in a manner that investors are asked to pay a certain amounts of money in order to gain high returns. They don’t make investments as expected by investors. It is composed of criminal who are highly respected and have gained trust from investors. The investors who contributed are paid back their returns from unexpected sources. New investors join the scheme with same hope that they will get high returns from the scheme’s investments. On the contrary, the money contributed by new investors is used to pay the current investors and they lose in the process (Deason, Rajgopal & Waymire, 2015). On the other hand, pyramid schemes are structured in a way that the initial schemer recruits investors who will in turn recruit other investors and so on. Investors pay to be added into the scheme. Again, investors who recruit more investors are given rewards and this makes individuals to increase their effort in recruiting many investors.

2.3 Active verses passive.

The essential difference between the schemes is that a Ponzi scheme will just ask you to invest your money. One is not asked anymore action than just to hand over the money and wait for high returns. The manager in charge will claim to take care of the rest and you are expected to wait for the returns after a certain period of time. The schemer is in charge of all the operation and he/she is always shuffling money from one person to another. Therefore it does not involve a lot of work. On the contrary, a pyramid requires a lot of work. It provides an opportunity to make money yourself whether through recruiting new participants or selling a product in order to get money. It involves paying to become a new member and start recruiting other participant. The recruiter is the pain a cut of the profits earned by the scheme (Baucus & Mitteness, 2016).

3.0 The similarities between Ponzi and pyramid schemes.

3.1 Unregistered investments

The two schemes are illegal and therefore, not accepted in most countries. Ponzi scheme starts over as a legal business that involves investment of investors’ capital to make profits. It becomes illegal as soon as it starts fraud lent activities. Pyramid schemes are always illegal from the start. These schemes are not registered with the state regulators. It is because they don’t meet the expected standards of being a good and reliable business that can improve the economy of a particular country. The registration is very crucial as it provides investors with key information about the company such as products, finances and services offered and how the business performs its operations. The schemes are not registered because new investors are not aware of the scheme’s operations (Cortés, Santamaría & Vargas, 2016).

3.2 Schemers operation.

Both the Ponzi and the pyramid schemes are operated by schemers (Luukkonen, 2014). They are also called criminals. They practice unwanted activities for their own selfish gains. These particular individuals are very intelligent and they are highly educated to get through with their tricks. Operations performed by such people can take a very long time for one to realize what is not right. Bernard Madoff operated the Ponzi scheme for a very long time without anyone realizing it and even an average consumer had never had of it. It was only when he admitted that it was realized that such operations were going on. Months later, several official including Tom Petters and R. Allen Stanford were arrested for such schemes that cost investors billions of shillings.

3.3 Transfer of money from one person to another.

The two schemes operate on transferring money between investors. In Ponzi scheme, investors hand in money to the scheme as an investment. The scheme is supposed to invest the money to gain profits. The portion of the profits made was supposed to be paid to investors as returns. Instead, the scheme pays the investors with money contributed by new investors. Again, the pyramid scheme performed the same operation. New members are recruited into the scheme with a fee. They earn by recruiting more participants. Small amounts of profits gained are deducted and paid to recruiters. From the scenarios, there is transfer is transfer of money from one investor to another (Mohd, Moideen and Moreira, 2016).

4.0 Why white collar criminals carry out their schemes for long than similar types of fraud.

4.1 The depth of the Ponzi schemes.

The reason why White collar criminals carry out schemes is because of their deep Ponzi schemes (Wilkins, Acuff and Hermanson, 2012). It is deep in the sense that it is very stable and cannot easily collapse. They usually have more connections to more money through investments; help from family members and even from friends. In most cases, they get money from investments and due to lots of property; they easily access loans from banks. Since they have more money connections, they establish many branches and invite more people to invest their money. A well spread Ponzi scheme and its ability to maintain the operations the higher the chances that it will last longer. It is because its roots are stronger to sustain any force that can try to destroy it. Also a well branched scheme to different regions means it has stable amounts of money that can boost a situation that requires a good amount of money (Vaknin, 2014). For instance if new investors are not adequate, it can comfortably pay current investors to save the business from falling. Therefore, white collar criminals are assured of their success no matter the situation they come across. On the other hand, other similar frauds easily collapse due to lack of an effective financial support. They are not financially stable because they are limited to a particular area. For this reason, inadequacy of money from new investors collapses the business.

4.2 Smart, ambitious and well-educated.

White collar criminals are not just ordinary people. They are always smart with their decisions, ambitious in everything they are doing and most important is that they are well educated. Such individuals have learnt in higher level institutions and attained good grades (Frankel, 2012).  A learned individual can always reason out and find solutions to any problems faced. It is the reason as to why their schemes cannot collapse easily. They always find appropriate solutions faster to curb any problem trying to affect their operations. The ability to solve problems makes them competitive which results to success. Unlike other schemers who don’t have the ability to solve problems and as result, their schemes collapse. Another identity is that white collar criminals are ambitious. It is the reason they really want to succeed. Most of them have worked in big companies and they know success is achieved and also how to carry out activities in order to succeed. From such companies, they get to learn the profit driven cultures. They operate business practices in a smart way. It involves lack of errors and smooth running of operations which results to success. Therefore, their schemes cannot easily collapse and instead take a longer time (Cox, 2014).

4.3 Highly successful

Most White collar criminals are highly successful. For instance, Bernard Madoff was high and he had a say (Rees, 2013). People who are successful have a say in the society. It is believed that what they say or do is right. An individual’s success is through many aspects. It can be academically or through prosperity in businesses. White collar criminals are not just ordinary people who don’t know the meaning of success. They are however, great individuals in the society who have some skills and experience in a particular field. It is because of their success that people tend to bow down to them in order to be successful as well (Akinladejo, Clarke & Akinladejo, 2013). For instance in our case, Bernard Madoff was successful and because investors wanted to be like him, they invested money in him not knowing how the money was invested. They were just waiting to receive their returns and in the process he was gaining money. It is because of his success that people were following what he said. Unlike other criminals who don’t have influence simply because they are not successful.

4.4 Seemed trustworthy

White collar criminals seem trustworthy just like Bernard Madoff who promised returns of 10 to 12 percent. It attracted several billions of dollars from potential investors. Investors believed in him and because he was successful too, they were sure that he was promising. Trust is a strong virtue and is highly respected. For one to be respected, it means that particular person is accountable. Investors also trusted him as he had been working for a very long time without issues arising concerning his accountability (Cortés, Santamaría & Vargas, 2013). It therefore made him successful as there were no doubts about his performance. For sure nobody realized the operations and all was well. Many of his clients became wealthy from such investment and they were sure it is the perfect way to investment. As more investors were interested in the investment, his trustworthy grew even wider among people.

5.0 Remedies of large scale frauds.

5.1 Legitimate adviser.

People should be aware of the kind of person they are looking for advises from. It is nice to ask friends and even relatives for recommendations. Anyone who calls himself or herself a financial adviser of planner should be checked with national organizations that issues the particular credentials. In case of any financial help, one can visit such organizations. They include the National Association of Personal Financial Advisers and Certified Financial Board of Standards among others. They have a searchable database with contact information of advisers or planners in each state. By using this approach, we tend to reduce the occurrence of such schemes in future where investors are tricked and end up losing their money (Keep &Vander, 2014).

5.2 Dig deep.

It involves getting to know Intel information about a business or the financial advisor. For instance get to know for how long has the adviser worked. What are his/her success trails and check whether he is under the Securities and Exchange Commission. Has he filed the ADV Form with the commission? Check the background, fees and services of the adviser. Also check the company’s information critically. If any information about its operations is not available then don’t transact with such companies because they seem to be schemers. Being anxious to know such information can save one from being exploited by criminals (Cheng, 2016).

5.3 The security and Exchange Commission.

The Security and Exchange Commission was established in 1934 by congress. It was meant to protect investors against fraud and misrepresentation in the sale and issuance of securities. It is dome by enforcing the laws governing securities. The law requires all companies offering their securities for sale to register with the commission. After registration, a full disclosure of certain information about the company is made to investors (Krige, 2012). The commission has controlled the rate at which schemers increase. It is because criminal schemes cannot be registered and any attempt to run such schemes results into legal actions.

5.4. Education.

Education is the most important gift one can be given. Being educated means you have stopped being ignorant (Basu, 2014). If basic education is provided to investors, the issue of large scale fraud will be forgotten. The basic education will make investors differentiate genuine investments from criminals. For this reason, they will therefore be sure that their investments are safe and free from fraud lent activities. Investors also get to know about organizations that can provide adequate advice required. Additionally, they became aware of the Security and Exchange commission where they can find adequate information about registered companies. Therefore, investors should be taught basic information concerning investments as they are very crucial.

6.0 Conclusion.

The Ponzi and pyramid schemes were carried out by intelligent, smart and educated individuals such as Bernard Madoff. This is evident as I was done for several decades without any recognition. Hence, they are classified as White collar criminals. They established themselves as respectable and trustworthy figures. Investors would then believe that their operations were legitimate. White collar crime is unique as it is perpetrated by an individual who knowingly cheats, manipulates or steals for personal gains. It can be controlled by establishing compliance standards and controls to detect misconduct. The established institutions and commissions to regulate such practices should exert more pressure to ensure honesty and transparency in operations relating to investment. Most importantly is to educate people on the basic information about investment and relevant institutions. They should not make mistakes out of ignorance.

7.0 References

Nolasco, C.A.R., Vaughn, M.S. and Del Carmen, R.V., 2013. Revisiting the choice model of Ponzi and Pyramid schemes: analysis of case law. Crime, law and social change60(4), pp.375-400.

del Carmen, S.J.D. and Rolando, V., 2013. Revisiting the choice model of Ponzi and Pyramid schemes: analysis of case law. Crime Law and Social Change.

Deason, S., Rajgopal, S. and Waymire, G.B., 2015. Who gets swindled in Ponzi schemes?. Available at SSRN 2586490.

Baucus, M.S. and Mitteness, C.R., 2016. Crowdfrauding: Avoiding Ponzi entrepreneurs when investing in new ventures. Business Horizons59(1), pp.37-50.

Cortés, D., Santamaría, J. and Vargas, J., 2016. Economic Shocks and Crime: Evidence from the Crash of Ponzi Schemes.

Luukkonen, T., 2014. » This will not be a Ponzi scheme»: persuasion in an American Ponzi scheme.

Mohd Sulaiman, A.N., Moideen, A.I. and Moreira, S.D., 2016. Of Ponzi schemes and investment scams: A case study of enforcement actions in Malaysia. Journal of Financial Crime23(1), pp.231-243.

Vaknin, S., 2014. The typology of financial scandals and ponzi (pyramid) schemes.

Cox, J., 2014. Fast money schemes are risky business: Gamblers and investors in a Papua New Guinean Ponzi scheme. Oceania84(3), pp.289-305.

Akinladejo, O.H., Clarke, M. and Akinladejo, F.O., 2013. Pyramid Schemes and Multilevel Marketing (MLM): Two Sides of the Same Coin. Journal of Modern Accounting and Auditing9(5), p.690.

Cortés, D., Santamaría, J. and Vargas, J.F., 2013. Income shocks and crime: Evidence from the break down of Ponzi schemes. In Technical Report, Universidad del Rosario.

W. Keep, W. and J. Vander Nat, P., 2014. Multilevel marketing and pyramid schemes in the United States: An historical analysis. Journal of Historical Research in Marketing6(2), pp.188-210.

Cheng, H., 2016. Informal Finance and Ponzi Schemes. In Financial Crime in China (pp. 83-101). Palgrave Macmillan US.

Krige, D., 2012. Fields of dreams, fields of schemes: ponzi finance and multi-level marketing in South Africa. Africa82(01), pp.69-92.

Basu, K., 2014. Ponzis: the science and mystique of a class of financial frauds. World Bank Policy Research Working Paper, (6967).

Rees, M., 2013. Warning signs of Ponzi schemes: investigations. Personal Finance Newsletter, (388), pp.5-7.

Frankel, T., 2012. The Ponzi scheme puzzle: A history and analysis of con artists and victims. Oxford University Press.

Wilkins, A.M., Acuff, W.W. and Hermanson, D.R., 2012. Understanding a Ponzi Scheme: Victims’ Perspectives. Journal of Forensic & Investigative Accounting4(1).