Beware of Fraud

Last year, I wrote about the Pyramid Scheme, a classic fraud where people are recruited into the scheme, pay some money, and, in turn, have to recruit more people into the scheme. Pyramid schemes are crimes.

There are many types of frauds that get committed on unsuspecting people. All of them are fueled by peoples desire to make a quick easy buck. This week, I want to explain a lesser-known, but more dangerous type of fraud.

The Ponzi or Bubble Scheme is a scheme where investors are asked to invest in a business opportunity (gold mines, oil & gas leases, whatever). Sometimes, you are even given fancy-looking brochures and accountants projections of earnings.

There is no business. There are no profits. Money obtained from later investors is partially used to pay off or make interest payments to earlier investors. The investors, seeing the money actually coming in, get very excited. It is here where the fraud can become quite deadly. While they may have been quite cautious at first and only invested a modest sum, the payments usually prompt them to invest larger sums in the scheme.

The investors that receive money get very excited about their rate of return and are encouraged to re-invest all the money, even the interest payments, into the business.

These people, who now think that they are getting rich quickly, (and they are, on paper) are quick to get their friends and others involved.

The scheme collapses when the mastermind (who is the person taking all the money) runs out of people to make investments. The mastermind can no longer pay the investors who are expecting money, and the whole thing blows up.

I had a client that was a victim of one scheme where the business was claimed to be high-interest loans to professionals (doctors, lawyers etc.) that needed money for office equipment and furniture. (Pardon me? Banks trip over themselves trying to lend money to professionals.) The client made a first investment of only $3,000, but, by the time he determined he had been defrauded, he had lost $66,000. Whats worse, he had borrowed the money from a relative to finance the Scheme. Fortunately for my client, we have recovered a significant portion of that money. However, he is extremely lucky in that respect.

Keep this in mind: Even in situations where there is no fraud, the only reason that someone is coming to borrow from you is because they can't borrow from a bank. A bank is a cheap place to borrow money. Banks are in the business of lending money. They give lots of loans, knowing that not all of them will be good. They expect certain loans to default. However, the bank has decided that they won't loan this individual any money. If the bank considers this loan to be too risky, shouldnt you?

The Ponzi Scheme is one of those classic schemes, like the Pyramid, that can be resurrected every so often and used to make victims of unsuspecting investors. You should always be on the lookout for it.

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