Economic Crime Journal

Economic Crime Journal

Dr. David Murphy is a Certified Fraud Specialist and Certified Public Accountant and is a member of the Board of Regents of the Association of Certified Fraud Specialists. In addition, he has served as the Senior Anti-corruption Advisor to the Controller General of Peru and the government of Bulgaria. He was also the director of a two-year USAID anti-corruption graduate education project in Bolivia and consulted to the Central Bank of the Philippines in the wake of a major bank fraud in Manila.

Other Posts:

How to Catch Fraudulent Financial Reporting (11/16/2009)
ASIS Economic Crime Council Highlights LC's Program (11/06/2009)
Fraud on Steroids (10/19/2009)
U.S. Banking Fraud Interview (04/27/2009)
Financial Statement Fraud (04/17/2009)
Internet Fraud on the Rise (04/06/2009)
Fraud Close to Home (03/27/2009)
Can Economic Crime Be Eliminated? (03/20/2009)
New Credit Card Scam (05/01/2008)

Bernard (Bernie) Madoff, the former Nasdaq chairman was charged in late 2008 with massive fraud.  He pleaded guilty this month (March, 2009) to eleven criminal accounts for orchestrating the biggest investment fraud, $65 billion, in Wall Street history and was jailed to await a sentence that will probably keep him in prison for the rest of his life.  His fraud has been described as a "Ponzi Scheme", so who was Ponzi and what is a Ponzi scheme?

Charles Ponzi emigrated from Italy to the United States in 1903.  He implemented a scam that took him from anonymity to being a well-known Boston millionaire in six months in 1920.  Profits in his company were supposed to come from exchanging international postal reply coupons (IRC). The purpose of the postal reply coupon was to allow someone in one country to send it to a correspondent in another country, who could use it to pay the postage of a reply. IRCs were priced at the cost of postage in the country of purchase, but could be exchanged for stamps to cover the cost of postage in the country where redeemed. There was profit potential if these values were different.  In essence, he was going to by IRCs in countries where postal prices were low, and convert them in countries where the postal rates were higher.  This looks like a simple case of price arbitrage.

High inflation in Italy after World War I had decreased the cost, in U.S. dollars of IRCs in Italy.  Ponzi claimed a return of 400 percent after paying transaction costs.  He explained his scam to others and marketed the idea through his Security Exchange Company promising a 50 percent return on investment in 45 days or double your money in 90 days.   About 40,000 people invested about $15 million in the Security Exchange Company.  Ponzi robbed Peter to pay Paul.  He used the cash received from later investors to pay off the early investors, giving the illusion of actual above-market returns.  In the end only a third of that money was returned to the investors. 

Ponzi's world started to fall apart in July, 1920 Clarence Barron, the publisher of Barron financial newspaper noted that Ponzi  wasn't investing with his own company and that 160,000,000 postal reply coupons would have to be in circulation to cover the investments made with the Securities Exchange Company. However, only about 27,000 coupons were actually circulating.   Ponzi was arrested on August 12, 1920, under 86 Federal indictments for mail fraud.   He was released from prison in 1934 and was deported to Italy.

Remember the old saying, "What goes around comes around."?  Ponzi didn't invent the scheme, in fact Charles Dickens describes it in his 1857 novel Little Dorrit.  Ponzi however lent his name to it because of the size of his fraud.  Remember, if an investment looks to good to be true, it probably is.