Duncan Williamson: Ponzi Schemes ponzi.html

The Enron scandal has led to the revival of the term Ponzi Scheme. The Directors of Enron have been accused of operating a vast Ponzi Scheme by members of the US Congress and others. So …

What is a Ponzi Scheme and How Does One Work?

Ponzi Schemes are named after Charles K Ponzi, an Italian who emigrated to the USA. Ponzi was a dapper five foot two inch rogue who ran such a scheme in Boston during 1919 1920. Ponzi raked in an estimated $15 million in eight months by persuading tens of thousands of Bostonians that he had unlocked the secret to easy wealth. $15 million, in 1920: that's a huge amount of money now, let alone then!

Mark R. Simmons tells the Ponzi story very well:

Ponzi schemes may be explicitly illegal, or may fall under statutes that address fraud or larceny, making them implicitly illegal: assuming there is intent to permanently separate the investors from their money.

Two Types of Pyramid

There are two types of pyramid schemes: one legitimate and the other illegitimate. The legitimate pyramid structure is often called a multi level marketing (MLM) organization. Its primary purpose of an MLM is to sell a product. There are many successful MLMs which sell encyclopaedias, soaps and cosmetics, among other items.. The return or earnings to the upper levels of the pyramid are from both the sale of the product and the recruiting of new salespersons. The return is generated from both one's own commission sales and also the commissions on sales of those one recruits.

Illegal Pyramids

In an illegitimate pyramid, the primary return to the upper level individuals is from recruiting of new levels rather than from the sale of a product. In this structure, the return is derived from recruiting others and not from commissions on the sale of any product. The illegitimate pyramid is often referred to as a Ponzi scheme, named after Charles Ponzi, an immigrant to Boston in 1919.

Ponzi Traded in Postage Stamps

Ponzi traded in pre paid postage coupons. He would purchase low rate coupons … and then sell them at a profit ... Desiring to leverage his own purchasing power, he solicited funds from investors, promising them a 40% return in three months. Unfortunately, there were not enough coupons in existence to support his large scale purchases. However, he continued to solicit and receive orders. Ponzi paid some of the investors their promised 40% return from funds collected from later investors. The scheme was perpetuated by the success stories of the payments to the original investors. According to the records, Ponzi made an investment of $50 of his own funds and fleeced $10 million from investors.

Robbing Peter to Pay Paul

The distinguishing feature of a Ponzi type pyramid is that old victims are paid back with funds received from new victims. As long as the fraud continues to grow, the investors are not usually aware that their money has been misappropriated. Most Ponzi schemes are uncovered when new "investors" can no longer be located. All Ponzi schemes, therefore, are pyramids. But not all pyramids are Ponzi schemes.

Entry Fees

Another distinction between legitimate and illegitimate pyramids is the entry fee. In a legitimate pyramid, the entry fee is generally small and used for acquiring a stock of inventory to be sold. In an illegitimate pyramid, however, the entry fees tend to be large and these fees are, in part, passed on to the recruiter.

The Return on Investment

A third difference between the two types of pyramids is the return one can expect. If it appears to be a "get rich quick" scheme, it probably is not legitimate. Abnormally high yields or returns for the amount of effort required is a tell tale sign of an illegitimate pyramid. In these cases, the sales pitch to the unsuspecting victim is that he will earn large amounts without much effort; all he has to do is recruit others to the program.

Golden Rules

The golden rules of illegitimate pyramids are as follows:

If it sounds too good to be true, it probably is.
Does the investment return sound better than what is offered in the marketplace?
Is the investor encouraged to reinvest the profits rather than take a payout?
The focus is on recruiting others, not the sale of a product.
Who endorsed the product, not the investment return?
The entry fee is large and no product (or little inventory) is received.

Generally, illegal pyramid schemes collapse of their own weight. The schemes often are not reported and, therefore, not prosecuted because individuals are embarrassed to admit that they were fleeced by a con artist. The illegitimate recruiter can be anyone: a friend, relative, neighbour, work peer, church member, or someone not known.

These schemes are ridiculous aren't they? No one would fall for them again would they? Er … well, here's another one ...

A Modern Example of a Ponzi Scheme From the FBI (see note at the end)

In 1984, Jean Claude LeRoyer, 54 years old with a history of criminal activity, began the Metro Display Company, with the idea of selling bus stop shelters with advertising space throughout Southern California. He pitched his plan to individual investors and soon received about $48 million from them. The majority of LeRoyer's investors were retirees on fixed incomes who were hoping the investment could better their financial futures.

The advertised investment strategy was as follows: LeRoyer claimed that an investor could buy a bus shelter for about $10,000. He promised each investor $170 in monthly dividend payments and then Metro Display would buy back the shelter from the investor for their initial $10,000 investment after five years. Plus, the company pledged to give investors a 20% share of that shelter's advertising revenue for the following five years. This process, according to LeRoyer, would double an investor's original investment. Sounds too good to be true? It was.

Business runs afoul

By 1991 Metro Display had become one of the largest and fastest growing public bus shelter firms in Southern California. The company owned 2,600 shelters in more than 60 cities and counties in Southern California and Southern Nevada. However, Le Royer quickly began losing control of his investment scheme. Over 1,600 shelters remained to be built and other financial problems were beginning to mount. LeRoyer failed to advise his investors, among other things, that 25 percent of their investments were being used to pay sales commissions, and that funds from new investors were used to cover the monthly payments due to long time investors. He claimed he was selling ads in the shelters for about $1,000 a month per shelter when actually the price was closer to $200. In addition, only 10 to 15 percent of the shelters carried paying ads, not the 85 percent that LeRoyer had claimed. Business grew dismal, new investor funds trickled to a halt, and long time investors clamoured to get their monies back from LeRoyer's collapsing business.

The Securities and Exchange Commission (SEC) was alerted. The SEC froze the sale of any additional shelters and called on the U.S. Attorney's Office, the Internal Revenue Service (IRS) and the FBI office at Los Angeles to form a special task force for a securities investigation of Metro Display, which had garnered a lot of attention with its irregular business transactions.

The investigation

The FBI executed six search warrants and confiscated computers and files from Metro Display's offices and from both LeRoyer's office and home. The FBI also investigated criminal misrepresentations and fraud by wire deals by the company's salesmen. The files revealed that in the first six months of 1991, Metro Display recorded losses of more than $7 million. The files also showed that LeRoyer and his wife Karen had diverted more than $800,000 from the bus shelter business to make improvements on their luxurious home. The LeRoyers also paid hefty amounts of money to relatives employed at the business.

Because of LeRoyer's diversion of funds from the business, the SEC filed a financial fraud and misappropriated funds lawsuit against LeRoyer. He, in turn, filed for bankruptcy and removed himself from control of Metro Display. However, he did continue to serve the company in a lesser capacity.

LeRoyer pleads guilty

In October 1996, LeRoyer pled guilty to filing false tax reports and to six charges of mail fraud, the mail fraud charge being from his use of mail to further his scheme. He was sentenced to 46 months in jail and was ordered to pay restitution to his victims. The company's chief financial officer also pled guilty and was sentenced to one year in prison. Karen LeRoyer, the firm's former bookkeeper, pled guilty to three counts of filing false tax reports. She was sentenced to 5 months in jail for her role in the investment scheme but the presiding judge placed her on probation so she could look after the couple's newly adopted 8 year old daughter.

Three of Metro Display's salesmen were indicted for their parts in the scheme. During their six week trial held late in the summer of 1998, prosecutors used 36 witnesses and 350 document exhibits (selected from the more than 2,500 documents seized) to demonstrate the salesmen's' involvement in the fraudulent activity. All three were convicted and received prison terms ranging from three to seven years.

Much is lost

Investors were only able to get back less than half of their original investments. About 200 Metro Display investors, many of them retirees, did not want to take their losses lying down. They formed a group to try to get the company back on sound financial ground in the hopes of ultimately selling it in order to recoup their losses. Investors, mostly volunteers, did everything from answering phones to selling adds. Slowly, Metro Display emerged from bankruptcy and was sold. Generally, investors in Ponzi Schemes lose much of their invested monies.

Conclusions

Unfortunately, there are thousands of people in this world who want to get rich quick and to do that they try to persuade the likes of you and me to get rich quick, too. The key point is, however, that THEY get rich quick and we don't.

My e mail InBox receives several MLM/Pyramid "offers" every day of every week. Since I'm risk averse anyway, my investment strategy keeps me well away from such ideas; but there are people who still break the first and most golden of all golden rules:

If it sounds too good to be true, it probably is.

Investing in stocks and shares is a bad enough way to make money; but to rely on a Pyramid Scheme is futile and dangerous. Don't do it!

Jean Claude LeRoyer Writes

For quite a while now I have been receiving emails from someone who may be the Jean Claude LeRoyer mentioned in the case above. He is steadfast in his defence of himself, I have to say. To present his side of the story then I have taken the very unusual step of allowing him web space here to let you read what he is telling me.

I do not know this man and have no idea whether the case is setting out is true or false. On that note, I place his message here for you to decide. Before you read on I should say that I have written none of the above apart from inter paragraph links: all materials coming from various sources.

10^th May 2007

Dear Sir:

I have tried several times to make you aware that your story on Ponzi Schemes was incorrect in regard to the part that involve what I was accused of, and especially the part that involve my wife Karen.

You are very much aware that your story is fabricated. First of all, my wife was "NEVER" accused of anything connected to my business. Second, she was not the book keeper of the company! We had one CPA, 2 accountants and 2 helpers (book keepers). If she was convicted of fraud connected with MDA I would like you to show me a copy of the conviction. She was accused of false tax returns because we filed joint tax returns for all the years since we were married. Even in that case, their allegations were wrong, there was no ground for such accusation, I received loans from the company, and these loans were not income like the DOJ wanted the court to believe.

Leave my wife and my child alone and from your tabloid type of story. Our life has been ruined because of people like you, telling lies and writing stories that are nothing but fabricated stories.

My wife and my young daughter are being hurt very badly by your lies, and I warned you a few months back that I will file a lawsuit against you and your organization for slanders. Several attorneys want to take the case on a contingency basis and I am sure they must have good reasons to be willing to take it that way.

As far as the rest of your story, I believe I told you that you should have checked the facts before writing what you wrote. I DO NOT HAVE A CRIMINAL HISTORY LIKE YOU SAID!!!!! If I do, show me the facts.

When you said that the investors received less than half of their original investment back, here again you should check what you are telling the readers.

The damages caused by what you wrote are devastating to my wife and my family. My daughter is ashamed to go to her school because of what you wrote. This is ruthless from your part and obviously you are not interested in telling or reporting what is the true. A good reporter or writer will check everything he or she writes. You are too low or too lazy to do that sort of good reporting.

One more time I am asking you to remove my wife from your story and to correct the lies you wrote!

Jean Claude LeRoyer
email address withheld

Finally, the number of visitors to this page of this site is exceptionally small.