When an investment promises a guaranteed return above what a cash investment would yield, chances are it’s a Ponzi scheme.

“Do you think this investment is legit?” That’s a question I receive at least once a week.

While it’s great that people are starting to become more aware of the number of fraudulent schemes out there, it is concerning that people still want to believe in the impossible. People are still lured by the promise of large returns, even when they know such returns are just not feasible.

Last year an acquaintance asked me about an investment he had made with a company that was claiming to give returns of 3% a week (12% a month) by investing in ‘crypto and forex’. He had invested money after friends recommended it to him.

The promise of such high guaranteed returns immediately raised red flags for me. Moreover, how can they be paying these returns when crypto-assets have collapsed? Another red flag was that they paid better profits if you referred friends and family. Sounded like a classic pyramid structure to me.

A quick look at the website, and a bit of Google research, revealed that the person behind the scheme had been implicated in previous Ponzi schemes – not a good start. The investment was in a country with very weak regulation (the Grenadines) and investments were made via credit card. These were all classic signs that this was not the kind of investment that was likely to be legit.

I suggested he take his money out as soon as possible. The company had a three-month “lock-in” clause and to be honest I was surprised when, after the three months, they actually did pay him out.

The key behind any Ponzi scheme is that it needs to pay initial investors in order to get referrals and more cash into the scheme.

In fact, some unscrupulous investors have become good at identifying Ponzi schemes and working the system. They ensure they are early investors, but then they draw out their capital and profits before the whole thing goes belly up.

Successful schemes can run for a relatively long time and early investors will make money. When journalists warn about a potential Ponzi scheme, the founders threaten lawsuits and investors even send death threats. The amount of money they will make all depends on how long they can keep the scheme going.

That is why the South African Reserve Bank has made it illegal to invest in a Ponzi scheme, even if you do so unknowingly. Ultimately the money you have received is not from any genuine investment activity, but the money taken from other investors. This is stealing, not investing.

How a successful Ponzi scheme operates

The Netflix series Madoff: The Monster of Wall Street is about Bernie Madoff who ran a Ponzi scheme in the US for over 20 years. It makes for fascinating viewing and provides insight into what makes a Ponzi scheme successful. It shows how even wealthy, financially astute individuals are entrapped in these schemes.

South Africa had its own “Madoff” in the form of Barry Tannenbaum whose Ponzi scheme collapsed around the same time in 2009 after four years of conning many wealthy individuals out of an estimated R12.5bn.

In his testimony Madoff confirmed that he had never made a trade and that all returns paid out were all from new investors, yet some of the wealthiest individuals in the US fell for this scheme. Locally, Tannenbaum’s victims included a former CEO of Pick n Pay, the one-time head of the Johannesburg Stock Exchange, and the ex-boss of OK Bazaars.

In retrospect it is quite easy to see that Madoff was running a scam because it had all the red flags we are warned about.

He offered guaranteed returns well above the market and never made losses even when markets fell. And when anyone asked any difficult questions, he just fobbed them off. He told them if they wanted to ask questions, they could take their money elsewhere.

He created the perception of a “secret club” making his investment “exclusive” ‒ something you wanted to be a part of. Investing in Madoff’s fund made you an “insider”. It was a status symbol and investors were so afraid of being excluded they didn’t ask questions.

Tannenbaum’s scheme was similar in this regard. It was marketed to wealthy “insiders” and had the added sweetener of being a way to circumvent exchange control and avoid tax.

And then of course, there is the greed. If your investment keeps giving these amazing returns, why walk away?

Yet it is those returns which are the biggest red flag. When an investment promises any return above cash, the first question you need to ask is: what is it invested in?

Madoff claimed he was using a hedging strategy that made money whether the stock market increased or fell. He was seen as some sort of “wizard” who could select the correct stocks every single time.

Tannenbaum claimed his fund was invested in the components to manufacture AIDS drugs and offered returns of up to 200%.

Nowadays most Ponzi schemes focus on crypto assets or forex, like the recent Mirror Trading International scheme which went into liquidation in 2021. With the rise in the value of cryptocurrency (prior to 2022) it seemed believable to investors. But even bitcoin never went up in a straight line.

The same rules always apply: if it seems too good to be true, then it is. Fraudsters can come up with all sorts of smoke and mirrors and use all kinds of fancy jargon to pull the wool over even financially sophisticated people’s eyes.

Don’t think that this time it is different. The only thing that’s different is the marketing story.

And if you are in doubt, just read the Consumer Protection Act which states that a pyramid (multiplication scheme) “exists when a person offers, promises or guarantees to any consumer, investor or participant an effective annual interest rate… that is at least 20 per cent above the REPO rate.”

This article first appeared in City Press.