Scammers Hall of Fame: Charles Ponzi — Mistakes Were Made

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Oxford dictionary defines a Ponzi Scheme as: A form of fraud in which belief in the success of a non-existent enterprise is fostered by the payment of quick returns to the first investors from money invested by later investors.

Charles Ponzi was an Italian immigrant who came to the U.S. in 1903 with only $2.50 in his pockets. Ponzi gambled away the rest of his life savings during the ship voyage from Italy to the U.S. Charles ended up spending 5 years in prison for forgery and taking part in an illegal immigration scheme. After doing a series of odd jobs in the U.S., Ponzi opened a small office in Boston in the summer of 1919. Ponzi goal for the office was to come up with business ideas. He would write to people he knew in Europe and try to sell them on these business opportunities or these ideas he had. One of these ideas was to sell advertising in a large business listing that was circulated to various businesses.

A few weeks later, Ponzi received a letter from a company in Spain asking about the advertising catalog. Inside the envelope was an International Reply Coupon (IRC). The purpose of an IRC is to allow someone in one country to mail to a correspondent in another country, and he or she could use the IRC to respond to the initial letter. IRC’s were priced at the cost of postage in the country of purchase, but could be exchanged for stamps to cover postage in the country where redeemed. If there was a difference in value between postage costs between the two countries, there was a potential for profit. Inflation caused by World War I, decreased the cost of postage in Italy compared to the cost of postage in the U.S. A IRC could be bought cheaply in Italy and then exchanged for U.S. stamps of higher value, which then could be sold. Ponzi saw the weakness in the IRC system and a way for him to make money.

Ponzi solicited friends into his IRC business idea. He promised them he would double their investment in 45 days with 50% interest. For perspective, the banks at the time only offered 5% interest for loaning your money to them. Some people invested with Ponzi and made $750 on top of their original $ 1,250 investment returned to them.

In January 1920, Ponzi started a company called the “Securities Exchange Company,” to promote the IRC investment strategy. In the first month of operation 18 people invested in the plan and were paid back in a month with money from new investors. Ponzi then set up a bigger office as investments came pouring in as word spread of Ponzi’s investment strategy. Ponzi hired agents and paid them handsome commission checks for every dollar they could bring in. From February to March 1920 the total amount invested had risen from $ 5,000 to $ 25,000 (equivalent to $60,000 -$ 320,000 in 2019).

As the investment frenzy increased, Ponzi sent agents to New Jersey and New England to seek new investors. By May 1920, Ponzi made $ 420,000 (equivalent to $5,400,000 in 2019). In June 1920 people had invested $2.5 million (equivalent to $32 million in 2019) in Ponzi’s investment plan. In early July, Ponzi was raking in a million dollars a week. In late July, that figure went up to a million a day! People were mortgaging their homes, and investing their live savings in Ponzi’s investment plan. These same people would take their returns and reinvest it back in Ponzi’s company. Ponzi’s company had branch offices ranging from Maine to New Jersey.

There was one little nasty secret the investors did not realize, Ponzi’s company was running at an enormous loss. As long as money kept pouring in from new investors, old investors could be paid off. This was the only method Ponzi had to continue providing returns to existing investors because the IRC strategy has yet to provide legitimate profits. Ponzi’s investors were comprised of working-class immigrants, the Boston elite, The Boston Police, and even young newspaper boys. Ponzi was willing to take a dollar from anyone as long as they had money to give.

Changing the IRC to money was a logistical impossibility that no one understood, not even Ponzi until he was rolling in the dough. For the initial 18 investors who invested $ 1,800 total, it would take 53,000 postal coupons to actually realize the profits. For the subsequent 15,000 investors, Ponzi would have to fill ships the size of Noah’s ark filled with postal coupons just to ship them from Europe to the U.S. to even realize any profits. Ponzi never had to deal with this reality because new investors kept pouring in and most of the old investors reinvested with him.

With the ridiculous cash flow, Ponzi had coming in he started living in the lap of luxury. He bought a mansion, had several bank accounts, in fact he deposited so much money in Hanover Trust Bank of Boston, that he was able to buy a controlling interest in the bank. Charles bought a Locomobile equivalent to a modern day Ferrari. Ponzi also bought a macaroni company and part of a wine company to help repay investors in Securities Exchange Company with profits from those two companies. Ponzi was such a friendly guy that he even donated $ 100,000 to the Italian Children’s Home in honor of his mother.

Ponzi’s rapid financial rise drew suspicion. A Boston financial writer suggested there was no way Ponzi could legally deliver such high returns in a brief period of time. Ponzi sued the writer for libel and won! He was awarded $500,000 in damages. At the time the burden of proof in libel law was on the writer and publisher. This lawsuit victory stopped people from publicly saying Ponzi’s investment idea was a scam, but that would only last for a short time longer.

On July 26, 1920, the Boston Post ran a series of articles that asked hard questions about Ponzi’s money-making machine. The Post contacted Clarence Barron, a financial journalist who headed Dow Jones and Company to examine Ponzi’s scheme.

Barron noted that for the Securities Exchange Company to cover the investments made with it, 160 million IRC’s would have to be in circulation. In reality, only 27,000 IRC’s were in circulation. The U.S. Postal office stated that IRC’s were not being bought in enormous quantities at home or abroad. In theory, the gross profit margin of buying Italian IRC’s and exchanging them for U.S. ones was colossal, however the overhead required to purchase and redeem the IRC’s was so great that it would have exceeded profits. Barron also noted that if Ponzi was really doing what he said he was doing, he would profit at the expense of a government whether the purchasing one or the redeeming one, and taking advantage of governments like that was deemed immoral.

Ponzi hired a publicity agent to deal with all the bad press he was receiving. The agent was William McMasters. McMasters quickly became suspicious of Ponzi’s endless talk of IRC’s and the ongoing investigation against him. McMasters would later describe Ponzi as a “financial idiot” who did not even know how to add. McMasters would later find several incriminating evidence that showed Ponzi was just “Robbing Peter to pay Paul” (AKA a Ponzi Scheme). On August 2, 1920, Mcmasters wrote an article for the Post that declared Ponzi was hopelessly insolvent. That article claimed that while Ponzi claimed $7 million in liquid funds, in reality he was actually $4.5 million in debt.

All this publicity brought the attention of Massachusetts Bank Commissioner Joseph Allen. Allen ordered two bank examiners to examine Ponzi’s banking accounts. The examiners found that Ponzi’s primary banking account was overdrawn. Allen then ordered Hanover Trust not to pay out any more checks from Ponzi’s account. This news forced Massachusetts Attorney General J. Weston Allen to release a statement that there was little to support Ponzi’s claims of large-scale dealings in IRC’s. Oh, by the way an audit of Securities Exchange Company revealed Ponzi was $7 million in debt.

The Post then came out with an article stating how Ponzi served prison time for forgery and the role he played in a scandal laden Canadian bank. That same afternoon Allen seized Hanover Trust for multiple banking irregularities. The next day Ponzi surrendered to federal authorities.

Ponzi was charged with 86 counts of federal mail fraud and faced life imprisonment. Ponzi plead guilty and got a 5 year federal prison sentence. Ponzi was released after 3 and a half years and was immediately arrested by the state of Massachusetts and charged with 22 state charges of larceny. Amazingly, it took Massachusetts 3 trials to finally convict Ponzi on the larceny charges. Ponzi served as his own counsel and was able to use the same persuasive skills he used to get people to invest to get a not guilty plea the first trial and a dead-locked jury the second trial. Ponzi received an additional 7–9 year sentence.

Ponzi was released on bail as he was appealing the state conviction and he fled to Florida and launched the Charpon Land Syndicate. This scheme offered tiny tracts of land, some underwater even, and promised 200% returns in 60 days. In reality, the “land” being sold was swampland. Ponzi was convicted of securities violations in Florida and given an additional year of Prison. Amazingly, Ponzi was once again given bail, and he tried to flee the U.S.for Italy via ship. He slipped up and revealed his identity to a shipmate and word spread on the ship. At the last American port in New Orleans, Ponzi was arrested and sent back to Massachusetts to serve his state prison sentence.

Ponzi served 7 more additional years in Prison and upon his release he was quickly deported to Italy as he never became an official U.S. citizen.

The IRC Scam brought down 5 other banks besides Hanover. His investors were wiped out, only receiving 30 cents on a dollar for their investments. In all, they lost 20 million in 1920 dollars (193 million in 2019 dollars).

When your name becomes a noun for a scam and criminal act, you deserve a first ballot introduction into the Scammers Hall of Fame. Charles Ponzi wasn’t the first person to pull a “Ponzi Scheme,” and he won’t be the last either. The most famous recent case is the case of Bernie Madoff. Madoff similar scheme cost his investors about $18 billion in 2008. Roughly about 53 times the amount of losses Ponzi investors faced. It seems Madoff took Ponzi’s blue print, tweaked it and brought it up a whole other notch.

The lesson to be learned here is that there is no way a person or company can offer such high returns in such a short amount of time doing something legal. If you receive this pitch, you are being pitched a Ponzi scheme. Another red flag that was overlooked in this story was that though Ponzi was giving such amazing returns on his investments, he never once invested his own money into the investment. He knew it was all fake. If someone is trying to sell you on investing in something they don’t invest in, run the other way.

Originally published at https://mwmblog.com on May 1, 2020.

Written by

recovering Lawyer, History buff who wants to share my knowledge with the world . To teach them lessons from our past. see all of the stories on www.mwmblog.com

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