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Ponzi Scheme

Ponzi Scheme

Definition

A type of fraudulent investment operation (named after the notorious 1920s swindler Charles Ponzi) that pays returns to its investors from monies provided by subsequent investors, rather than from profit earned by the person or the organization running the operation. Ponzi scheme operators entice and secure new investors by offering higher rates of return than are otherwise obtainable in the marketplace. Another important characteristic of Ponzi schemes is that they require an ever-increasing flow of money from new investors to sustain the scheme.

One notable, recent Ponzi scheme was perpetrated by Bernard Madoff (for which Madoff was sentenced to 150 years in prison) and considered to be the largest financial fraud in U.S. history. The trustee for victims of the fraud estimated that investors lost $18 billion as a result of Madoff's fraud.

The sheer volume of the scheme was, in part, made possible because Madoff had access to banks, insurers, pension funds, mutual funds, charitable trusts, and other money management firms, which, in return for generous fees and commissions, channeled their customers'/clients' funds to Madoff. Investors brought numerous lawsuits against the directors and officers of these institutions, in which investors alleged that the money management firms were negligent in not discerning that Madoff's operation was fraudulent.

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