Per Investor.gov, a Ponzi scheme is an investment fraud that produces little to no actual earnings. Such a scheme relies on the continual flow of new money to survive. To keep old investors happy, the scheme’s founders pay them with monies invested from new investors. The organizers say they will invest parties’ funds and generate high returns, an opportunity that poses little to no risk. Unbeknownst to investors, however, the organizers do not diversify the money; instead, they disperse the money among top investors and save a chunk for themselves.
Ponzi schemes are illegal. This is because the fraudsters typically keep the scheme going until they feel as if they have collected enough money. At that point, they disappear, taking all investors’ money with them.
If the state or federal government accuses a person of organizing and/or operating a Ponzi scheme, it must prove the existence of five elements. ThoughtCo. shares what those five elements are.
The first element of a Ponzi scheme is the promise of an above-average rate of return. Typically, the rate of return is specified. It is also high enough to attract worthwhile investors, but not so high as to be unbelievable.
The second element is the setup. To assuage potential investors’ doubts, the organizers have a story lined up as to how they are able to achieve such high rates of return. The explanation may include the investors are more skilled than others on the market, possess inside information or that they have access to an opportunity not otherwise available to the public.
The third element is credibility. A person running a fraud as big as Ponzi schemes can get needs to have a reputation, charisma or both. Investors need to trust the organizer enough to leave money with him or her.
The fourth element is happy investors. The initial investors, at least, must be able to claim the promised rate of return, if not better.
The fifth and final element is communication. Investors must have a network of other investors with deep pockets. The goal is to get more investors to hear about the opportunity and want to join. Without this final element, a Ponzi scheme would not work.