We have never been short of Ponzi schemes and that too innovative ones. These scams are not restricted to the usual asset classes. They have taken into their fold the animal world (the emu scam) and the plant kingdom (teak plantations). Whatever the nature of the scheme, the underlying story is always the same, promise of very high returns, such returns actually get paid initially; more investors are attracted by word of mouth; until new investments stop and the scheme crashes for want of fresh money to pay existing investors.
Why do these Ponzi schemes turned scams crop up time and again? Experts point to a lack of a widespread and formal financial and banking system. This may be true of the Sahara scam case where a number of people from town and villages, perhaps having little or no access to regular means of finance, put their hard earned money in the fund. And yet, large cities do not lag behind either, when it comes to being conned by Ponzi schemes.
Thus, it makes us believe that the promise of high returns can often times overpower simple financial wisdom. Needless to say, it is the retail investors who mostly fall prey to these schemes. The fear of loss in equity market and the lack of inflation-beating returns from regulated fixed deposits push investors into taking a higher risk, the risk of losing all their savings and having little or no redressal mechanism. Here are a few points that may be worth giving a thought if you ever come across a scheme that lures you with high returns.
Complicated business or investment strategy
Ponzi schemes often work in multi-tiers. They are called pyramid schemes and often take the structure of multi level marketing (MLM) agencies. If somebody is trying to sell you a product or idea that you do not understand, it is not your fault. It is the likely that the idea is a weak or dubious one. Walk away. It is best to seek opportunities in businesses that have existed for a good period. Even if the business appears promising, remember retail investors cannot be angel investors, providing finance to budding businesses that hold plenty of promises and no assets.
Regulations governing the scheme
Large returns mean larger risk; that entails huge amount of information and verification before you invest. The first step towards such verification is knowing what laws govern the investment. It could be the RBI or SEBI or simply the Companies Act. You should also know if the firm has authorisation to borrow from the public. For instance, a Non-Banking Financial Corporation must be registered with the RBI and also have authorisation to collect deposits from the public. They are also required to have a credit rating on such deposits. Direct equities and mutual funds are governed by SEBI laws while insurance by the IRDA. Chit funds, on the other hand, are mostly governed by state laws (not by RBI) and have less redressal mechanisms when compared with the others mentioned above. You need to know if you have a lifeguard before you get into the troubled waters.
Initial euphoria
Do not go by the high returns that a friend just received from a ‘too good to be true’ firm. That’s how a Ponzi operates. Economist Robert Schiller’s definition of ponzi scheme in his research paper is often quoted in the media: “It (ponzi scheme) creates a false perception of high returns for initial investors by distributing to them money brought in by subsequent investors. Initial investor response to the scheme tends to be weak, but as successive rounds of high returns generate excitement, the story becomes increasingly believable and exciting to investors. Finally, the scheme collapses when new investors are not prepared to enter the scheme.”
No quick bucks
In all scams, time and again, bring to light that there is no such thing as quick money. As investors, we have little choice but to start building investments early, if we aim high. For retail investors the only recipe to build wealth is making regular investments through regulated systems, taking calculated risks and seeking the help of qualified people in case they need advice. Remember curiosity pulls people to the scam.
