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PONZI Schemes:

Double your money in 90 days. A highly tempting and lucrative offer for anyone who hears it the first
time. 1919, a time when the first World War had finally stopped on its path of destruction and the
European countries were still in the process of damage assessment, Charles Ponzian Italian immigrant
to the US came up with an ingenious scheme. Ponzi discovered an arbitrage opportunity existing, in the
form of difference in stamp rates across different countries in the world. He contacted a person in Spain,
g asking him to subscribe to an export magazine he planned to launch. The subscriber sent Ponzi an
International Reply Coupon(IRC), which could be exchanged at the local post office, for American
stamps, needed to dispatch the magazine to Spain.
The whole point of the postal reply coupon was to allow someone in one country to send it to a receiver in
another, who could use it to pay the postage of a reply. IRCs were priced at the cost of postage in the
purchase country, but could be exchanged for stamps to cover the cost of postage in the country where
redeemed and a difference in prices meant a potential profit. Inflation after World War I led to depreciation
of the Italian currency, resulting in cheaper stamps when expressed in American dollars. This meant that
IRCs bought at lower rates in Italy could be exchanged for stamps of higher value in US and later sold to
generate profit . Ponzi calculated that the net profit after accounting for the expense and exchange rate,
turned out to be around 400%! And Italy was not the only inflated country in Europe at that time. The
World War had consumed almost all of Europe, providing many sources at Ponzis disposal.

He pounced upon this opportunity, borrowed money and sent it to his relatives in Italy to send him IRCs.
But when he tried to reimburse them, he ran into a lot of bureaucratic hurdles, something that he had
clearly not expected. Undeterred, he contacted some of his friends and explained them about the
arbitrage opportunity. He got some of them to invest and even paid them back. As word spread, money
started pouring in. he hired more agents and paid them commission. The money from new investors was
used to pay off the old customers who wanted to cash out. Most of the people instead of redeeming their
profits, further re-invested. But then there were never any legitimate profits and when there were no new
customers, the scheme collapsed. People who had put in their life savings, went bankrupt. His investors
lost about $20 million in 1920 dollars ($225 million in 2011 dollars).
Bernard Madoff is another genius who has been credited with running the largest Ponzi scheme in
history. A former NASDAQ chairman, Madoff was also the founder and chairman of the hedge fund firm
Bernard L. Madoff Investment Securities LLC, from the inception of the company in 1960 to his arrest in
2008. In the early 1990s Madoff started started convincing his family and friends to invest in his scheme
which promised to add 10% interest to their account every year. Investors took his word and also spread
the word that his fund was reliable and the popularity of the scheme grew. Also Madoff was himself a well
reputed investor and was known to have the Midas touch. Union BancairePrive, a swiss bank, explained
that because of Madoff's huge volume as a broker-dealer, the bank believed he had a perceived edge on
the market because his trades were timed well, suggesting they believed he was a front runner.
Whenever somebody wanted to withdraw, he would simply pay him off from other investors money. But
sadly for Madoff, 2008 exposed another scandal, leading to a recession, which led to a bank run on his
firm. He was exposed by his own sons, arrested and imprisoned for life. His scheme cost his investors
about $18 billion, 53 times the losses of Ponzi's scheme!!

Another variant of the Ponzi scheme is the Pyramid scheme which are primarily same as Ponzi scheme.
The difference lies in the structure. In Ponzi schemes, there is primarily one portfolio manager who
collects the funds from the subscribers whereas a pyramid scheme is structured so that the initial
schemer must recruit other investors who will continue to recruit other investors and those investors will
then continue the recruitment process. Each investor pays the person who recruited them for the chance
to sell this item. The recipient must share the proceeds with those at the higher levels of the pyramid
structure.

Coming to India, its no surprise to find that India is not immune to Ponzi schemes. In a country where the
amount of money scammed in 1 scandal is larger than the market capitalization of the largest companies
combined, Ponzi schemes come as no surprise.(Wah! Very cool!)
The most recent ones comprise the Saradha Chit Fund scam and the Amway Pyramid scheme.

Chit funds are kind of a depository saving schemes where the people subscribing to the chit fund deposit
a certain amount of money( or grains in some cases) after a fixed time interval over a certain period of
time and at the time of next payment, an auction or tender is held which determines the prize money to be
doled out to the awardee. The no. of time intervals equals the no. of people who have subscribed to the
chitty.
Lets consider an example:
The general pattern of a chitty is given by:

Monthly Premium Duration in Months = Gross Amount


E.g.: 1000 * 20 = 20,000/- Where 1000 is the maximum monthly contribution required from the subscriber,
20 is the duration of the chitty in months and 20,000 is the maximum sum assured. The duration equals
the no. of subscribers because every month one subscriber is allotted the prize money.
The minimum prize money of an auction is limited to 70% of the gross sum assured (14,000 in the above
example). The person willing to take this amount takes it and the remaining amount i.e. 6,000(also known
as the auction discount) is distributed to all members equally(i.e. 6000/20=300). If more than 1 person,
decision is made through lottery and if no one is willing to take this amount then bidding starts from the
higher end. People bid lower amounts each time and the person bidding the lowest takes that amount.
This process repeats itself every month and each subscriber gets the chance to take home the money. A
person who has already won once is not allowed to participate in the lottery again but has to make the
contribution every month.
Coming to the Saradha chit fund scam, lets first look into the various forms of financial institutions
available to the common man. India houses a large poor population with low access to proper banking
facilities. This gave birth to many informal banking sources, primarily the moneylenders. But the
government soon regulated a law which brought the downfall of these pawnbrokers. However, the
government failed to address the main issue of providing formal financial institutions which gave rise to
many dubious fly by night schemers who conned a lot of people. The healthy rural economy of West
Bengal had earlier relied on small savings schemes run by Indian Postal Service. However, low rates of
interest in the 1980s and 90s gave birth tomany Ponzi schemes in questionable ventures such as
Sanchayita Investments, Verona Credit and Commercial Investment Company. These scams in total
wiped out investors wealth of close to 10 billion rupees.
In spite of this history of Ponzi schemes, many new firms with many types of Ponzi schemes came up and
flourished in West Bengal.They raised their funds through various legal routes like collective investment
schemes, non-convertible debentures and preference shares or illegitimately through hoax financial
instruments such as teak bonds or potato bonds. More than 8 out of 10 multi level marketing and finance
schemes have been reported to be Ponzi in West Bengal, making it the 'Ponzi capital of India'. It is
estimated that these ponzi funds have all-together amassed around 10 trillion rupees from the innocent
depositers.
The Saradha Group according to their website description was a consortium of companies that ran many
collection saving schemes for the public. Like a typical schemer, they offered to give sky high returns
through risky but credible investments. With other investment schemes by govt offering much lower
returns, people fell for the trap. Its funds were sold on commission by agents who were recruited from
local rural communities. Upto 40% of the deposit was given back to these agents as commissions and
lucrative gifts were given, establishing a pyramid of agents in the process.The consortium of companies
was built with the very purpose of laundering money from one firm to the other to beat the regulators.
Initially, the companiesraised money from the public via secured debentures and redeemable bonds.But
SEBI guidelines forbid any company to raise money from more than 50 ppl without issuing a proper
prospectus, revealing its balance sheet and also having itself audited by SEBI. So when faced with
charges by SEBI in 2009, the company opened as many as 300 more companies and transferred
accounts and money to these making it difficult for SEBI to put blame on any one company. SEBI
persisted, but the crooks were always a step ahead. They now operated through Collective Investment
Schemes(CIS) like real estate, tourism packages, money forwarding, infrastructure financing etc. Again in
2012, SEBI informed West Bengal government to take action and again the group changed its modus
operandi. Now, they started trading in stocks of some of the big firms. They kept evading SEBI, ignoring

its warnings, the governments threats. One by one all their companies closed down and the scam was
finally exposed in April this year
Now the question arises, how was this group able to attract so many investors to it. It wasnt just the low
income households but also the upper and higher economic sections of the society that invested them.
The one thing that the group focused upon was building its brand. As they say in business, its the brand
that sells. And so it turned out to be in the case of Saradha. Saradha invested in high visibility sectors,
such as the Bengali film industry, where it recruited Satabdi Roy, a famous actress and MP, as its brand
ambassador. KunalGhosh, another MP from Trinamool Congress was made or made to act as the CEO
of the media division which brought the spotlight on the company highlighting it as reputable and trustable
investment firm because it was being endorsed by such popular figures. But obviously these people were
also making their money, knowing all along that it was a scam.
Rs. 200300 billion (US$46 billion). Thats the total loss that was estimated from the scam. Many went
bankrupt as soon as the bubble burst. The government set up a fund of Rs. 5 billion to ensure that low
income investors are not bankrupted. The UPA govt ordered probes into many other multi-level marketing
schemes and the SEBI made regulation norms stricter. But the damage had already been done.
So what does this incident tell us. Inspite of being known as the Ponzi capital of the country, people still
succumb to these scams. Are they that stupid? Is it because of the faith they have in their leaders to
follow them blindly if they are heading some organization or appearing in commercials? Is the govt itself
too corrupt and is happy with its share from letting these scams run? Probably the answer is a mixture of
all these. Perhaps more to do with the government because in other states Ponzi schemes are not that
prevelant. Or maybe just a coincidence. Whatever it is, we will never get to know for sure.

Now focusing on the Amway scandal in Andhra Pradesh. Amway is a leading brand in health, beauty
and home care market segments.Amway conducts business through a number of affiliated companies in
more than a hundred countries and territories around the world. Its a direct selling company which
operates through multi-level marketing techniques. Amway has often been accused of running a pyramid
type model. It has faced many trials in countries across the world and gotten away in most of the cases
without any damages.
The Timeline:
2006: Suspicions about its operations in India began back this time in Andhra Pradesh thanks to an
Amway distributor who got entangled in a dowry dispute. The Andhra Pradesh police conducted raids and
seizures against many of the companys distributors, and filed a petition against them for violating
the Prize Chits and Money Circulation Schemes (banning) Act. It has been accused of running a Ponzi
like scheme by generating revenues by recruiting more and more distributors than actually selling off the
products to a customer. Amway requested to the High Court for the petition against them to be
dismissed and the High Court ruled that if on further investigation the company is found guilty of violation
of the act, its operations will be discontinued in Andhra. The case was then handed over to the Supreme
Court which asked the police to complete its investigations within 6 months. Nothing concrete was found.
2009: The State government banned Amways media commercials which was later revoked when Amway
filed a complaint to the High Court.
2011: Kerala police starts closing down Amway offices in various districts in August, and starts calling
distributors to the police station for interrogation following complaints and the distributors had few

answers as they themselves didnt know about the companys modus operandi. With further
developments and show cause notices, the police conducted searches at the offices of Amway at
Kozhikode, Thrissur and Kannur and closed down the firm's godowns at these places seizing products
worth more than 2 crores, in the month of November
May 2013: MD & CEO of Amway India Enterprises, William S. Pinckney, along with 2 other directors of
the company were arrested from Kozhikode thanks to a bold move taken by the Kerala police for which it
later faced a lot of heat from various political parties as well organisations like FICCI. However, the men
were released on bail the very next day and the offices were soon allowed to resume business by the
court on lack of evidence.

Multi-Level Marketing(MLM) companies have always been under the radar across the globe for running
pyramid or Ponzi like schemes. Amway has faced several charges like tax evasion, money laundering in
several countries, even in countries like USA, Canada and UK and its not entirely the companys fault.
MLM models have proven to be prone to police action and lawsuits. Resemblance to pyramid schemes,
cloud over fixing of products, emphasis on recruiting new people than focus on sales, using personal
relationships to get sales or new recruits are some of the factors due to which the MLM model has faced
criticism over the recent years. MLMs are generally very hard to monitor and regulate because its difficult
to implement and regulate laws that can monitor and regulate so many distributors and their activities,
and that the distributors are not becoming customers themselves.
Whether or not Amway is actually making its money by selling it to actual end customers or just by
recruiting new and new distributors will never be known to us unless actually revealed by the officials
themselves because its easy for the company to just portray one of the distributors after a particular stage
as the end customer.
But what both these scams in quick succession have done is atleast woken up the dormant bodies like
SEBI, FICCI, RBI and the finance ministry from their slumber and spurred them into action. They have
drawn attention on similar illegal deposit mobilising companies which are now facing increasing heat from
these bodies. July 18, the cabinet amended the SEBI Act, loading it with more firepower to beat down on
suspicious schemes especially the CIS(Collective Investment Schemes) like Saradha. Sebi will be able to
summon any person or organisation to assist in an investigation into a chit fund or a para-banking
operation. It will also be able to undertake "search and seizure" operations and help them access call
records.The companies have been trying to resort to many other unregulated or not very well regulated
investment areas to continue their financial operations. Nevertheless, rest assured its going to get
tougher for them to sustain.
But then again, public is fickle minded. One day after the scam is revealed, people will go into frenzies,
start blaming the government, SEBI, RBI for not being efficient and start questioning the way they are run.
The newspapers will yell it out, news channels will run day long shows to scrutinize the details, calculating
and projecting the losses as news bulletins and political parties will play their usual blame game. A few
days will pass,govt bodies will announce their measures and order a few raids. Newspapers will have a
new story to popularize and the common man will have something else to feed upon. What one must not
forget is that the government body can make rules, try its best that they are implemented but cant keep a
check on all transactions. Scamsters will always be a step ahead of the rule makers. It ultimately boils
down to the investor to think twice before he is putting in his money. Its his money after all and he himself
is the first one to blame if he makes the decision out of his greed without paying heed. The saying If it
sounds too go to be true, it probably is works every time. The regulators will regulate to as much extent
they can but its ultimately down to the people involved in the transaction to act responsibly.