Netflix just released a new documentary about Bernie Madoff, who orchestrated one of the biggest Ponzi schemes in Wall Street history, defrauding thousands of investors. In this four-part series, we follow the rise and fall of the financier and its investment empire. And to some, it will bring back painful memories.
A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. So, to operate, it needs a constant flow of new money.
The Madoff scheme was a global one, and Switzerland was not left unscathed. The most respectable Swiss financial institutions and their clients were caught in the fraud. Some didn’t even survive it.
At the time, I was lucky to work in a bank with very little exposure to Madoff but I remember vividly the shock. Most of the financial world was caught off guard.
If the Madoff’s scandal was unprecedented in size, it was not the first in history (see table below) and white collars do not always carry them on. The European Kings Club scam of the 1990s, which was very prominent in the central part of Switzerland is a good example.
Some of the largest Ponzi schemes that shook up Switzerland
| Scheme | What | Dates | Estimated Amount |
| Stanford case | The U.S. investment broker who sold fraudulent high-yielding certificates of deposits defrauded 18’000 investors. | 2001-2008 | $7 Bln. In 2020 Switzerland handed over $ 200m to the US. |
| Dieter Behring case | An investment fund is supposed to generate market-beating returns using complex algorithms. The Ponzi scheme set up in Basel has defrauded more than 2000 persons. | 1998-2004 | CHF 800 M |
| AB case | A Ponzi scheme operated by an external manager in Geneva. The fund promised annual returns above 20%. | 1990-2007 | CHF 72M |
| Bernie Madoff | One of the largest scams in history defrauding thousands of investors. Madoff attracted investors by promising them extraordinarily high returns on their investments. However, when investors handed over the money, Madoff just deposited it into his personal bank account at Chase Manhattan Bank. He paid “returns” to earlier investors using the money obtained from later investors. | 1990-2008 | $ 64 Bln |
| European Kings Clubs | A large-scale Ponzi scheme operated in Switzerland, Austria, and Germany. The EKC promised investors to record profits after buying “letters” for 1’400 CHF each. Swiss investigators, who have led inquiries into the scheme in 12 cantons, believe that as many as 30,000 people in Switzerland have been defrauded of between CHF 200 million and CHF300 million. | 1991-1994 | CHF 360 M |
So is there a way to detect a Ponzi scheme before getting caught in it?
There are certainly red flags that we will list below, but you have to remember one thing: it all starts with you.
Ponzi scheme organisers will try to lure you with compelling arguments to ensure this. Your greed only matches their promise of exceptional returns. So before succumbing to temptation, exert what I would call “constructive suspicion”.
What you see is what you get
One of the golden rules of finance is that any investment involves risk. And the size of potential returns is usually commensurate to the risks you take. So high returns with little risks should be treated with suspicion. Especially guaranteed ones.
Moreover, these returns must be produced by some assets. So fund’s performance must be somehow linked to the performance of the underlying assets.
For example, if a fund invests in stocks or crypto, you should expect volatile returns, not a straight line or overly consistent returns. So your first reflex should be to inquire about the underlying strategy and if you feel any mismatch that you can’t explain, treat it as a red flag.
Leave secrets to fiction lovers
Secretive and complex strategies are often on the menu to hide a scam. Large-scale Ponzi schemes are not that different from the junk emails we receive in our mailboxes. They just look more credible. How do they do this? Often with an ounce of sophistication.
As a rule of thumb, you should avoid investments if you don’t understand them or can’t get complete information about them.
The regulation is your friend
The great financial crisis was a terrible experience for many, but if anything good came out of it, it was stronger regulation meant to protect individual investors.
The number of documentation and controls asset managers and banks have to produce is enormous to ensure the protection of their clients. Ponzi schemes often operate on the margin of the financial system. Unregistered investments, unlicensed sellers, and light documentation should be treated with caution.
Get out to better get in
In the event, you have already invested and you have a doubt. Try to withdraw a portion of your money. If you don’t receive payment or have difficulty cashing out, and the lack of liquidity is not explained by the lack of liquidity of the underlying strategy, well, maybe your suspicion was correct.
“Post mortem” analyses are always easy, but the Bernie Madoff tragedy reminds us that Ponzi schemes can be operated at very large scales, so don’t skip the due diligence step and don’t let your greed gets in the way.
There will be others Ponzi schemes for sure, some are already betting that FTX in the crypto space is likely to be the next monster. To avoid them best remedy against scams remains a healthy dose of skepticism.
