The Never Ending Attraction of the Ponzi Scheme
Pearl Jacobs, Linda Schain · 2011
In the 1920’s, Charles Ponzi engaged in a notorious money making scheme. This scheme had been tried before but no one prior to Charles Ponzi had managed to swindle millions of dollars out of unsuspecting people. Thus, the scheme bears his name. In December 2008, Bernard Madoff, a major Ponzi schemer, was exposed. He managed to con investors out of over $65 billion over a thirty year period. Madoff was a highly respected financial expert. The investors were mostly well educated and supposedly financially savvy. How did this happen? This paper will examine some theories which may help explain both the reasons individuals fall victim to Ponzi schemes as well as how legitimate business professionals can become involved in unlawful Ponzi schemes. The paper will also provide some suggestions on how to avoid falling victim to such illegal ventures. INTRODUCTION Bernard Madoff ran the largest reported Ponzi scheme in history. He operated a $65 billion Ponzi scheme for over thirty years. How was this possible? Society is much more sophisticated today than it was in the days of Charles Ponzi, the man for whom the scheme is named. How could educated, streetwise investors be taken in by such an old ploy. How could respected professionals become involved in such schemes? There is an old saying that the more things change, the more they stay the same. This paper will explore the factors that may contribute to the success of Ponzi schemes. It will discuss the multidimensional theory of gullibility proposed by Greenspan, (2009), the principles of influence and persuasion proposed by Cialdini, (2001), and the nature of affinity fraud which is what some schemes such as Madoff’s involved. The paper will discuss possible explanations for the Ponzi schemer’s behavior. This will include the desire for control, the illusion of control, neutralization theory and cognitive dissonance as possible explanations for the Ponzi schemer’s behavior. The paper will also present ways to detect and avoid becoming a victim of such schemes. Factors That Draw Individuals to Ponzi Schemes Theory of Gullibility Greenspan (2009) considers gullibility to be a sub-type of foolishness. He defines a foolish act as, “one where someone goes ahead with a socially or physically risky behavior in spite of danger signs, or unresolved questions which should have been a source of concern for the actor (Greenspan, 2009:22).” Journal of Comprehensive Research 41 Greenspan (2009) proposes a multidimensional theory of gullibility to explain the success of Ponzi schemes. The four factors Greenspan (2009) believes contributed to the success of the Madoff Ponzi scam and could be responsible for the success of other Ponzi schemes are situation, cognition, personality, and emotion. Each of these factors will be examined. Situation In a scam the individual is presented with a challenge to consider. The challenge is whether or not to invest in a risky venture and thus, engage in a foolish act. An individual is more likely to engage in gullible behavior, “if the social and other situational pressures are strong and less likely to occur if the social and other situational pressures are weak (Greenspan, 2009:22).” The Madoff scam, for example, had strong social feedback pressures. Madoff was a prominent philanthropist. Thus, the reputation of the schemer may affect the judgment of the potential victims. This was a factor in the Madoff scheme. Madoff was rarely involved with the individual investors. He relied on feeder funds to collect money from individual clients and pass it on to him for investment. The hedge fund managers trusted Madoff because of his reputation and the fact that he had been giving steady returns over a long period of time. However, his name was unknown to most of the investors in the feeder funds. Since the individuals were dealing with long established and reputable hedge funds, they didn’t question how the returns were achieved. They relied on the hedge funds and assumed the investments had been carefully studied. The risks they presented were assumed to be acceptable.