Talking just months before his death in 1949, Charles Ponzi described his business as ‘simple’. “The old game of robbing Peter to pay Paul,” he told the Associated Press. How – and why – did Ponzi’s name come to be synonymous with fraudulent investment propositions when others before him had done much the same?

The dreamer

Before his birth in 1882, Ponzi’s family had been linked to the Italian aristocracy and enjoyed the wealth that came with those ties. Growing up, his mother made no secret of the fact that she believed in him to bring the family back to its former glory. This, combined with his personality, charm and entrepreneurial spirit, drove a hunger for riches – and for years Ponzi yearned to make a powerful name for himself.

Moving to the US was the first step towards realising this dream and Ponzi’s story begins in earnest with his arrival at Boston Harbour in November 1903, with very little money to his name. Aged 21, Ponzi had just $2.51 in his pocket when he set foot on American soil, having reportedly lost a couple of hundred dollars gambling during his journey over from Italy!

The schemer

Despite enormous aspirations, Ponzi’s initial experience in America was beset by failure. He travelled the country, taking odd jobs, but often ended up being fired (because he spent so much time dreaming up schemes to make money). Finally, in 1907, he secured a job at Banco Zarossi in Montreal, Canada and it was here that he first witnessed ‘robbing Peter to pay Paul’ activity by his bosses. Although not directly involved, when the bank started getting in trouble for offering exaggerated interest rates and stealing money from depositors, Ponzi was arrested for forging a cheque in an attempt to get away quickly. Shortly after completing his 20 month sentence for this crime, he was arrested again and charged with smuggling Italian immigrants into the United States in return for cash.

Regardless of his bad experiences, Ponzi still held a strong desire to be rich and remained determined and optimistic about his potential for success in the US. The idea that finally brought this ‘success’ for the entrepreneur (in his eyes at least) came with the arrival of a letter from Spain in late 1919. With several rent payments overdue and his office furniture about to be repossessed, a flimsy document inside the envelope gave Ponzi a monumental idea. It held an international reply coupon – similar to sending a self-addressed stamped envelope.

In the early 1920s, 63 countries had adopted this prepaid coupon system for international postage. You could buy a coupon in Rome for it to be redeemed for stamps in Boston, for example. While these coupons resembled currency, they weren’t money; Ponzi, however, realised that they could be as good as.

The coupons were of fixed price and did not reflect the dramatic devaluation of some currencies post-World War I. Consequently, purchasing coupons in countries with weak economies could yield profits and, according to a reconstruction of Ponzi’s calculations by Mitchell Zuckoff, author of the 2005 biography ‘Ponzi’s Scheme: The True Story of a Financial Legend’, $1 worth of Italian lira would buy enough coupons to enable the redemption of $3.30 worth of stamps in the US. Ponzi realised he could exploit discrepancies in the prices of coupons in different currencies – making money via mail.

Originally running the scheme just for himself, he soon began to look for investors. And during a time when the banks offered 5% annual return, Ponzi’s grand scheme promised an opportunity that sounded too good to miss. It initially offered, by word of mouth, a 50% return for investors within 90 days – a deal later sweetened to 50% in just 45 days.

Too good to be true

Ponzi’s firm, the Securities Exchange Company, (ironically sharing the same initials as the Securities and Exchange Commission later set up to police markets and protect investors from schemes such as his) wooed numerous investors with its attractive offer. By the time spring arrived in 1920, the company was bringing in $30,000 a week (approximately $319,000 today). It is rumoured that so much cash was coming into their offices, drawers were overflowing with notes and workers used waste paper bins to store the ‘excess’.

However, as the saying goes: if it seems too good to be true, it probably is. Ponzi’s investment strategy may not have been illegal and, in theory, the postal coupons were potentially profitable, but the scheme was fundamentally flawed. It was impossible to buy and transport coupons in sufficient quantities to earn the returns promised – with the first 17 investors alone it would have taken 53,000 coupons to pay them off. Since there were only approximately 27,000 international reply coupons in circulation, Ponzi was out of his depth. Furthermore, soon after he announced his scheme, postal authorities in Italy, France and Romania temporarily suspended the sale of postal coupons. They were suspicious that Ponzi’s scheme was illegal and worried that someone could profit.

Aged 21, Ponzi had just $2.51 in his pocket when he set foot on American soil, having reportedly lost a couple of hundred dollars gambling during his journey over from Italy!

These factors were not the only reasons for the scheme’s failure – Ponzi apparently never even got round to buying that many coupons. In fact, a final audit of his company’s assets revealed only $61 worth of coupons. Furthermore, Ponzi failed to work out a reliable system for converting the redeemed stamps into cash.

With little or no legitimate earnings, it wasn’t long before he was forced to begin paying off his earlier investors from money invested by those joining the scheme later – what is now known as a Ponzi scheme, also often referred to as a pyramid scheme. Although he never admitted to being inspired by his experience at the bank in Montreal, it’s hard to believe his prior exposure did not influence this decision.

Heading towards the summer of 1920, the rapid growth of Securities Exchange Company attracted the attention of more and more newspapers – and reporters started to dig. Nobody had any knowledge of how, precisely, Ponzi was making profits from his investments and he continuously – albeit politely – refused to divulge such details on the grounds that secrets needed to be kept for competitive reasons. The first of a series of articles published by The Boston Post suggested that public scrutiny of Ponzi was lax and the paper followed – and actually played a huge part in – his downfall throughout that summer.

A front-page story on 11^th August 1920 about Ponzi’s prior conviction in Montreal included his ‘mug shot’. Investors in the scheme could then see that this was the same man they had trusted, so they panicked and began withdrawing their money from the company. As with any pyramid scheme, this caused the entire set-up, less than nine months after it began, to come crashing down.

Despite Ponzi never publicising the methods behind the postal scheme and his unrelenting obsession to make it succeed, his arrest in August 1920 confirmed that it was all a hoax. Although he had been paying some investors, he was an estimated $7m ($74m) short – and this was owed to some 20,000 people.

A media circus of a trial ensued and saw Ponzi act as his own defence attorney, claiming that adverse circumstances led to the company’s failure. The trial ended with a guilty verdict and Ponzi was convicted on federal charges of using the mail to defraud on 1^st November 1920. He served four years in federal prison and was sentenced to an additional seven to nine years in state prison.

Free on appeal before this second incarceration, in a bid for freedom, Ponzi adopted the alias Charles Borelli and took off for Florida. But Ponzi’s greed prevailed and he was convicted of failing to file proper papers in his attempts to, once again, make a fortune – this time by purchasing real estate and selling the subdivided plots. After serving one year’s hard labour in Florida state prison, he faked his own suicide in Jacksonville, created another new name (Andrea Luciana) and boarded a ship headed for his home country. This time Ponzi’s ego prevailed, he couldn’t keep his identity to himself and the authorities were soon made aware of his whereabouts. He was arrested before the ship left US waters and finished his seven year sentence in Massachusetts state prison.

Investing in a pyramid

The scheme that bears his name is based on the fraudulent idea of initial investors being paid abnormally high short-term returns by new investments, rather than any money generated by the operation itself. Such a scheme relies on a promise at the top, the continual recruitment of new investors and the movement of money upwards – each layer taking a piece of the proceeds on its journey. Ponzi schemes are able to give the impression of integrity through initial satisfied customers responsible for spreading the word. Before long, investors are not always lured in by the perpetrator, but by their trust in friends of friends who know the perpetrator.

What is certain is that people across the US – due to greed, clever selling or some other reason – believed in Ponzi’s scheme and lined up to invest in it, often acting as self-appointed salespeople themselves.

Arguably, the aura of exclusivity helps. The offer was spread by word of mouth enabling Ponzi to portray his Securities Exchange Company as holding a get-rich-quick secret that eluded others – all without any advertising. Whether Ponzi intended to exploit investors or foolishly stumbled into problems with an idea he believed was extremely lucrative remains uncertain. What is certain is that people across the US – due to greed, clever selling or some other reason – believed in Ponzi’s scheme and lined up to invest in it, often acting as self-appointed salespeople themselves. Reportedly, even 75% of the Boston police force were invested in the scheme. Of the investors that did receive returns, many reinvested their money back, relieving Ponzi of actually having to make good on the promised returns. After his arrest, Ponzi admitted “I started a small snowball downhill. But it developed into an avalanche by itself.”

Split opinions

Although Ponzi had arguably ruined many peoples’ fortunes with his scheme, the character and charm that helped him garner so many investors in the first place led him to go down in history as something of a loveable rogue. According to an article in the Washington Post on 23^rd December 1920, for instance, Ponzi sent a message to his investors, expressing “the hope that the mishap to his creditors’ investments would not mar the spirit of the Christmas season and asked them to look forward with him to the day when he would step from jail a free man to aid them in recovering their losses.”

Many also believe that Ponzi never set out to intentionally defraud people. Zuckoff, for one, thinks that Ponzi’s desires were genuine, that he didn’t intend to break the law and “he sincerely believed he had found a way to turn lead into gold.” Furthermore, it is reported that, after the realisation that the postal scheme wasn’t going to deliver for his investors, Ponzi invested in other banks and businesses with desperate hopes of fulfilling their expectations. “I kept up the bluff, hoping that I might eventually hit upon some workable plan to pay all of my creditors,“he wrote in his 1936 autobiography. The Washington Post observed that Ponzi “is one of the best examples of misdirected energy in the annals of American crime” and, certainly for Zuckoff, in another life Ponzi may have featured as a financial legend for all the right reasons.

However, Ponzi appeared incapable of moral clarity and could never quite admit to himself that his scheme was an impossible failure. Ultimately, he had fooled others because he had fooled himself. The result of his never-ending optimism was a lack of serious remorse for the financial damage he caused. Losses are estimated between $8m ($100,000m today) dollars and as high as $20m (over $230m today).

Lasting legacy

While Ponzi never fathered any children, his legacy lives on; the Ponzi scheme did not die with his downfall nor his death. According to the Oxford English dictionary, the term ‘Ponzi scheme’ gained entry to the Encyclopaedia Britannica in 1957. Exactly when the phrase was coined is unknown but, by the 1930s, it was often used in the newspapers.

Now, the term yields over 3 million hits on Google. In fact, the label is arguably overused today to refer to almost any scam. “The combination of Ponzi’s huge personality and the enormous, if brief success of his scheme, combined with the tremendous publicity which surrounded it, is ultimately what attached his name to it,” Zuckoff says.

Looking back, it seems easy to assume the population would be too well-read to fall for a similar pyramid scheme today, but a multitude of con artists have followed in Ponzi’s footsteps. When William H. McMasters, one of Boston’s top publicists recruited to work for Securities Exchange Company (subsequently writing an expose in The Boston Post confirming Ponzi as a crook who spoke gibberish about postal coupons), wrote “I do not anticipate that another Charles Ponzi will ever appear in the financial world,” he couldn’t have been more wrong.

While Ponzi never fathered any children, his legacy lives on; the Ponzi scheme did not die with his downfall nor his death.

Bernie Madoff (who will be featured in this column in the April 2015 edition of Treasury Today) was probably the most famous pyramid scammer since Ponzi. In March 2009, Madoff pleaded guilty to fraud in an investment-advisory scheme – estimated to have cost nearly $65 billion in investor money – by inventing fictitious returns. Whereas a Ponzi scheme is dependent on a supply of fresh investors – and the perpetrator typically acts in a hurry to recruit – Madoff actually spread rumours that his fund was closed to new investors in order to increase the aura of exclusivity. And, somewhat inevitably, he ended up with thousands of clients.

Other, perhaps less well-known, dreamers and schemers in a similar vein to Ponzi include: Lou Pearlman, a music producer who, for over 20 years, convinced individuals and corporations to invest in two companies that only existed on paper; Pastor Gerald Payne who preyed on churchgoers to invest with him with the promise of doubling their money and the now disbarred lawyer Scott Rothstein who funded a lavish lifestyle by dealing in bogus structured settlements. But, as Ponzi’s story proves, you have to be a special kind of con man to have your name go down in history. Even if it is synonymous with fraud.