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How greed can land you into a Ponzi scheme trap

  • The responsibility of avoiding fraudulent schemes is largely on investors themselves
  • A 30-40% guaranteed return per annum itself is a red flag. Avoid schemes that offer unrealistic returns

Italy-born Charles Ponzi, a famous conman in the history of the US, became known in the 1920s when he swindled millions of dollars of investors’ money by launching a scheme that promised unthinkable returns. The scheme promised investors 50% returns in 45 days and 100% in 90 days. The case came to notice given the massive scale of the fraud—$20 million by estimates on Wikipedia. Eventually, all such fraudulent schemes came to be known as Ponzi schemes.

About a century later, people around the world are still falling for similar schemes and offers, and Indians are no exceptions. Over the years, the amount and scale of fraud has only increased, though.

In a recent case, a Bengaluru-based company illegally collected over 2,000 crore, from gullible investors, promising to provide returns at the rate of 14-18% per month. The promoters and directors of the company are allegedly on the run, while investors are running from pillar to post to recover their money with no headway. There is a long list of such cases across the country.

We tell you why people still fall for such schemes and the red flags to watch out for.

Why people fall for it

Greed and easy money: Every other person who saves and invests wants their money to grow in leaps and bounds in a short period of time. Such greed is often a source of trouble.

“Most Ponzi schemes promise very high returns in a very short time along with safety. Many people are not patient and want to make easy money quickly. This greed or want to make easy money is one of the major factors (why they fall for such schemes)," said Lovaii Navlakhi, managing director and chief executive officer, International Money Matters Pvt. Ltd, a financial planning firm.

Peer pressure: People are often willing to take risks just because they think another person they know—a family member, friend, neighbour or colleague—is also taking the same risk. The feeling of missing out on an opportunity that can help them grow their wealth eggs them on, so much so that they forget to do the basic due diligence.

Trust and marketing: Most experts said that persons who offer such schemes are good salespersons who have good conversational skills.

Also, typically, investors already know and trust the salesperson. There is a high probability of getting introduced to a scheme through a known or trusted person, who in turn may have bought the scheme through another known and trusted person and so on. “Most investors end up investing as some relative or a friend introduces the scheme to them," said Mukul Shrivastava, partner, forensic and integrity services, EY, an accounting firm.

Short-term memory: Investors, typically, have short-term memory; not many of them learn from others’ ’ mistakes. Every now and then, there are reports about such firms, schemes, their modus operandi and so on, but people still go ahead and make the same mistakes. “Some people are just gullible and easily convinced and sometimes do not ask tough questions," said Navalakhi.

Red flags to watch for

Significantly high returns: A 30-40% guaranteed return per annum itself is a red flag. “When average borrowing rates are hovering around say 9-12% how can someone give such high returns is a question you must ask," said Rohit Shah, founder and chief executive officer, GettingYouRich, a financial planning firm. Avoid schemes that offer unrealistic returns.

The lure of high returns lands even people with high levels of education and experience into trouble sometimes. Last year, former Indian cricketer Rahul Dravid lodged a complaint against an investment firm for cheating him of 4 crore. As reported, the company promised him a 40% per annum return on investment. Apparently, Dravid was not the only one; there were various other high net-worth individuals who were lured with offers of 40-50% annual returns.

“High returns lure most investors and they ignore the risks. The history in the financial world also rhymes and repeats," said Shah.

Business model: Investors should find out about the business and how a company will earn enough money to pay them. “Investors should ask questions about how the scheme plans to generate high returns, and what’s the underlying business model," said Shah. Navalakhi agreed. “An honest scheme generally discloses what are the underling investments and how the returns are being made," he said.

Credibility and financials: One needs to check the credibility of the company and its promoters. How long have they been in the business, are they registered or affiliated with any government authority are key questions to ask. “Try to find out if the company is registered. Does it file its annual returns on time and regularly, or is there any discrepancy there. One can find most of such information on the ministry of corporate affairs’ website," said Shrivastava.

Besides, “one should Google about the promoters and firm and look for complaints and allegations, if any, associated with them," added Shrivastava.

Also look at the long-term payment track record. Typically, in order to build trust and attract more investors, these companies initially pay the promised amount to a bunch of people.

Mint take

Time and again, the government issues warnings through various media for the public to stay away from such schemes. A bill in this regard, The Banning of Unregulated Deposit Schemes Bill, 2018, is also under process, and is waiting for Rajya Sabha’s approval to become law.

The Bill aims to provide for a mechanism to ban unregulated deposit schemes and protect the interests of depositors. However, the onus is largely on the investors to avoid such schemes.

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