You Can't Cheat an Honest Man

YOU CAN’T CHEAT AN HONEST MAN

How Ponzi Schemes and Pyramid Frauds Work ...and Why They’re More Common Than Ever
James Walsh
SILVER LAKE PUBLISHING
LOS ANGELES, CA ABERDEEN, WA

You Can’t Cheat an Honest Man
How Ponzi Schemes and Pyramid Frauds Work…and Why They’re More Common Than Ever

First edition, second printing 2003 Copyright © 2003 Silver Lake Publishing

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Library of Congress Catalog Number: Pending

James Walsh
You Can’t Cheat an Honest Man
How Ponzi Schemes and Pyramid Frauds Work…and Why They’re More Common Than Ever

Includes index. Pages: 354
ISBN: 1-56343-169-6
Printed in the United States of America.

Table of Contents

Introduction
Some Background to the Current Situation ...1

Part One: How the Schemes Work
Chapter 1: The Mechanics Are Simple Enough ...19
Chapter 2: Location, Location, Location...Then the Money’s Gone ...29
Chapter 3: A Better Mousetrap Makes a Good Scam ...39
Chapter 4: Paying First Class, Traveling Steerage ...49
Chapter 5: 1040-Ponzi ...61
Chapter 6: Sure-thing Investments and Sweetheart Loans ...71
Chapter 7: Precious Metals, Currency and Commodities ...87
Chapter 8: Affinity Scams ...101

Part Two: Why the Schemes Work
Chapter 9: Trust ...117
Chapter 10: Greed ...131
Chapter 11: Family Ties ...141
Chapter 12: Secrecy and Privacy ...155
Chapter 13: Loneliness, Fear and Desperation ...167

Part Three: Contemporary Variations
Chapter 14: Multi-level Marketing ...183
Chapter 15: Faith, Religion and New Age Gurus ...203
Chapter 16: Charities and Not-for-Profit Organizations ...217
Chapter 17: www.ponzischeme.com ...231

Part Four: What to Do if You’ve Been Scammed
Chapter 18: Make Friends with the Regulators ...243
Chapter 19: Go After the People Who Got Money Out ...257
Chapter 20: Go After the Lawyers and Accountants ...273
Chapter 21: Go After Banks and Financiers ...287
Chapter 22: Fight Like Hell in Bankruptcy Court ...305

Conclusion
The Mother of All Ponzi Schemes ...319

Index ...331

INTRODUCTION
Introduction:
Some Background to the Current Situation

Ponzi schemes have a strong—almost addictive—grasp on the people who perpetrate them and the people who invest in them. Why? Consider the original scheme.

Carlo Ponzi was a loser. He knew this. Everyone who knew him knew this. But he was desperate to be something more.

Floating from job to job in the hard-scrabble Boston of the early 1920s, the formal little man (he was 5’2" and irregularly employed but elegantly dressed) was, in one sense, loosely moored to reality. He would stay up late nights dreaming up ways to get rich.

Ponzi had been born in Italy but arrived in New York in 1893 at the age of 15. He immediately set to the task of finding a fast way to make a lot of money. His impatience lead him into the most basic kind of swindles—and an itinerant lifestyle. He served short stretches of time in prison in both Canada (for mail fraud and passing bad checks) and Atlanta (for an illegal immigration scheme). He ended up moving to Boston in 1919.

Boston has always been a particularly tough place to be poor. Frustrated by the luxury he saw being casually enjoyed by the local swells, Ponzi kept dreaming of ways to take his piece. And he wrote letters home to various members of his extended family. Living in the aftermath of World War I, they were anxious for their traveling son to strike it rich in the New World.

His letters home provided Ponzi with the origin of what he would later—famously—call his “Great Idea.” Although Ponzi himself probably couldn’t describe it, the scheme was essentially a crude form of currency exchange speculation.
In the early 1900s, a person could enclose a coupon with a letter to save a correspondent the cost of return postage. An organization called the International Postal Union issued postal reply coupons that could be traded in for postage stamps in a number of countries around the world.

Ponzi figured that the coupons could be bought on the cheap in nations with weak economies and redeemed for a profit in the United States. He decided to stake some of his hard-earned money on a test of his Great Idea. But he quickly discovered that there was a lot to the scheme that he hadn’t anticipated. Most importantly, the red tape among postal organizations absorbed his profits. Delays prevented him from moving enough money through the system to make his plan work.

But, as his Great Idea wilted, something unexpected bloomed. Whenever he discussed the scheme with people, they quickly caught on and seemed interested in what he had to say. Friends and family members would ask him—unprovoked—how his tests were going. People were interested in the investment because it made sense to them...even though it didn’t work.

So, near the end of 1919, Ponzi made a decision which would make his name an icon of modern-day thievery. He stopped buying international postal coupons and dealing with endless bureaucracy—and focused instead on bringing in investors.

The Original Ponzi Scheme is Born

In December 1919, with capital of $150, Ponzi—who’d started using the first name “Charles”—began the business of borrowing money on promissory notes. He started out by inviting friends and relatives to get in on the ground floor of what he dubbed the “Ponzi Plan.”

Ponzi claimed that he was making 100 percent profit on his money in a few months. His problem was that he didn’t have enough capital to exploit postal rate discrepancies fully. Because there was room, he was willing to include investors on his deals.

Like many of his disciples in years since, Ponzi targeted people with the same ethnic background as his own.
Ponzi made his presentation...his pitch...shine. He would explain that he had received a letter that contained a reply coupon that cost the equivalent of one cent in Spain but could be exchanged for a six-cent stamp in the U.S. “Why can’t I buy hundreds, thousands, millions of these coupons? I’ll make five cents on every one,” he’d ask convincingly. His tone was described as something between a plea and a command.

Whatever it was, it worked. A few wary acquaintances decided to take a gamble, and Ponzi collected about $1,250. Early investors included extended family members, his parish priest, and players at the local bocce court. Ninety days later, he returned $750 in interest. Stunned investors told their friends and soon Ponzi’s office was filling with people eager to fork over money. He promptly moved his operation to a tony address in the city’s financial district.

With a written promise to repay $150 in 90 days for every $100 loaned, Ponzi convinced thousands of people to lend him millions of dollars. He placated investors’ fears by paying his 90-day notes in full at the end of 45 days. Within eight months, he’d taken in $9 million, for which he’d issued notes with a paper value of $14 million. He paid his agents a commission of 10 percent. Calculating the 50 percent promised to lenders, every loan paid in full would cost him 60 percent.

But Ponzi’s financial method was not based on actual earnings. Instead, it used incoming investors to pay the returns promised to earlier investors. Although he was cash-rich, Ponzi never actually made any money. As one court would later point out: “He was always insolvent, and became daily more so, the more his business succeeded. He made no investments of any kind, so that all the money he had at any time was solely the result of loans by his dupes.”

In time, Ponzi was taking in $200,000 a day...and paying out dividends of 50 percent in 90 days. He later upped the promised payout to 100 percent in three months. Investors literally lined up at his offices to invest in his company.

Keeping Up Appearances

Ponzi was a genius about maintaining certain parts of his scheme. One example: When investors went into Ponzi’s offices to redeem their notes, they had to walk all the way to the back of the place, to one of two or three redemption windows. There were usually long lines at these windows.

Once the investors had their money, they had to walk past dozens of investment windows, with shorter lines and eager people investing hundreds and thousands of new dollars. Most didn’t make it all the way out the front door again. They’d reinvest.

At the height of his liquidity, Ponzi went on manic shopping sprees, buying scores of suits, dozens of gold-handled canes, diamonds for his wife, limousines and a 20-room mansion in the Boston suburb of Lexington. As would hold true for many of the con men who’d follow in his steps, Ponzi seemed most in his element spending money.

By early July 1920, Ponzi was taking in a steady $1 million a week. On one particularly flush afternoon, he walked into the Hanover Trust Co. with $3 million stuffed in a suitcase and bought controlling interest in the esteemed bank. But his success would not last long.

While hundreds of people lined up at Ponzi’s offices every day, an editor at the
Boston Post
asked the opinions of several financial experts and concluded that—while it might be possible to make a few thousand dollars trading the reply coupons—the Great Idea couldn’t support the amount of business Ponzi was doing.

Soon, skeptical reporters called for interviews. Nervous about the image he would make, Ponzi hired a public relations executive named William McMasters to handle publicity. It was a major misstep. McMasters spent a couple of days in Ponzi’s office, realized the operation was a sham and went straight to state authorities. “This man is a financial idiot,” McMasters said. “He can hardly add.... He sits with his feet on the desk smoking expensive cigars in a diamond holder and talking complete gibberish about postal coupons.”

Ponzi was summoned to the State House in Boston. He was cheered by Italian admirers on the way in, but when auditors got hold of his ledgers they found only an addled mix of names and numbers. His employees, when questioned, had no idea how Ponzi’s huge returns were earned.
A month later, fearing his scheme was about to collapse, Ponzi drove to Saratoga Springs with $2 million in a suitcase. He hoped to win back in the casinos the money he’d spent living like a tycoon. He lost everything.

In August 1920, the
Boston Globe
published an expose on Ponzi. A near riot ensued, with thousands of angry investors storming Ponzi’s office and demanding their money back. In short, it was a run on the bank. A court would later explain the details:

At the opening of business July 19th, the balance of Ponzi’s deposit accounts at the Hanover Trust was $334,000. At the close of business July 24th it was $871,000. This sum was exhausted by withdrawals on July 26th of $572,000, on July 27th of $228,000, and on July 28th of $905,000, or a total of more than $1,765,000. In spite of this, the account continued to show a credit balance, because new deposits from other banks were made by Ponzi. The scheme was finally ended by an overdraft on August 9th of $331,000. Bankruptcy was then filed.

At the height of his scheme, Ponzi owned only $30 worth of postal coupons—against which he’d borrowed $10 million from 20,000 investors in Boston and New York.

In less than ten months, Ponzi had catapulted to greatness and then crashed back down to ignomy again. Most investors lost their life savings. Ponzi was arrested by federal agents and eventually sentenced to four years in Massachusetts’ Plymouth Prison.