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Ponzi Schemes, Explained: Why Investors Keep Falling For Scams

Ironically, it’s just the kind of juicy con story you might binge watch on these platforms: Horwitz, a 35-year-old actor who had bit parts in a handful of low-budget films over the decade, pleaded guilty last fall to committing federal securities fraud and conducting an illegal transaction known as a Ponzi scheme. For years, prosecutors say, Horwitz used his investors’ money to fund a lavish Hollywood lifestyle — until his scam was unraveled.

In short, a Ponzi scheme is a type of financial fraud that uses money from new investors to pay off previous ones.

The term comes from 1920s con man Charles Ponzi, but in recent years has become synonymous with the crimes of Bernie Madoff, the mastermind behind the biggest financial fraud in history, who died in prison last year.

Although Ponzi schemes have a long history, they are far from an outdated threat, experts say. In fact, they remain a major risk for investors in an era of booming stock markets and wild surges in cutting-edge assets like NFTs and cryptocurrency.

“Fraudsters really thrive on times of uncertainty, financial distress, upheaval, times of change, and those are really the times we’ve had in recent years,” says Kathy Bazoian Phelps, a lawyer who blogs on Ponzi. diets. “And of course there’s a lot of money out there that people are looking to invest.

The Horwitz case seems to check the main boxes of a Ponzi scheme: they are usually perpetrated by (a) men who (b) promise consistently high returns with minimal risk and (c) often prey on their friends and family to get rid of the scam. Earth.

Early investors in a Ponzi scheme are rewarded with eye-popping dividends – Horwitz is said to have promised returns between 25% and 45% – which drives them to tell others about the golden opportunity, which keeps money fresh in the game. scam. Once the pool of new investments dries up, of course, the fraud plummets.

A fraud is born

Prosecutors say Horwitz, who goes by the name Zach Avery, promised his investors – many of whom were friends – that their money would be used to buy film distribution rights which he would then license to streaming platforms for a purpose. lucrative.

“But, as his victims learned, [Horwitz] was not a successful businessman or Hollywood insider,” prosecutors said. “He just played one in real life.”

(Wildburn, prosecutors.)

Horwitz’s company “did not acquire any movie rights or enter into any distribution deals with HBO or Netflix” and he provided false documents to his investors. HBO, like CNN, is part of WarnerMedia.

Horwitz instead funneled the funds into his own accounts, shelling out $5.7 million for a home and splurging on trips to Vegas on private jets, according to a complaint filed by the Securities and Exchange Commission.

It’s not hard to imagine how an investor could get sucked into such a scam in an age of stock market rallies and overnight cryptocurrency millionaires. The fear of missing out is a powerful tool for scammers.

Phelps, who wrote “The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes,” says people often rely too heavily on word of mouth without due diligence to determine if an investment is legitimate. This can be especially true when it comes to schemes involving cryptocurrencies or artificial intelligence.

“All it takes is someone to say they have the proprietary algorithm that guarantees returns and that seems pretty technical and fancy and like a sure thing,” she said. “It’s comfortable for people because someone technically knows what they’re talking about, supposedly, and the result is a much higher guaranteed return than something they’re going to find elsewhere.”

In fact, the SEC is particularly concerned that the rise of cryptos “could entice fraudsters to lure investors into Ponzi and other schemes,” in part by promising investors an opportunity “to get in on the ground floor. of a growing Internet phenomenon.
The agency cited a 2013 case in which an alleged Ponzi scheme advertised a bitcoin “investment opportunity” on an online forum. Investors were promised up to 7% interest per week and that their funds would be used for bitcoin arbitrage. Instead, crypto funds were used to pay existing investors and exchanged into US dollars to pay for the organizer’s personal expenses.

Even professional investors can fall victim to fraud, Phelps notes, but there are several ways to avoid being taken for a ride. The first step is simply to be aware of the potential for fraud. “I don’t even know if that crosses people’s minds,” she said. Beyond that, investors should ask due diligence questions, be wary of promises of risk-free guaranteed returns, and watch out for returns above what you’re likely to find in the market.

“If you can’t really figure out what investing is after a five-minute explanation,” says Phelps, “you probably shouldn’t invest in it.”

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