A Ponzi scheme is an investment fraud in which the investor uses the investments from new investors to make promised payments to prior investors. A Ponzi scheme typically has little or no legitimate investments that are actually occurring. A scheme falls usually apart when the main operator decides not to continue with the operations or when new investors cannot be found. Many red flags of a ponzi scheme can be recognized. A main concern for this scam is the promise for high, consistent, and guaranteed returns that have little or no risk. The returns are consistent, even when the economy is experiencing a recession. Typically, the investor is not registered with the Securities and Exchange Commission (SEC) or other regulatory bodies. The schemer lacks transparency with both their investment strategy and the investor’s account. Most are also very urgent regarding investments in order to continue operations. Even though they promise they will return funds, the schemer often will create excuses or persuade the investor to keep the money within the scheme. Charles Ponzi, the ultimate “creator” of the Ponzi scheme started his ventures in 1919. Using the postal system, Ponzi sent international reply coupons that were exchanged for postage coupons back to the country the letter was being sent. Since the currency rate fluctuated, Ponzi was able to purchase postal reply coupons in a foreign country and swap them in the United States for a profit, which was perfectly legal. However, Ponzi started to secure investors in his company, known as Securities Exchange Company, with a promise of a large return in a short period of time. After two years, Ponzi was circulating so much money from new investors that he could just pay the old investors with the new cash. Towards the end of 1920, regulators investigated Ponzi and discovered that his quantity of coupons were not enough to satisfy the amount of money he was making from the deal and essentially committing fraud. Besides being faced with mail fraud charges, 86 other charges were brought against him(13). Pleading guilty of charges in United States District Court and District of Massachusetts, Ponzi was sentenced to 5 years in prison. After being released from prison 3 years later, he was charged with multiple counts of larceny in Massachusetts and was found guilty. He was deported back to Italy as an undesirable alien (14). The Securities and Exchange Commission (SEC) and Federal Trade Commission are the two main enforcers that target a Ponzi scheme. Federal law allows these agents to act on investment complaints that relate to the scheme and investigate (2). Often, a ponzi scheme case is interpreted in bankruptcy law and a trustee is appointed to oversee and administer the assets. “Under 11 U.S.C. § 548(a)(1)(B)’s constructive fraud provision, the receiver may recover profits and principal with a showing of bad faith on the investor’s part” (3). If actual fraud is proved with a Ponzi scheme, the investor in good faith may recover their investment from a trustee. A court will look at “factors relevant to the analysis are the defendant’s experience as an investor, whether the debtor promised rates of return greatly exceeding market rates, whether the debtor provided implausible explanations as to how it could pay those extremely high rates, and factors that would indicate insolvency. Law takes profits away from all the investors in a Ponzi scheme (subject to a statute of limitations) and strips away (even) principal from those who should have known things were awry.” (3)
The SEC was criticized after the Madoff scam went public for missing many opportunities in discovering his scheme. Many new reforms were proposed at the SEC during the aftermath of this event to try to prevent the SEC from not discovering schemes like this in the future. The reforms included greater transparency and coordination between regional offices, as well as the creation of a central division that would be in charge of handling tips received and market intelligence. Other reforms included greater efforts to encourage whistleblowers to come forward, independent custody requirements, and improved fraud detection procedures. A few years later the SEC also adopted requirements that required brokers holding investor assets must file quarterly reports showing how they maintain their assets. Within these reports, the brokers must explain their compliance efforts thoroughly. (11)
In addition to changes being made to the SEC, many of the lawsuits occurring after Madoff created precedents that allowed many more institutions to be blamed for Ponzi schemes, not just the investment company. There cannot be a large Ponzi scheme without a bank involved, so this ensures that the banks will follow the rules as closely as possible. These lawsuits established that even nonfinancial institutions can be held liable, such as lawyers, auditors, or brokers. (15)
In October 2009, the House Banking Committee drafted a bill intending to try to stop any more scams like Bernie Madoff’s Ponzi scheme. The bill included higher fiduciary standards for financial professionals, expanded SEC powers, court-based arbitration, and larger bounties for whistleblowers. The higher fiduciary standards meant that unlike the brokers just making suitable recommendations to customers, they would now be held to a fiduciary standard. The expanded SEC powers stated that now the SEC could create and promote rules that would prohibit sales practices, conflicts of interest, and compensation schemes for financial intermediaries that it deems contrary to public interest and the interest of investors. Also, the bill would allow the SEC to prohibit mandatory arbitration clauses in the contracts between the customers and the brokers or advisers. The larger bounties for whistleblowers would allow the SEC to pay cash bounties to any whisteblower that supplied information leading up to an SEC enforcement case. (12)
The efforts that the SEC made regarding these reforms have shown to be successful. In 2011 and 2012 the SEC filed a record number of enforcement actions against investment companies. (11) However, it does not seem that Ponzi schemes are on the decline despite all of the efforts. “Gaps” in the rules do exist, but the only way to really put a stop to them would be to have more educated investors. Educated investors would be able to see the signs of a Ponzi scheme before getting involved, such as returns that seem too good to be true and not being able to understand how the fund works. (15) Potential conflicts between the legal standards and the ethical standards that society expects to be met exist because of the gaps in the rules. Having other institutions being able to be deemed liable as well helped this issue, but conflicts might still arise when investment companies act in a legal way while still misleading the investor.

Works Cited:
2. http://www.acfe.com/ponzi-schemes.aspx
3. http://www.bu.edu/law/journals-archive/bulr/documents/levmore.pdf
11. http://www.forbes.com/sites/jordanmaglich/2013/12/09/madoff-ponzi-scheme-five-years-later/2/#75fa31676581
12. https://hbr.org/2009/10/the-bernie-madoff-law
13. http://mentalfloss.com/article/20377/who-was-ponzi-what-was-his-scheme
14. https://en.wikipedia.org/wiki/Charles_Ponzi
15. http://www.marketplace.org/2014/01/09/economy/are-we-safer-ponzi-schemes-now