You Can't Cheat an Honest Man - James Walsh [9]
The Numbers Never Add Up
“There’s not a lot to be done about pyramids” or Ponzi schemes says Larry Hodapp, a senior attorney for the Federal Trade Commission in Washington D.C.. “People just have to be educated that the return rates these operations suggest are ridiculous.”
A Ponzi scheme or pyramid plan, like a chain letter, is dependent on each new level of participants securing more persons to join. The new participant makes payment to the person on top of the list or pyramid, who then is removed, and replaced by those at the next level.
The fraud in the scheme is that when participants pay, they must assume that they and those that follow will be able to find new participants until all of the levels are filled.
In a four-level scheme, for all of the first group of new participants to be paid, 64 people need to join. After 20 levels of new participants, 8,388,608 additional investors would be needed. And there would be a total of 16,777,200 people in the scheme. These numbers are a practical impossibility.
Ponzi schemes are usually more secretive about these details than pyramid schemes. Ponzi perps keep their growing need for new money quiet—while pyramid perps usually announce their growing need as part of their pitch. In either case, the ultimate problem is the same: The schemes have to keep doubling, tripling or quadrupling in size just to avoid collapsing.
A Simple Four-level Pyramid
In 1987, a number of Wilmington, Delaware, residents were drawn into a pyramid investment scheme which was so simple in structure that it serves as a good primer for the basic mechanics.
The investors attended meetings where promoters pitched what they called an “airplane” scheme. If an investor bought a “seat” on the airplane for $5,000 and brought in two other people, he or she would receive $40,000. The scheme was a four-level pyramid:
1) When you paid your $5,000, you joined the group as a “junior sales executive.”
2) After recruiting two other investors willing to pay $5,000, you moved up the ladder to a “senior sales executive” position.
3) After each new junior sales executive introduced two new investors (a total of four) to the group, you were promoted to “branch manager.”
4) After each of those new people introduced two new investors (a total of eight) to the group, you became a “division manager.”
The division manager would receive the money invested from each of the eight junior sales executives several levels below. At that point, he or she left the group or started the process anew.
The Delaware pitches were made by two men: John Ferro and Robert Jorge. They assured potential investors that the investment was riskfree and that the scheme was legal as long as investors declared the income.
Ferro and Jorge also waived off another possible problem: not having the $5,000 to invest. They could arrange financing in the form of personal lines of credit through several sources, including Chrysler First Financial Services Corp. Jorge passed out Chrysler First application forms at some of the meetings and introduced potential investors to Larry Doub, an employee of Chrysler First who attended several pitch meetings and participated as an investor in the scheme. Chrysler First approved dozens of personal lines of credit connected to Ferro and Jorge’s scheme. Many of these people borrowed the money (very expensively, with loan origination fees and high interest rates considered), invested in the scheme and got nothing out. The scheme collapsed after a few weeks when Delaware state police arrested Ferro and Jorge.
A group of investors sued Chrysler First, arguing that the loans were part of the fraudulent scheme and, therefore, not enforceable.
Delaware courts didn’t show much sympathy to the investors. In a March 1991 decision, James M. Burns, et al., v. John J. Ferro, et al., and Chrysler First,