Charles Ponzi - the father of Ponzi schemes - redux

From Tokyo, Japan and New Plymouth, New Zealand – this is Down to Business English. With your hosts Skip Montreux and Samantha Vega.

Samantha, do I ever have an amazing investment opportunity for you!

Whoa … hold on. Let’s back up a step, Skip. You've been MIA, missing in action for most of January.

I know.

You can’t just suddenly show up without a bit of an explanation.

You are absolutely right Samantha. January turned into a very challenging month, which unfortunately, and unavoidably, took my focus away from Down to Business English.

And what would that be?

The honest truth to the matter is that on January 13, my father passed away.

Oh, Skip. My deepest condolences. I’m very sorry to hear that. I’m sorry for your loss.

Oh, thank you Samantha. I appreciate that. His health had been declining for quite some time, so it was not unexpected. But, you know … losing a parent is never easy.

No, it certainly isn’t. I think about my parents all the time.

But, life goes on, and D2B is back. Onwards and upwards

Right. So, what is this investment opportunity that you’re talking about?

Oh right. Okay, well … how would you like to make a guaranteed 40% return on your investment over the next two years?

I’m a little bit skeptical.

As you should be. You should be suspicious, or skeptical of anyone claiming they can get you those kinds of returns.

So what is this amazing investment opportunity’?

Oh, I don’t really have one. But that was the pitch a Japanese father and son team were using in a Ponzi scheme that bilked 10,000 investors from around the world out of $1.5 billion.

Oh no.

Actually they were just two members of a three person team. The father, Junzo Suzuki, and his son, Paul, recently plead guilty to the fraud in a Las Vegas courtroom, where the scheme was based.

What about the third person?

The mastermind, Edwin Fujinaga, is already serving 50 years in prison. He was found guilty of fraud and money laundering back in 2019. The court system is just now getting around to the Suzukis.

Well, it’s always good news when corporate criminals are caught and brought to justice. Did you see that Elizabeth Holmes was found guilty at the end of her fraud trial last month?

I did. We reported on her and the Theranos fraud trial when it was just getting underway last September, in D2B 188.

That’s right. But we will have to wait until later this year to see what kind of sentence she receives.

Oh? I didn’t hear that. When will her sentence be handed down?

For some reason, and it’s not clear to me why, she’s not going to receive a sentence until much later, in September. From now until then, she is out on a $500,000 bond.

Well, that’s crazy. But her crime, as bad and as harmful as it was, is a little different from the Ponzi scheme Fujinaga and the Suzukis were perpetuating.

I have to ask Skip, what is a Ponzi scheme? I mean, of course I’ve heard the term and I know it is a type of financial scam, but why is it called a ‘Ponzi scheme’?

That my dear Samantha, is a great question and I am so glad you have asked. Because today on Down to Business English, we are going to go back in time and report on the financial scandal that rocked the United States in the 1920s that gave the world the term ‘Ponzi scheme’.

Sounds great.

So, let’s do it. Let’s get D2B … Down to Business with Ponzi schemes. What is a Ponzi scheme? And where did this financial term come from?

I am all ears Skip, what exactly is a Ponzi scheme?

Probably the best place to start with all of this is to talk about the person the Ponzi scheme is named after.

Okay. Who is it named after?

It’s named after an Italian immigrant who arrived in the Northeastern city of Boston, Massachusetts, in 1903. His name was Charles Ponzi and when he landed in America he only had $2.50 in cash in his pocket but a million dollars of hopes and dreams.

Sounds like the same aspirations hundreds of thousands of immigrants streaming into the US at that time had.

And very interestingly, the very first thing he did was learn English.

That makes sense — a very important skill if you are living in an English speaking country.

But even with that under his belt, he wasn’t finding much success in the US. So, in 1907 he relocated to Montreal, Canada. And with his language skills, I guess in addition to Italian and English he also spoke French, he got a job as a bank manager at a newly opened bank — Banco Zarossi.

Banco Zarossi … sounds very Italian.

It was very Italian. It was founded by another Italian immigrant, Luigi, or Louis Zarossi and Banco Zarossi mainly served the Italian immigrant community living in Montreal.

With his English, French, and Italian language skills, it would have been a perfect position for Charles Ponzi.

Not only did his skill set suit this job, but it was at this job that he witnessed a ‘rob Peter to pay Paul’ fraud scheme that would later serve as the basis of his own Ponzi scheme.

‘Rob Peter to pay Paul’ What exactly is that?

This is when you pay returns to the original investors, not with profits of the investment, but with funds you are collecting from new investors.

And how did that work at Banco Zarossi?

Well, Zarossi was paying 6% interest to customers who deposited their money in his bank. This was twice as high as competing banks so of course a lot of people wanted to take advantage of such an attractive rate.

And how did the bank manage to pay those high interest rates?

Initially, Zarossi took the deposits and made real estate investments. But when those investments failed, he started using money from newly opened accounts to pay the 6% interest to customers who were cashing out.

Ah, robbing Peter to pay Paul.

Exactly. Now as long as Zarossi could pay the 6% ROI he was promising, and keep attracting new customers, the longer the scheme could last.

I’m guessing that eventually, it became unsustainable.

That’s right. And Zarossi absconded to Mexico with almost all of the money the bank had in its vault.

And what happened to Ponzi?

Ponzi was left homeless, and he had very few options. And even though he was not behind this scam, he did make a very serious mistake.

What was that?

Not having any money, he forged a check from one of Banco Zarossi’s customers to himself and cashed it.

Well, that’s clearly illegal.

Yes, it is illegal and it certainly is an indication of Ponzi’s business ethics. But in his defense, the check was only for something like $423.58 which in today’s dollars would be around $12,000.

Well, that’s not a small amount.

No, but it's not an exorbitant amount either.

Regardless of the amount, it was still theft.

Yes there is no denying that. And he was arrested by authorities and ended up spending three years in a Canadian prison for that check forgery.

So, how did Ponzi go from a Canadian prison to perpetuating the scandal that made the history books?

For that we need to jump ahead a little bit to the 1920s. By this time, Ponzi is out of prison and has made his way back to Boston. He has married a younger, beautiful woman from a middle class family and has been able to save a little money by working for his wife’s family business.

Sounds like a stable existence, something most people would be content with.

Not Charles Ponzi. His dream was to be ultra wealthy, live in a mansion, and have a life of luxury. He was always looking for good ideas to make money.

And what did he come up with?

In 1919, while trying to set up an import-export magazine called the Trader’s Guide, he stumbled on something called international postal reply coupons.

Postal reply coupons - what are they?

Are you familiar with the concept of self-addressed stamped envelopes?

Sure. If you want someone to send you something in the mail, but you don’t want them to have to pay for the postage, you send them a self-addressed stamped envelope.

Right, but doing so internationally, across borders, is problematic because the stamps you buy in one country won't be accepted by the postal system in the other.

And that is where postal reply coupons come in?

Yes. What happened was someone in Spain sent Ponzi a letter, requesting a copy of his Trader’s Guide. Enclosed in the letter was one of these postal reply coupons. Ponzi had never seen one before, and it suddenly dawned on him that he could become mega rich through these coupons.

How?

Well remember, this is 1919, just after World War One. The values of European currencies were very low compared to the US dollar. Ponzi realized that he could go over to Europe, buy a dollar's worth of coupons, return to the United States and exchange those coupons for 5 to 10 dollars worth of stamps.

Ah, and if he did that at a large enough scale, it would make him rich beyond his wildest dreams.

That was his plan, yes. In investment terms, this is known as arbitrage. An opportunity to make a virtually risk free investment by purchasing an asset in one market at a low price, and then simultaneously selling it in another market at a higher price.

Clearly there are some risks to his plan. First, he’d have to have enough capital to buy a large number of coupons.

Yes.

Then, he would have to physically go to Europe to purchase the coupons and bring them all the way back to the US.

Yes, of course.

And even if he somehow managed to get his hands on every single coupon in Europe, once he got them back to the States, he would only be able to redeem them for postage stamps.

That’s right. He would still have needed to sell the stamps in order to cash out.

Yeah, some pretty big holes in that business plan I would say.

Well, Charles Ponzi was much more optimistic about it than you. Even though he wasn’t sure how he would navigate the very issues you’ve just pointed out, he was convinced he could make it work.

So what did he do?

At first, he visited his local bank and tried to get a loan. But they basically laughed him out of the office.

Not surprisingly.

He then tried to raise capital amongst his friends and acquaintances. But everyone he knew was in the same boat as him and didn’t really have any money. So finally, he made the decision to sell his idea directly to the public.

He thought people would give him money for this hare-brained idea of buying international postal coupons?

Yes. He thought that if he offered them a high enough return on investment, they would. So, what he did was open a company that he named the Securities Exchange Commision.

Hold on a minute, the Securities Exchange Commision? The same name as the US government’s financial regulatory body?

The very same name, yes. But seeing as how that SEC wasn’t set up until the 1930s, there was nothing so unusual about the name in 1920.

Okay. Well, it’s a bit strange the government choosing to go with a name connected with such an infamous money scandal.

But other than the name, there is no connection between the SEC we know today, and Ponzi’s SEC. Just an interesting piece of trivia.

So, Ponzi opened his Securities and Exchange Commision and started raising capital?

He did. In January of 1920 he started issuing Ponzi notes, promising to pay investors 50% interest on any amount of money they gave him after 90 days.

And did it take off?

Oh boy did it ever take off. In the first month of operations he raised $1,700. By the second month he was earning $30,000 per week and by June 1920, he was raising $2.5 million per month.

My goodness. Talk about exponential growth. That’s incredible.

There became such a demand for Ponzi notes that he had to open up offices all over the United States.

And who was investing in these Ponzi notes?

All kinds of people. All the way from the true believers who invested every penny they had, to the mildly curious — people who didn’t quite believe in the investment, but at the same time didn’t want to miss out in case it actually materialized.

You know what that reminds me of? The current craze around cryptocurrencies.

Hmm. I suppose you could draw parallels between how investors reacted to Ponzi notes and the cryptocurrency situation of today.

So, what was Ponzi doing with all of the money? Did he actually use it to buy these international reply coupons from Europe?

Not surprisingly, no he did not. He did make some investments in real estate, but for the most part he just parked the cash in banks around Boston. And of course he bought himself a beautiful home and a very expensive chauffeur driven car, and started wearing the very best clothes he could get his hands on.

So he was looking the part of a successful businessperson.

He was, and appearances and the projection of confidence were very important to sustain the fraud.

Of course, you can’t be a con man without confidence. So how did it all fall apart? You can’t raise that amount of capital in such a short period of time without raising eyebrows.

One person who was extremely skeptical was the publisher of the very powerful newspaper, the Boston Post. A man by the name of Richard Grozier. He was convinced that Ponzi was a fraud and had his newspaper publish stories on how impossible it was for Ponzi to make good on his promise of paying 50% interest.

That must have caused panic over at the offices of the Securities and Exchange Commision.

Actually, no. The initial result was even more people wanted to invest.

Really?

Yeah. The first story on Ponzi acted more like one huge advertisement than a criticism. But then Clarence Barron came out criticizing Ponzi notes.

Clarence Barron, that name sounds familiar.

He was the publisher of the Wall Street Journal and the very famous Barron's Financial report, and probably in that day he was the most respected financial journalist around.

Ah. So, what did he have to say?

He simply explained that Ponzi’s investment scheme was unsustainable and made no mathematical sense. He also pointed out that Ponzi kept most of the money in banks. Why would he do that if he was able to earn higher interest rates using his own scheme.

A very salient point.

All of this negative press caused law enforcement to start poking their noses in. The States’ Attorney General, The Banking Commissioner, and even the Postal Inspector got involved.

Anyone who had money invested in Ponzi notes would have been quite nervous.

Sure. All this negative press caused a run on Ponzi notes. Initially, Ponzi was able to handle it and he made a point of showing up at the office everyday in his chauffeur driven car, dressed in the finest of clothes, and with a smile on his face. He even went as far as serving coffee and donuts to the people waiting in line to get their money back.

But what was he paying them with?

With the money from the later investors. He was robbing Peter to pay Paul.

Unbelievable.

Yeah. He was just trying to bide his time. If he could calm people’s nerves, convince them to not pull out their investments, and attract new investors by projecting his confidence, there was a chance he could weather the storm.

But that didn’t happen.

No. The final nail in the coffin was the Boston Post reporting two stories at the end of July 1920. One story was about how there were not enough International Reply Coupons in existence to make the amount of money Ponzi claimed he could make. And the other report was on how Ponzi had spent time in prison in Canada for bank fraud. They even printed a photo of his mug shot.

You said this was in … in July?

Yeah. And when those stories came out, the game was up.

So this all happened over six months.

It was very fast. Something like eight months to a year from the sale of the very first Ponzi note to his conviction on mail fraud charges.

So what kind of punishment did Charles Ponzi get?

He ended up spending four years in Federal prison, and another seven years in State prison. He was released in 1934 and was immediately deported back to Italy.

He never got his American citizenship?

As a matter of fact no he didn’t.

And what was the final tally on the damage he had done to investors?

At the end Ponzi had about $7 million in liabilities and $4 million in assets, basically cash. So that is a deficit of $3 million, a lot of money in those days. His home, and car were seized and sold off, and investors, in the end, got about 40% of their money back.

Still, a huge loss.

But you know, compared to other scams that were going on in the banking industry, it wasn’t very regulated at that time, this Ponzi scheme was not so irregular. It just caught the public’s attention and became part of the culture from that era.

And became part of financial history.

It is the reason why these types of get rich quick opportunities are referred to as Ponzi schemes.

Charles Ponzi may not have realized his dream of becoming extremely rich, but his name will be infamous for eternity.

And with that, I think it is time for us to get D2V … Down to Vocabulary.

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Let’s jump right into vocabulary today with the verb abscond. When a person absconds they leave someplace, suddenly and secretly.

And it is usually to avoid being caught by police or some other authority.

That’s right. In the report, Skip talked about how Charles Ponzi’s boss in Montreal, absconded to Mexico with all the money he had defrauded from the customers of his bank.

In other words, he took the money, and jumped on a plane to Mexico.

It must have been on a ship or train, there weren’t any commercial airlines in those days.

It was just a figure of speech.

Okay. Can you use abscond in another example?

Oh yeah. Have you heard anything about the real difficulties high end brick and mortar retail shops in San Francisco and Los Angeles are having recently?

No. No, what’s going on there?

They have been hit by a wave of crime. Hit and run bandits, in gangs of 10-20 people rush the store, absconding with as many high end products they can get their hands on.

Oh my goodness no. I haven’t heard anything about that. It sounds terrible.

It's becoming a major problem for the retail sector, law enforcement, and insurance companies.

I’ll look into it.

I will send you a link.

Thanks. What’s our next word?

Next, let’s take a look at the phrasal verb to dawn on someone.

Dawn? Like the time of day, just before the sun rises and the sky starts to get light.

That’s right. And just like the way the morning light lets you start to see the world around you, when you say something dawns on you, you are communicating that you have come to understand something for the first time.

So it is a bit of an idiom.

It does have an idiomatic nuance to it, yes. In the story, I recounted how Charles Ponzi learned about the International Reply Coupon system, and it dawned on him that he could get rich off of them.

In other words, he realized that those coupons could make him rich.

Could you give another example using this verb Samantha?

Sure. This is a very useful verb that you can use when speaking with coworkers. For example, if you are trying to schedule a videoconference with an overseas colleague, and at first you suggest a Tuesday at two o’clock. But then you suddenly realize that Tuesday is a national holiday, you could say, “Sorry, it just dawned on me that there is a national holiday on Tuesday, so how about Wednesday instead.”

How can you forget about a national holiday? I have them circled in bright red in my calendar.

It happens. Shall we move on?

Sure. Do you have our next word?

Next is the adjective hare-brained which means foolish, or describes something that you think will not be successful or will fail. In the story, I described Ponzi’s idea of purchasing reply coupons as hare-brained. I was communicating that I thought it was a foolish plan.

I recently attended a brainstorming meeting. And at the start of that meeting, we were encouraged to offer our ideas freely and told specifically not to criticize anyone else’s ideas, no matter how hare-brained they seemed.

That’s the whole point of brainstorming. Many great ideas start out as crazy, out of the box suggestions.

That’s very true. Do you remember that hare-brained idea Dez had last year? He wanted all of us to fly over to Hawaii and spend a week together recording episodes of D2B and relax in the sun.

I do remember that. But I don’t think it’s that hare-brained. If it wasn’t for the pandemic, I think we should try doing something like that.

I don’t know. It looks good on paper, but I really wonder how productive we could actually be.

Well, fortunately we don’t have to worry about it too much at the moment. What is our next word?

Our next, and final word for D2V today, is another adjective — salient. When you describe something as salient, you are saying that it is very important, or fundamental.

Or that it is the key point.

Yes. In the story, Samantha commented that Clarence Barron’s criticism of Ponzi’s scheme, was a very salient point.

In other words, I thought his questioning of why Ponzi kept the money in a regular bank, rather than putting it into his own investment scheme, was a very important point to consider.

Do you know who I think always has salient points to make when it comes to investing in general?

No, who’s that?

None other than the Oracle of Omaha — Warren Buffet. The man is now in his 90s and has been investing since he was 11 years old. He knows a thing or two about a thing or two when it comes to investing money.

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Well thank you for that report on the origin of Ponzi schemes Skip. I did not know any of the details behind that financial term.

My pleasure Samantha. And again, I’d like to apologize to you , and to everyone for the long, unexpected hiatus, or break Down to Business English took in January.

Totally understandable, no problem, no worries Skip.

Well, thanks for understanding Samantha. So, everyone, stay tuned. Down to Business English will be back very soon with another episode of business news to improve your business English. Thanks for listening everyone. See you next time.

Take care.

Have a comment or question about today’s show? Don’t be shy. Visit the D2B website or Facebook page, and post any comments or questions there. Skip, Dez, or Samantha will be sure to leave a reply. Down to Business English … Business News, to improve your Business English.