Many unscrupulous people target seniors and other trusting people for scams and frauds.  In recent years, the emergence of cryptocurrencies and digital tokens, has had its fair share of scams and frauds.  It is not surprising that with tokenization, follows tokenized scams and frauds.  These signs of a ponzi scheme apply to any ponzi scheme, including the tokenized ponzi scheme. 

While many understandably become frustrated with the regulatory framework in the United States for its broad reach and the complex structure that has evolved over the last 86 years, the Securities and Exchange Commission (“SEC”) plays a key role in targeting and weeding out fraud.  The broadness of its application arises from the myriad of creative fraudsters over the years that devise remarkably clever schemes to defraud.  The tokenization of fraud is no different.

Because the SEC has limited resources, the statutory scheme of our securities laws allows for private actions to be taken by investors, which means plaintiff’s lawyers play a significant role in weeding out fraudulent security offerings.  The private right of action is necessary to assist in the policing of fraud in the markets.  Today, this role is critical to healthy cryptocurrency markets and much continues to be done in this respect. 

But fraud is not new to securities or business law, as the securities laws have been around since the 1930’s and frauds and scams of all shapes and sizes have emerged and existed ever since the enactment of these laws and regulations.  One thing seems clear thus far.  Blockchain and the technology emerging from cryptocurrency is not yet changing the behavior of fraudsters and scammers, though it may prove helpful in providing a new means to introduce reliable evidence in the prosecution of those who wish to defraud the public and record such fraud on blockchains.  One can hope.

Ponzi schemes are older than the Securities Act.  Ponzi schemes are investment frauds that pay existing investors with funds collected from new investors.  Ponzi scheme operators often promise to invest with high returns and little risk.  Often, the money is not invested or only some portion of the money is invested.  Rather than invest it, the new money is used to pay earlier investors, while the promotors keep a portion for themselves.

In reality, a ponzi scheme often creates little or no return and relies on a constant flow of new money to maintain itself.  As investors dry up or investors choose to withdraw their investment, the scheme eventually collapses.  The last one in loses and often loses big.

One of the first ponzi schemes was run in the 1920’s and involved speculation on postage stamps. That scheme was run by Charles Ponzi.

Ponzi schemes tend to have common characteristics and these characteristics serve as warning signs as you are approached by potential investment promotors.  Here are seven things to watch for:

  1. High returns with little or no risk.  Returns have a direct correlation to risk in the investment world.  The more risk, the higher the return.  The less risk, the less return in relative terms.  When a promoter of an investment reverses this, beware.  Be very aware.
  2. Overly consistent returns.  Real investments fluctuate in the marketplace.  There is a natural up and down to any market, due to temporary inefficient market theories (FUD and FOMO come to mind) and the technical ebb and flow of markets.  Be very skeptical of a promotor that suggests you will generate positive returns in any market or regardless of overall market conditions. 
  3. Unregistered Investment.  Scammers and fraudsters rarely register with regulatory agencies, such as the SEC or state securities agencies.   The registration process is a path to access to information about the company and the investment.  Be cautious of unregistered security offerings, which would nearly always be limited to accredited investors. Even then, filings with the SEC are often necessary.
  4. Unlicensed Sellers. The sale of securities to the general public requires investment professionals and firms to be registered or licensed as Investment Advisors or Investment Companies.  Most ponzi schemes are run by unlicensed individuals or companies.
  5. Secretive or complex strategies.  If you are not able to fully understand an investment or it is unnecessarily complicated, it is wise to avoid such investment.  A promoter of an investment should be able to explain an investment and provide you a clear and easy to understand presentation of how the investment works.  Again, be cautious of overly complicated schemes. 
  6. Inadequate or lacking paperwork.  As you review the documents provided, if you see errors or missing information, that may be a sign that things are not as they appear.  If an investment is not well documented or contains inconsistencies, that may be purposeful, and you should use caution. 
  7. Difficulty with payments.  As you experience any delays or attempts to get you to not withdraw funds, that is another red flag.  Delays can indicate fund shortages and an objection to your withdrawing funds suggests the same concern.  Be wary if payments are not made timely upon request.  As you review an investment, look for unusual conditions or delays when you choose to make a withdrawal.  This is the best time to catch that, before you invest funds.

With these 7 warning signs, hopefully you will discover a scam before you invest.  Of course, before you invest is the best time to avoid a ponzi scheme or other fraudulent investment. The warning signs can signal other issues with an investment other than a ponzi scheme as well. All of these warning signs can be applicable in avoiding any scheme to defraud you, the investor.  Over the last several years in the cryptocurrency space, DLT’s lawyers have come across all of the above more than once.  More often than not, the warning signs prove valid.

If you do fall for a scam, keep in mind that the SEC has limited resources and, while suspected scams should be reported to the SEC, you also have a private right of action and can take action in a civil case.

Fraud has a detrimental effect on how markets run and operate.  As the tokenization of assets proliferates, the community can expect new scams and frauds to continue to emerge.  While the SEC works to police the markets and ensures a more efficient and safe market environment for investors, diligent, educated investors can go a long way in assisting in weeding out this activity that hurts the entire market.  As noted, a private right of action also plays a role when an investor falls victim to a cunning scheme, despite being diligent and prudent with investment decisions.  The tokenization of financial markets is not likely to avoid or overcome those willing to defraud investors, but hopefully it can assist us all in revealing the schemes sooner than later. 

Dislaimer: A Deeper Dive with DLT and each blog post is not intended as legal advice, nor should you consider any part of this blog or website as such. Nothing herein acts to create any attorney client relationship with the lawyers at DLT Law Group. The blog is designed to provide general information and thoughts from the lawyers at DLT Law Group. You should not act upon any information contained in this website without first seeking professional advice from a lawyer licensed in your state or country.