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Appendix A. Short History of Business Fraud and Speculative Bubbles - Pg. 271

Appendix A. Short History of Business Fraud and Speculative Bubbles The Spanish-born American philosopher George Santayana said, "Those who can- not remember the past are condemned to repeat it." To save you, the potentially poor reader, from nancial ruin, what fol- lows is a rogue's gallery of nancial frauds to avoid. First, here are a few investing rules that will help you avoid such frauds: 1. Do not invest in arcane schemes with promoters who will not explain the investments clearly. Make sure you understand exactly where the investment returns will come from and at what risk. 2. Beware the "quick buck" or getting "something for nothing." Promises of "too-good-to-be-true" returns are just that. 3. Always do reference checking before investing. Charlatans spend much time, money and effort in trying to appear legitimate. Beware. Do not be fooled. Unfortunately, just following these three rules doesn't guarantee you will never be eeced. So do not "put all your eggs in one basket." That way, even if you are duped, not everything is lost. Diversify your in- vestments. Ponzi Schemes In a Ponzi scheme, gullible investors are enticed to purchase arcane invest- ments that promise fantastic returns. Early investors are paid off with money raised from later victims, until no more money can be raised. Ponzi schemes are doomed to collapse because there are no underlying earn- ings--just recycling of money. However, not all investors lose. The rst investors can gain if they manage to get out in time. Charles Ponzi (1919) With $200 in bor- rowed capital, the "Ponzi scheme" name- sake, Charles Ponzi, opened up his Securi- ties Exchange Company at 27 School Street in Boston on the day after Christ- mas in 1919. Ponzi claimed to invest in an arbitrage of international postage return coupons and promised a 50% return in 45 days and a 100% return in 90 days. Early investors did get these spectacular returns. Actually, Ponzi was paying off these investors by using money received from new investors. For a time, Ponzi was the toast of the Northeast. His investment company was a great success. In 1920, Ponzi bought a grand house in Lexington, a wealthy sub- urb of Boston, and even a local bank, the Hanover Trust Bank. However, Ponzi's operation collapsed in August 1920 when, based on a tip from a local newspaper, federal agents raided Ponzi's corporate headquarters and the Massachusetts Attorney General put him in jail. In a little more than eight months, Ponzi had collected $10 million from more than 10,000 investors. In bankruptcy, in- vestors received just 37 cents on the dollar. At trial, Ponzi pleaded guilty to federal charges of mail fraud and was sentenced to ve years in federal prison, serving three years. When released from federal prison and facing state charges, Ponzi jumped bail and ed to Florida, where he set up a real estate business and began selling "prime Florida property" (i.e., swamp land) to gullible investors. Eventually, Ponzi spent nine years in a Massachusetts prison and then was deported back to Italy. Bernie Madoff (2008) Bernard Madoff, the former chairman of the NADASQ stock exchange, was one of the most respected nanciers on Wall Street when he was -- 271 --