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Can I pay older investors with new investor money, just to cover my losses?

Answer:

No, you cannot, and if you get caught doing this, you'll be accused by the government of running a

Ponzi scheme

. A Ponzi scheme is a financial fraud, whereby an individual (usually a stockbroker or someone with some background in the financial markets) lures investors in by guaranteeing unusually high returns. These high return schemes are as old as the hills and will never go away; the schemer prays upon people's greed and their belief that they can get something for nothing. Sometimes, the schemer starts off with the best of intentions by trying to dig their way out of losses by covering them up, thinking all the while that they will eventually replace all the money lost. And then they get into a hole from which there is no turning back. As a Jacksonville criminal attorney, I have seen financial planners with the best of intentions get caught up paying off older investors with new investor money. Take the case of Bernie Madoff, probably the biggest Ponzi scheme ever orchestrated to date. Some say he started off with the intention of running a legitimate investment firm. Five years ago, Madoff was sentenced to 150 years in prison for running the biggest fraudulent scheme in U.S. history. A well respected financier, Madoff convinced thousands of investors to hand over their savings, falsely promising consistent profits in return. He was finally caught in December of 2008 and charged with 11 counts of fraud, money laundering, perjury and theft. Incredibly, Madoff conned his investors out of $65 billion and went undetected for decades.

The Ponzi scheme was named for Charles Ponzi, who promised 50% returns on investments in only 90 days. Does this seem to good to be true? Well it is, and it continues to be. It's a wonder people still fall for these promises. Ponzi schemes are run by a central operator who uses the money from new income investors to pay off the promised returns to older ones. This makes the operation seem profitable and legitimate, even though no actual profit is being made. Meanwhile, the person behind the scheme pockets the extra money or uses it to expand the operation (or both). To avoid having too many investors reclaim their "profits", Ponzi schemes encourage them to stay in the game (or investment fund) and earn even more money.

This is precisely what Bernie Madoff did, successfully convincing investors to keep their money with him, while showing them ever increasing paper profits over the years. Madoff also expertly used the other part of any good Ponzi scheme: he made sure the "investment strategies" used were vague and secretive, which schemers claim is necessary to protect their business model. Ponzi schemes aren't usually very sustainable. The setup eventually falls apart after (1) the operator takes the remaining investment money and runs or (2) new investors become harder to find, meaning the flow of cash dies out or (3) too many current investors begin to pull out and request their profits and returns. In Madoff's case, things began to deteriorate after clients requested a total of $7 billion back in returns.

Unfortunatley, Madoff had only $200-$300 million left to give. Madoff was able to fly under the radar for so long (despite multiple reports to the SEC about suspicions of a Ponzi scheme) because he was a well respected member of the financial community. He started his investment firm in 1960, helped launch the Nasdaq stock market, sat on the board of the National Association of Securities Dealers and advised the SEC on trading securities. No wonder the SEC didn't want to investigate him.

Lesson Learned:

If you're involved in the securities industry as a broker/dealer, financial planner or the like, it's not worth it to try and cover up your losses, no matter how tempting and easy it seems. You will almost certainly leave a paper trail (or computer trading trail), that will lead prosecutors to the conclusion that you've committed fraud. Your best intentions won't matter. And after the Madoff case, prosecutors are hyper-sensitive to any allegations of wrongdoing on the part of those entrusted with investing the monies of others. When in doubt. disclose your actions, and your losses, even if it might cost you the client (or your job). Every broker at one time or another will make an honest mistake in judgment and lose an investor's money. That's the nature of investing. There is risk involved. But losing the occasional client is a lot better than ending up behind bars.

Madoff speaks out and says, incredibly, that his investors should have known better than to invest with him.

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