If it seems too good to be true, it is

By DAVID MOON, Moon Capital Management
August 15, 2004

John was an Italian immigrant, living in Boston. He was good with numbers, but even better talking. Within the north Boston Italian community, he developed a reputation for making money ' lots of it. His friends and neighbors invested their own savings with John, with the hope of enjoying these fantastic returns. These were people of hope and dreams. They came to this country seeking a better, more prosperous life. John offered that possibility.

Folks were soon earning as much as ten percent a month. Word spread and John's operation grew. He bought his own bank and lived a life of luxury.

But the only person making money was John. The fantastic returns weren't real. He simply told people he was generating the returns, when he was actually depositing the funds in a bank where he earned five percent interest ' and lived quite comfortably off that interest. If someone decided to redeem his investment, John provided the money (including the promised profit) from the other peoples' money.

In 1920, a series of investigative newspaper articles prompted a state audit of John Ponzi's operation, revealing a scheme that defrauded thousands of people of millions of dollars. The Ponzi scheme was born.

* * * * *

A couple in Morristown were arraigned last week, accused of stealing $12 million in a Ponzi scheme dating back to 1996. Ironically, only a year earlier, in 1995, a Knoxville man committed suicide after his Ponzi scheme began to crumble, revealing as much as $50 million in squandered assets. The 1995 case garnered significant media attention throughout east Tennessee, as his victims included folks from Knoxville, Johnson City, and, believe it or not, Morristown.

Less than 12 months after the collapse of one local Ponzi scheme, a couple decided it was a good business model and started their own. And they succeeded for almost a decade.

A day before the arrest of the Morristown couple, the Wall Street Journal published an interview with former Ponzi scheme operator Eric Stein. Stein is serving eight years in prison for stealing $34 million from almost 1,800 investors. He warned of the common factors in most Ponzi scams. The most obvious commonality is the promise of extraordinary returns. Stein warned against putting money into anything described as 'low risk, high yield,' especially when touted by a friend, relative or fellow church member. Scams lack audits and independent custodians.

Stein says that the people who fall for these pitches are, surprisingly, most often educated and already successful in some endeavor. They are risk takers and like to play it big. They are doctors, dentists and entrepreneurs. They like to talk about their financial exploits and are more influenced by testimonials ' especially from acquaintances ' than by details or logic. They are afraid they will miss a great deal.

If history is any indication, someone is reading of the exploits of this Morristown couple and beginning his own scam. George Santayana was right: those who do not learn history are doomed to repeat it.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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