This brochure is one of a series created by the U.S. Securities and Exchange Commission to acquaint you, as a possible investor, with the intricacies of investing. It is not intended to be, and is not, exhaustive in its descriptions. Should you require further information, contact the nearest office of the Securities and Exchange Commission listed at the back of this brochure.
WHAT DOES THE SEC DO?
The Securities and Exchange Commission was established by Congress in 1934 to protect investors against misrepresentation and fraud in the issuance and sale of securities. The SEC does this by enforcing the securities laws. These laws require most companies offering their securities for sale in interstate commerce to register them with the Commission so that full disclosure of certain information is made to investors. They also prohibit misrepresentation, deceit and other fraudulent acts and practices in connection with the purchase or sale of securities generally (whether or not required to be registered).
ARE ALL SECURITIES REGISTERED WITH THE SEC?
Not all securities are required to be registered with the SEC, but many are. Sellers of registered securities are required to furnish prospective investors with a prospectus (selling circular), divulging financial information. However, the SEC does not pass on the accuracy of the prospectus or approve or disapprove securities offered. Any representation to the contrary is a criminal offense.
WHERE CAN YOU GET INVESTMENT INFORMATION?
Most broker-dealers maintain an extensive file of financial information on the companies whose stock they recommend. Because of this, they may be able to assist you in evaluating the merits of an investment. Independent investment advisers, many of whom are registered with the SEC, may also be in a position to assist with information and advice, though usually for a fee.
STATE REGULATORY AUTHORITIES
If the investment is legitimate, it may be registered with some appropriate authority in your state. This authority may be the State Securities Commission, the State Corporations Commission or the Secretary of State. These agencies can help you ask the right questions about your investment.
PONZI AND PYRAMID SCHEMES
Investors generally set two objectives in evaluating an investment: (a) As high a return as possible ("yield" in the form of interest, dividends and/or long term appreciation), and (2) Safety. Ponzi and pyramid schemes normally attract unsuspecting investors by the promise of an unusually high rate of return.
Experience has demonstrated, however, that as a general rule, the higher the return on an investment, the riskier it is likely to be. In other words, the higher return is usually paid to justify the higher risk. The prudent investor will compare the return promised or proposed with that generally being realized on other types of investments.
It is impossible to describe thoroughly the various forms Ponzi and pyramid schemes might take, but these operations do have certain hallmarks. You should be particularly cautious when an investment opportunity emphasizes:
Named for Charles A. Ponzi, who defrauded hundreds of investors in the 1920s, a Ponzi scheme pays off old "investors" with money coming in from new "investors." It works this way:
In this manner P collects a pool of money that he can use to pay out to those few wishing return of their money. P may operate his scheme for some time before "pulling the plug" - that is, either disappearing with all the "investments" or revealing the bad news that the investments went "sour."
A major factor in the eventual collapse of a Ponzi scheme is that there is no significant source of "income" other than from new investors.
A PONZI SCHEME IN OPERATION
Joe Smith claims that he operates a factoring business, buying accounts receivables from small companies at a discount and then making a large profit when he collects the receivable. In order to conduct his business, he says that he needs, on a short term basis, large amounts of money. Because his factoring business is so profitable, he is prepared to offer promissory notes paying 20-50% within 6-9 months.
In this case, there was no factoring business. The promoter used the borrowed money for his own personal uses. The operation kept going because many "investors," instead of cashing their promissory notes upon maturity, agreed to new ones that they thought would allow their capital and profit to accumulate. Those "investors" who did not want to continue were paid off with funds from new and present "investors."
The "pyramid" scheme is essentially a business variation of the familiar "chain letter." It works this way:
Month Participants 1 6 2 36 3 216 4 1,296 5 7,776 6 46,656 7 279,936 8 1,679,616 9 10,077,696 10 60,466,176 11 362,797,056 (Exceeding US Population) 12 2,176,782,336 13 13,060,694,016 (Exceeding World Population)
The chart also shows why such a scheme is called a "pyramid" - the promoters are at the top of a pyramid-shaped flow of money. Money coming from later investors flows upward to the top. Being at the top may result in your receiving a lot of money quickly, but it is virtually impossible to determine, at the beginning, where in the pyramid you stand.
OTHER CHARACTERISTICS OF PONZI AND PYRAMID SCHEMES
In brief, Ponzi and pyramid schemes may also be characterized by:
WHAT CAN I DO ABOUT THESE SCHEMES?
You can help by notifying the SEC promptly if you are approached to participate in a questionable investment scheme or if you think you have invested in such a scheme. Information should be sent to any regional or district office of the Commission (see list at the end of this document) or to:
Securities and Exchange Commission
Office of Consumer Affairs
450 Fifth Street, NW
Washington, DC 20549
PHONE: (202) 942-7040
LIST OF THE SEC'S REGIONAL AND DISTRICT OFFICES
Northeast Regional Office
7 World Trade Center, Suite 300
New York, New York 10048
Philadelphia District Office
The Curtis Center, Suite 1005 E.
601 Walnut Street
Philadelphia, Pennsylvania 19016-3322
Boston District Office
75 Tremont Street, Suite 600
Boston, Massachusetts 02108-3912
Southeast Regional Office
1401 Brickell Avenue, Suite 200
Miami, Florida 33131
Atlanta District Office
3475 Lenox Road, N.E., Suite 1000
Atlanta, Georgia 30326-1232
Midwest Regional Office
500 West Madison Street, Suite 1400
Chicago, Illinois 60661-2511
Central Regional Office
1801 California Street, Suite 4800
Denver, Colorado 80202-2648
Fort Worth District Office
801 Cherry Street, 19th Floor
Fort Worth, Texas 76102
Salt Lake City District Office
500 Key Bank Tower
50 S. Main Street, Suite 500 Box 79
Salt Lake City, Utah 84144-0402
Pacific Regional Office
5670 Wilshire Boulevard, 11th Floor
Los Angeles, California 90036-3648
San Francisco District Office
44 Montgomery Street, Suite 1100
San Francisco, California 94104