Like many doomed ideas searching for capital, Charles Ponzi started out with a simple plan to arbitrage coupons. With charisma and false promises, his scheme quickly ballooned into one of history's most famous fraud cases.
Even though Ponzi was convicted and imprisoned more than a century ago, his infamy lives on. Ponzi or pyramid schemes, which seek to pay earlier investors with new investor funds, remain common today, with cryptocurrency opening new fraud opportunities. And his legacy is still being scrutinized, most recently in the Apple Original podcast Easy Money: The Charles Ponzi Story.
Observers are drawn to those schemes because of their magnitude. The biggest generally involve the large sums of money—often in the billions.
Harvard Business School Professor Eugene Soltes, who shares insights from decades of risk and integrity research on the podcast, says shifting regulatory priorities are creating a “grifter’s paradise,” with potential consequences for years to come.
HBS Working Knowledge talked to Soltes, the McLean Family Professor of Business Administration, about Ponzi, the state of corporate crime today, and the influence of artificial intelligence and cryptocurrency. The interview has been lightly edited for length and clarity.
Why do you think there's still so much interest in Ponzi?
Every decade, we see another major Ponzi scheme scandal that's very large. The most recent one that people will obviously recognize involved Bernie Madoff. Observers are drawn to those schemes because of their magnitude. The biggest generally involve the large sums of money—often in the billions.
What's impressive is that unlike the sophistication of Enron’s financial fraud, where executives were making complex changes to financial statements that make it hard for people to understand, the essence of a Ponzi scheme is not actually complex from a business side—because there isn't actually any underlying business. What's most fascinating is that it “works” because it’s a psychological scheme of attracting and retaining victims.
If you think of Madoff, just through his style and demeanor, he was able to attract extraordinary amounts of capital from many deeply sophisticated people and respected charities. Even he couldn’t have imagined when he started that he would be able to raise billions based on a nonexistent financial offering.
Why do you think this style of scam remains popular?
We’re all susceptible to the allure of making a quick buck. It goes back to the most basic financial advice people hear at a young age: “There’s no free lunch.” When your bank is offering you a 2 percent rate of return, and someone else offers you 15 percent for “no additional risk”, it should be viewed as too good to be true. And yet, if you see other people making that, it becomes just too attractive to pass up. Call it “FOMO”—fear of missing out. Your initial hesitation is thrown out and that’s how another victim is born.
I wrote an article years ago about a company called MMM. It was the largest Ponzi scheme in Russia and it reached people across Asia and parts of Africa, too. They were active on Facebook groups and even did in-person events. The company stated that their scheme was like a charity that could pause or reset—euphemistic wording that meant it would need to start over when the Ponzi became unsustainable.
Regulators had trouble shutting it down because it wasn't fraudulent; they literally described what they were doing. It was the rare Ponzi that was not actually being deceptive and people still invested!
We interviewed people who were investing and we heard many say how they lost everything when banks failed or knew people who did. For people who’ve been through a crisis and lost all of their money, they don’t trust central institutions like banks. Then, all of sudden, you hear that people you trust say they’re making lots of money in something that seems credible, you jump back in to catch up with them.
Is cryptocurrency the new frontier for Ponzi schemes?
So we’ve gone through three waves, so far:
We had many initial coin offerings, which were mostly shut down.
Then we had these NFTs (non-fungible tokens), until those went out of fashion.
Now, we have crypto. While there's obviously some important potential opportunities and uses, there are also many that resemble the most basic “pump and dump.”
In a pump and dump, an investment is touted by people who get the price to rise quickly, and then the promoters sell large amounts of their holdings at a profit causing the price to plummet. Many of the crypto offerings clearly are too volatile to be an effective store of value or an effective means of exchange. Yet, you see their values dramatically rising and falling based on touting. This doesn’t look all that different in some instances from what pump and dumps looks like in stock market.
What challenge does this investing psychology present for regulators?
I have a paper coming out later this year on this. We used a set of investor data that involved known pump-and-dump schemes. And what was fascinating was that there's a subset of investors—not a trivial subset—that seems attracted to pump-and-dump schemes. They've been involved in them and find more to invest in. Despite often losing, they keep doing it! Psychologically, they must enter them with the thinking that it’s like a lottery ticket. It’s a thrill and you think you can make 10 times your investment quickly.
Our conclusion from the paper suggests that the thing that regulators do—tell people how to avoid pump-and-dump schemes—may work in reverse. That means, that if you tell people that something is a pump and dump, a lot of people will run toward it because everyone has this overly optimistic belief that they're going to sell before it gets dumped.
What’s the state of corporate crime?
I’m concerned with the general climate today around corporate conduct and fraudulent behavior in markets. We're operating in an environment where federal priorities have shifted away from fraud to other areas, such as immigration. There are new products, especially in crypto and AI, that can facilitate new waves of crime. And the notion of truth and deception is being confounded in everyday business conversation. I’d describe the current environment as a grifter’s paradise.
I do see this eventually coming back to bite those who are engaging in deception though. Years often pass—six is a commonly cited number—before a white-collar crime faces investigation or prosecution. That suggests that, right now from afar, business conduct can look stable and acceptable. But once we inevitably hit the next bump—for example, an economic downturn when such conduct is more likely to be exposed—we’ll see a very different picture.
Already, based on some of our work viewing internal company culture, we see more challenges emerging. I see it as just a matter of time until we unfortunately see a much larger abscess of damaging corporate behavior exposed. It remains to be seen whether and how that conduct will be dealt with from a regulatory and enforcement perspective. Will the US take a strict line as in the past or will companies be giving a pass in the name of “economic growth”?
How might this affect investment in the US?
One of the things that has made the US such an attractive place for capital is that when people put money in the United States and invest in a company or business, you have confidence. You have federal regulators that use the criminal code. You have numerous vigorous civil regulators. You have significant private litigation. Such an environment doesn't exist in many places around the world.
I don’t think it can be taken for granted that certain kinds of misconduct will be naturally viewed as off limits by employees as was even quite recently.
I am certainly empathetic to a lot of corporate leaders who see the US regulatory environment as overly burdensome, and certainly one can find plenty of cases in which that is the case. At the same time, the environment also makes the US an attractive place to put capital because you don’t need to worry about someone stealing it.
Whether all the rapid changes happening today are making the US a more or less attractive place to securely invest capital will depend on whether investors can still trust that unscrupulous managers cannot deceive them without consequences as in many other parts of the world.
What can leaders do to shore up their businesses in these conditions?
One of the challenges that corporations are currently facing is that, on paper, they are saying the same thing that they always have about their obligations, their responsibilities, and their focus on integrity.
But the workforce is reading the news and seeing the environment shift. Again, I'll point to corruption—they’re seeing a literal push away from enforcement. They see prominent individuals that are being pardoned and firms not facing the same sanctions and can draw the inference that that's not as serious an issue anymore.
From a corporate leadership perspective, this requires a real conversation on risk appetite and the company’s mission and values. To the extent that you want employees to continue avoiding certain conduct, it will require leadership to make the case of why that is important to the company and its employees. I don’t think it can be taken for granted that certain kinds of misconduct will be naturally viewed as off limits by employees as was even quite recently.
What about investors?
Nothing we teach at HBS in our finance or accounting classes on valuation supports why meme stocks are doubling, tripling, or quadrupling in a matter of days. They're trading purely based on momentum. If people want to invest—or gamble, as I would argue—on those stocks, they should think of it as a playful gamble and not a serious investment.
But in the short run, the grifters will grift. And a small portion of them, but probably an increasingly larger portion, will get away with it.
I am worried that when you read articles about people putting significant capital in these stocks, it becomes normalized. You start to think of it as an investment, because everyone’s piling in, even though you've only read about it on Reddit. It’s not an investment.
The market is moving toward more momentum investing rather than away. That said, the businesses that develop value, make good products you can hold, treat their employees well, and do things with integrity are generally the ones that succeed over the longer run.
But in the short run, the grifters will grift. And a small portion of them, but probably an increasingly larger portion, will get away with it. That’s not a great long-term strategy though!
What’s the role of AI? Could the next Bernie Madoff be a bot?
We’re going to see a host of entirely new kinds of schemes that have the potential to be very effective and impactful. Just to name a few:
AI bots that could autonomously collude to fix prices. Who is responsible—the companies using the software, the software vendor, the engineer? We don’t have a framework for that yet.
AI bots that use extreme measures to achieve their aims. Perhaps it’s a bot that wants to maximize an investment. So, it creates a smart contract to cause physical harm to a competitor’s leadership or physical infrastructure to increase its value, which would automatically be paid out to whoever completes the contract. I see AI creating a Silk Road 2.0 that is much more damaging and efficient.
AI systems that use psychology and circumstances to deceive. Such a system would exploit a victim’s psychology and surrounding environment to create an irresistible “fraud pitch” to raise money. The damage wrought by personalized pitches, especially ones using voice and video, could make Bernie Madoff’s fraud look trivial.
None of these things are science fiction, but real issues we’re going to need to confront in the coming years. I don’t think we’re ready to confront these as a society, but this is what we’re looking into, research-wise, to prepare us for when these issues do begin to emerge at scale.
Image: Kent Dayton
