Episode #243 - What Was Ponzi's Scheme?  ## Document Notes ## Highlights - **How Ponzi Recruited His First Investors** - Charles Ponzi convinced his furniture dealer to loan him $100 after pitching the international reply coupon idea and 50% returns. - Ponzi then used small local salesmen like grocer Ettore Ghiberti to recruit 18 investors who put in $1,770 total. Transcript: Sebastian Major Ponzi's brainwave concerning the earning potential of international reply coupons came to him not a moment too soon. In late 1919, his import-export company was languishing in debt, and his self-published Trader's Guide had done nothing to help the situation. Ponzi was getting behind on his payments, and creditors were starting to get itchy. One of the people that Ponzi owed money to was his furniture dealer, a man named Joseph Daniels. Ponzi had furnished his offices with a fine wooden desk and comfortable chairs, all of which he had bought on a payment plan from Daniels, which he had now fallen behind on. When Daniels came into Ponzi's office in late 1919, it was with the intention of either getting paid or repossessing all of Ponzi's furniture right there on the spot. The script of this encounter. After pitching a new convoluted payment plan to Daniels that involved Ponzi drawing up a $200 promissory note, he then went into an eloquent spiel about how international reply coupons Could be used to make a man rich. Ponzi promised Daniels that he would not only repay him in full within 60 days, but he would also pay him 50% interest if he chose to invest in this new scheme. Now, Daniels didn't have much to gain by repossessing the furniture at that moment, but he also wasn't feeling so confident in Ponzi that he was ready to gamble on his postal coupon idea. But a deal was made for Daniels to give Ponzi a small loan. Now, this episode really illustrates just how persuasive Ponzi could be when he hit his stride. Daniels came in that day looking to repossess Ponzi's desk, and he left agreeing to loan Ponzi $100. But that was all Ponzi needed to get started. Within a few days, he had filed the paperwork to rebrand his company. He first tried on the name International Securities Company before changing his mind a few days later and settling on the Securities Exchange Company. The new company would offer a unique investment opportunity. Money invested with Ponzi would be used to purchase international reply coupons in countries with devalued currency. Ponzi would then work his magic and investors would reap the rewards. To help sell the seriousness of this investment, Ponzi ordered a stack of specially designed certificates decorated with all the filigree that was usually reserved for banknotes. These certificates, soon nicknamed Ponzi notes, guaranteed their holders their invested amount plus 50 percent, 90 days from the date that it was issued. Eventually, Ponzi shortened the pay period to an unbelievable 45 days. In the first days of January 1920, Ponzi hit the bricks and started pitching his scheme to friends and friends of friends, really anyone he could get a sitting with. His success with Daniels had emboldened him and convinced him that the best way to get things started was to solicit small investments. He suggested that new investors should only invest between $50 and $100 just to test Ponzi's system. Ponzi was also careful not to appear over eager. He merely explained his novel postal coupon plan, made sure his prospective investors knew the address of his office on Boston School Street, and then let them come to him if they wanted To discuss things further. Was his acquaintance Ettore Ghiberti. Ghiberti was a fellow Italian immigrant who worked as a green grocer in the Boston suburb of Revere, Massachusetts. Ponzi sat his friend down and did his best to wow him with tales of 50% returns based on the exchange rates currently set by the Universal Postal Union. Ponzi would later reflect in his autobiography that he could tell that Ghiberti wasn't fully getting the somewhat complex workings of his mail coupon scheme. Sensing that he was going to lose the sale, Ponzi got what he called, a brand new idea, the result of impulse rather than of sober consideration. But impulse and nerve constituted then about nine tenths of my assets, end quote. Impulse and nerve. Yeah, that was Ponzi. He pitched that the grocer should start selling Ponzi's scheme at his grocery store. If Ghiberti could get his customers to invest, Ponzi would give him a 10% commission. That was a deal that Ghiberti could not turn down. It seemed like minimal work to potentially make a little cash on the side. And by the way, this is some high-level scamming right here. The best scams have a way of making the mark a part of the scam. And Ghiberti was about to get in up to his elbows. In the end, Ghiberti ended up investing just $10 of his own cash with Ponzi, ostensibly just so he could truthfully tell his customers that he was not only a salesman, he was a Ponzi client. Sure enough, by the end of the month, the green grocer had managed to entice 18 people to invest a total of $1,770 with Ponzi. The game was now afoot. In a few weeks, Ponzi had turned a delinquent furniture payment into a startup loan and a skeptical investor into a salesman. But he had immediately created an impossible situation for himself. He now had 90 days to turn that $1,770 into $2,478. That's 50% minus ([Time 0:22:21](https://share.snipd.com/snip/3a690663-1168-4639-94b1-64f0d176e184)) - **Coupon Scheme Was A MacGuffin** - The postal-coupon scheme was logistically impossible at scale, needing tens of thousands of coupons for small early investments. - The MacGuffin cover worked because most people didn't understand the details, which hid the fraud. Transcript: Sebastian Major He now had 90 days to turn that $1,770 into $2,478. That's 50% minus Ponzi's service charge. And it didn't look like he was going to be able to do it by buying international reply coupons. Setting aside the dubious legality of this plan, the actual logistics of working the scheme had already become unruly. The sheer number of international reply coupons that would have needed to be purchased, sent across the Atlantic, and then redeemed was so huge that less than $2,000 had revealed just How impractical this whole plan was. As Ponzi biographer Mitchell Zukov explains, quote, it would have taken more than 53,000 coupons to satisfy the first 18 investors. A stack of 200 coupons measured about one inch high. 53,000 would make seven three-foot high stacks or enough to fill a steamer trunk. End quote. It's not clear that there even were 53,000 international reply coupons available for sale in Italy in 1920. Have required someone driving around the country, hitting every post office they could find, and then buying up the entire stock of coupons available. Now, let's say you managed to do this once. Could you have done it a second time? And that was just to satisfy 18 investors. What would happen if you had more investors? This is to say nothing of redeeming the coupons in America and then selling the stamps. ([Time 0:29:10](https://share.snipd.com/snip/7cb8c9af-77eb-4556-845a-9d02c5b50c0b)) - **Pay Early Investors To Fuel Growth** - Pay early investors to create satisfied customers who recruit for you. - Use those payouts as marketing to grow funding quickly while you buy time. Transcript: Sebastian Major From then on, the number of investors grew rapidly and steadily. Now, Ponzi was no doubt helped by the fact that most of those first 18 investors did not ask to be paid out at the first opportunity. Most of them reinvested their money with Ponzi, not knowing that the first 50% return was likely just an illusion. This bought Ponzi time. And as Ponzi would say, quote, Each satisfied customer became a self-appointed salesman. End quote. That little observation is the key to every Ponzi scheme. By hook or by crook, the early investors must get paid. Once they do, they'll run the scam for you. ([Time 0:31:46](https://share.snipd.com/snip/950614e6-d7de-447f-ad50-19843cce6576)) - **Luxury Purchases Prevented The Dash** - Rather than flee at peak inflows, Ponzi bought a large Lexington home and an expensive locomobile. - Those purchases anchored him to Boston and made escape harder. Transcript: Sebastian Major Once again, he went shopping. In late May 1920, Ponzi bought an expansive new home with a columned porticoed entryway on a two-acre lot in the affluent Boston suburb of Lexington. Ponzi even made it a condition of the real estate deal that the former owners should become investors in the security exchange company. A month later, Ponzi splashed out on a luxury car known as a locomobile. The limited series limousine ended up costing Ponzi nearly half what he paid for his Lexington mansion. On top of that, Ponzi was freely spending on fine clothes, expensive cigars, jewelry, and any other luxury that caught his fancy. In half a year, Ponzi had gone from being a man mired in debt, renting a two-bedroom apartment, to being one of Boston's most conspicuous consumers. But of course, the car, and especially the house, more firmly anchored the Ponzi family to Boston. Running away now meant losing the lifestyle. The Ponzi scheme was now in full swing. ([Time 0:38:34](https://share.snipd.com/snip/8e26deac-d55d-48e2-aed4-ce1a261aae72)) - **Buying Businesses To Launder The Scam** - Ponzi bought businesses and a bank to launder and obscure his liabilities while appearing legitimate. - Owning a bank made him "too big to fail" but increased accounting complexity and scrutiny. Transcript: Sebastian Major He was sure he could find a legitimate way to start making a profit. So, in June of 1920, Ponzi started buying real businesses whose profits he hoped would offset his growing liabilities. This end, Ponzi bought up enough shares to gain a controlling interest in the C&R construction company. Then he bought a controlling interest in the Napoli macaroni manufacturing company, a move that Ponzi loved drawing attention to because it let him make ingratiating jokes about Italian stereotypes. Oh, who me? I'm just a humble macaroni salesman. He also paid a visit to his old employers at J.R. Poole's Importer Exporters and audaciously bought that company from Mr. J.R. Poole himself. This acquisition also came with a sardine factory in Maine and a meatpacking plant in Kansas. This shopping spree also included a number of fresh real estate deals, including acquiring a tenement house in Boston's West End. Then, the Coupe de Gras. Ponzi bought a bank. After aggressively buying up enough shares to give him a controlling interest, Ponzi was elected director of Hanover Trust. This was especially poetic because just one year earlier, that very same bank had denied Ponzi a loan. In his autobiography, he would crow about this as a type of sweet revenge. Writing of the bankers, quote, I had the officers by the small of their neck. Those same officers a few months before had refused me a $2,000 loan because my account was more of a bother End quote. Now, there are a few different ways one could interpret all of this. Clearly, Ponzi enjoyed using his money to settle scores and embarrass people who had looked down on him before he struck it rich. He would admit as much in his autobiography, explaining, quote, When someone tries to put on airs and make me feel like 30 cents, I am off on a rampage, end quote. But obviously, buying the bank was about more than just petty revenge. This quickly acquired collection of businesses and financial institutions could be seen as a clever attempt to launder the Ponzi scheme. These various businesses could be borrowed against or brazenly plundered. Just as significantly, they could be used to obfuscate the financial chicanery going on at the securities exchange company. Ponzi's accounting just became considerably more complicated. If the goal was to hide the Peter T'Pol scam, having a handful of legitimate businesses and a bank in your back pocket was a good way to do it. But Ponzi may have been trying to use these businesses for more than just cover. He may have been hoping that these businesses would bring in enough money to help him cover any investors who wished to cash out the scheme. If his businesses and banking empire could grow large enough, then he could eventually stop robbing Peter to pay Paul, and the whole thing could become legal, legitimate, and sustainable. Or why not both? The bank, the sardine cannery, the macaroni company, all acted as good cover while also offering the hope of legitimacy. Ponzi was essentially trying to get too big to fail. Now, if he went down, it would also mean the collapse of a bank and a handful of other honest American businesses. It was a clever move, especially if his goal was to stay rich without running away. ([Time 0:40:06](https://share.snipd.com/snip/20556126-7d88-4940-a800-a8a4d3e66109)) - **Lawsuit Sparks Public Frenzy Then Confidence** - A $1 million lawsuit by his former furniture dealer made Ponzi front-page news and triggered a run. - Ponzi refunded many investors, which paradoxically restored confidence and attracted more funds. Transcript: Sebastian Major Boston had caught a type of Ponzi fever. But the first bump in the road came on July 4th, when Ponzi's old furniture dealer, Joseph Daniels, served Ponzi with a newsmaking $1 million lawsuit. Ponzi had repaid Daniels his original loan months earlier and had settled all of his outstanding accounts regarding his office furniture. As far as he was concerned, Daniels had been properly compensated. But in the intervening months, Daniels had seen Ponzi's business explode and was now insisting that his startup loan entitled him to half the ownership of the securities exchange Company. The lawsuit was completely frivolous. Daniels really did not have much of a case, but he gambled correctly that Ponzi would eventually be compelled to settle to simply make the lawsuit go away. Sure enough, Ponzi would eventually end up shelling out $50,000 in a hasty settlement. But the most significant effect of the lawsuit was that it drew all sorts of new attention to Charles Ponzi. In 1920, a million-dollar lawsuit was so rare that it was considered newsworthy. So on July 4th, the Boston Post ran its first-ever news story about Charles Ponzi and the security exchange company. The first time the name Charles Ponzi appeared in print in a Boston paper was under the headline, Boston Man Sued for $1 Million. The news that Ponzi was being sued kicked off the first proper run on the securities exchange company. After the story hit newsstands, hundreds of panicked Ponzi investors crowded School Street and demanded that they be refunded their initial investments. Luckily for Ponzi, at that point, he had enough cash squirreled away in his various accounts that he was able to cover everyone who wanted out. Ironically, the run served to help Ponzi's business. When word got out that Ponzi had refunded hundreds of investors without any trouble, this acted as great advertising for the securities exchange company. Ponzi would remember that, quote, in those two days, I refunded about a million dollars and saved thereby 500,000 in interest, which I would have had to pay at the maturity of those notes. 48 hours were enough to restore confidence, and the million dollars came back again in less time than it had taken to pay it out. End quote. In the week after the initial run, crowds in the hundreds once again returned to School Street, but this time to invest. ([Time 0:47:11](https://share.snipd.com/snip/cbf1e6d6-9d38-4113-8594-47bb2e8a31bf)) - **Audit Gambit Bought Time But Backfired** - Ponzi invited an audit to pause new investments and hoped time would let his assets catch up. - That strategy bought time but invited deeper scrutiny that ultimately exposed him. Transcript: Sebastian Major To that end, he hired a publicity manager, a former Boston Post reporter turned political spin doctor named William McMasters. But McMasters had barely started working for Ponzi when they were gifted some positive press. Ironically, it may have been a little too positive. On July 23rd, a Boston Post reporter dropped by Ponzi's office ostensibly to follow up on the story about the million-dollar lawsuit. Ponzi greeted the reporter with his characteristic charm. He toured him through his offices and even invited him to his family home in Lexington. Along the way, he sold the young reporter on his ingenious money-making method involving international reply coupons. The reporter credulously ate it all up, and the next day, the Boston Post ran a glowing story, Doubles the money within three months. 50% interest paid in 45 days by Ponzi has thousands of investors. The article gave the impression that the securities exchange company was entirely on the up and up. Ponzi came across as a financial genius, the living embodiment of the American dream who had pulled himself out of poverty through sheer ingenuity and gumption. Most importantly, the article assured Post readers that despite Ponzi's incredible claims, quote, the authorities have not been able to discover a single illegal thing about it. End quote. The reply coupon McGuffin had once again done its job. But Ponzi's wish for better press proved to be one of those monkey's paw wishes that comes with a terrible curse. The Post article was so effusive in its praise that it set off a fresh stampede of would-be investors at the School Street office. Before the day was out, a massive jostling crowd had formed outside of the securities exchange company. The characteristically hyperbolic Ponzi would gleefully remember that, quote, it seemed as if everybody had made a date to meet at 27 School Street. Everybody was there. The two million inhabitants of greater Boston were all there. If there were not exactly two million, they looked that many, end quote. The exact number of people in the crowd has been hard to verify, but there's no doubt that the article and the ensuing commotion had caught the attention of Boston. But more attention brought more scrutiny. As already mentioned, there were many at the Boston Post who had been skeptical since Ponzi first came to their attention at the start of the month. This very much included the acting publisher Richard Grosier. Feeling some pressure after touching off a public frenzy after their last Ponzi story, the Post decided to run a far more skeptical story a few days later. For this, they contacted the venerable finance journalist Clarence W. Barron, president of Dow Jones and its associated newspaper, The Wall Street Journal. Barron was asked to offer an expert opinion on Ponzi's unusual business model. His ensuing editorial on the feasibility of the international reply coupon scheme proved to be the true start of Ponzi's unraveling. Published on July 26th, just two days after the Stampede-inspiring Post article, the Dow Jones President's piece ran on the front page. It was headlined, Questions the Motive Behind the Ponzi Scheme. Barron says reply coupon plan can only be run in a small way. In the article, Barron laid out his opinion that while Ponzi's plan might be workable in theory, it was totally impractical for his international reply coupon scheme to be run at a large Scale. Just as significantly, he declared the scheme to be immoral. Now, interestingly, the article did not immediately set off a backlash. The next day, there were just as many eager investors crowding School Street. But Ponzi was spooked. He understood just how dangerous Barron's article was. Most worrying was the promise in the Boston Post that postal officials from Italy and other foreign countries, where Ponzi claimed to be buying these international reply coupons, Were going to be reporting to American authorities in a matter of days. That it meant that Ponzi was days away from being found out. Those foreign postal officials would report that Ponzi had not bought any postal coupons at all, revealing the whole thing as an elaborate Peter DePaul scam. This also may have been a good time to make the dash. But Ponzi being Ponzi, he attempted to brazen his way through the crisis. After reading Barron's article, Ponzi concluded that a good defense is a good offense. Impulsive as ever, Ponzi got on the phone and called the United States District Attorney for Massachusetts, the Suffolk County District Attorney, and the Massachusetts Attorney General. He then set up two meetings, one with the DAs, who just so happened to be old college buddies, and a separate meeting with the Attorney General. At the first meeting, Ponzi boldly suggested that the Suffolk County District Attorney should appoint an independent auditor to audit his books. The idea would be that this auditor would determine the full extent of Ponzi's liabilities, and then Ponzi would be allowed to demonstrate that he had enough assets to cover them. Now, why would Ponzi suggest this? Well, first, it was good optics. Would a guilty man volunteer for an audit? The ([Time 0:54:05](https://share.snipd.com/snip/198777eb-724d-49bb-94ea-aa045efe9646)) - **Publicist's Exposé Triggered The Collapse** - Ponzi's publicity man, William McMasters, secretly sold an exposé to the Boston Post admitting doubts about Ponzi's funds. - Shortly after, Ponzi bounced checks and regulators froze his accounts. Transcript: Sebastian Major Then two days later, they dropped the real bombshell. Ponzi's publicity man, William McMaster, had privately become worried that he had taken a job with a fraudster. So, after a cursory investigation snooping around Ponzi's office, McMaster came to the Post with his own expose. He was handsomely paid by the Post for his story. They believed that it might just be the final nail in Ponzi's coffin. The sub-headline said it all. Quote, Publicity expert employed by Wizard says he has not sufficient funds to meet his notes, states he has sent no money to Europe nor received money from Europe recently. End quote. The accusations, leveled as they were by a Ponzi insider, caused yet another run on the securities exchange company. By this point, banking regulators were watching Ponzi's accounts and his bank, Hanover Trust, very closely. In Ponzi's haste to transfer money between what had become a labyrinth of different bank accounts, he slipped up, misjudged how much money was available in one of his accounts, and Bounced two checks. ([Time 1:09:00](https://share.snipd.com/snip/219e20ad-10d8-4c9f-9a69-8cccac786bf8)) - **Numbers, Not Morals, Ended The Scheme** - The audit revealed $7M liabilities against $4M assets, forcing Ponzi's surrender and mail-fraud charges. - The coupon story conveniently justified mail-fraud counts even though coupons were never central. Transcript: Sebastian Major It was now revealed to the world that Charlie Ponzi had a history as a fraudster. That story ran on a Wednesday, and on the Friday, Ponzi was going to be faced with the final results of the independent auditor's review of his index card books. When all was tallied, Ponzi was determined to have liabilities of around $7 million. Even the most generous accounting of Ponzi's assets had him at only $4 million. He was $3 million short. With rumors circulating that Ponzi's arrest was imminent, Ponzi decided to turn himself in to the district attorney. The DA made the fateful choice to charge Ponzi with mail fraud. In retrospect, this was kind of a ridiculous charge, given the nature of the Ponzi scheme. Ponzi would eventually face 86 counts of mail fraud for mailing his clients letters, telling them to come and collect on their mature Ponzi notes, which he then dutifully paid out. Now, this was technically using the mail as part of a fraud, but I mean, barely. ([Time 1:12:11](https://share.snipd.com/snip/ca571e7c-380e-45e5-8570-9740bac4ec40)) - **Aftermath: Prison, More Scams, Deportation** - Ponzi served multiple sentences, continued smaller scams, and was deported to Italy in 1934. - About 20,000 people lost money, some their life savings, during his eight-month rise and fall. Transcript: Sebastian Major State larceny charges would follow, and eventually more jail time. Ponzi never fully lost his taste for get-rich schemes. He managed to have a few more scammy adventures before he was ultimately deported to Italy in 1934. By mid-August of 1920, the Ponzi scheme was officially over. ([Time 1:16:09](https://share.snipd.com/snip/7a238182-d805-42dc-bc9d-cdfbdc422a96))