The Simplest Scam In the World

As the UK descends into recession, `get rich quick' swindles will multiply. Here's how one reader nearly lost a fortune to the oldest trick in the book...

The grim reality of the UK's economic decline hit today, with an official announcement that the country has slipped into recession for the first time since 1991. One widely used definition of recession is when the economy shrinks for two quarters in a row. For the record, the UK economy contracted by 1.5% in the final quarter of 2008, on top of a 0.6% drop in the previous quarter.

Recessions breed rip-offs

As the economy continues to decline, desperate people resort to desperate measures in order to make ends meet. Indeed, crime tends to rise during economic downturns, particularly financial crimes such as fraud. For example, during the last recession, while working in the legal department of an insurance company, I witnessed a huge surge in the number of fraudulent insurance claims.

Today, there's no doubt that we have a few difficult years ahead of us. This leads me to believe that we will see an explosion in the number of `get rich quick' schemes being promoted. You know the kind of thing: "Become a Property Millionaire in a Week", "Make Your Fortune as a Trader" and so on. Hence, we all need to be ultra-cautious when presented with money-making opportunities that prove too good to be true.

Beware of the Ponzi

Today, I'm going to tell you how I saved a friend from losing half of his personal wealth in what turned out to be the oldest trick in the book: a Ponzi scheme. You've probably heard this word quite a lot in the news recently, thanks to the collapse of American fund manager Bernard Madoff's bogus hedge fund last month.

Madoff's fund may well have been legitimate in the beginning. Alas, over time, he started using new investors' contributions to keep up fake `returns' to existing investors. As stock markets collapsed around the world and investors withdrew their money, the game was up for Madoff (ironically, pronounced `made off'). He admitted to FBI agents that his secretive fund was nothing more than an old-fashioned Ponzi scheme which had lost investors a staggering sum: $50 billion.

Ponzi schemes are named after infamous fraudster Charles Ponzi, who carried out a massive fraud in the US in 1920 by promising fantastic returns to investors. However, they also fall into a category known simply as `advance-fee frauds'. In effect, these solicit money upfront from punters by offering them a generous return further down the line. In fact, they are pyramid schemes, with later entrants paying returns to earlier investors.

My Madoff moment

Five years ago, I had a terrible shock when I realised that a friend, whom I'll call `Dave', had fallen victim to a classic Ponzi scheme. He'd sold his house early in 2004, pocketing a tax-free profit of around £60,000. Dave planned to use this money to take a year off work and travel around the world.

One day, Dave quietly revealed to me that he was making a terrific return on half of this cash (£30,000) which he'd put into a secretive investment scheme. He claimed to be getting a return of £330 a month on this money. With compounding, this monthly return of 1.1% amounts to a handsome return of over 14% a year.

At the time, the Bank of England base rate was around 4% a year, so any investment earning 10% a year on top of the base rate must be extremely risky. In fact, 14% a year is considerably higher than the average yearly return earned by stock-market investors over the past century or so. Hence, I warned Dave that this scheme was an outright scam. What's more, without the protection from the Financial Services Compensation Scheme, he was sure to lose every penny.

This bad news made Dave very angry and, in fact, he started avoiding me. However, in time, he came to his senses and realised that I was telling the truth. After a bit of arm-twisting, Dave managed to extract his entire £30,000 from the fraudster, who was living high on the hog on other people's money. Alas, one of Dave's relatives (a well-off, financially sophisticated executive) ended up losing -- brace yourself -- over £250,000 when this fraud eventually collapsed. Ouch!

My final warning

Please, please, please don't let greed and fear blind you to the obvious weaknesses of get-rich-quick schemes. Even wealthy, experienced investors are taken in by the smooth patter and mouth-watering returns promised by conmen. Always remember: If in doubt, never take your wallet out!

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