2009-03-06 / Columnists

Notes On Consumer Affairs

By Assemblywoman Audrey Pheffer

AUDREY PHEFFER AUDREY PHEFFER In December of last year, the investment community and thousands of individual investors were shocked to learn that Bernard Madoff, a respected and well-known investment adviser and previous chairman of NASDAQ, ran a $50 billion Ponzi scheme.

The massive size and scope of Madoff's scheme left investors and regulators aghast. How could such an enormous fraud have gone undetected for so many years? How did Bernard Madoff pull it off? While the answers to these questions will surely be intriguing, the most important question for individual investors is: How can I avoid schemes like this in the future? Fortunately, consumers can protect their hard-earned money by educating themselves about fraudulent investment schemes and exercising caution when considering new investment opportunities. In order to avoid Ponzi schemes, it is important to understand how these schemes work. A Ponzi scheme is a variation of a pyramid scheme. A pyramid scheme is a fraudulent system of making money that relies on recruiting an ever-increasing number of participants or "investors." The original promoters of the scheme recruit investors, who then are required to recruit more investors, who then recruit others, and so on. At each new level in the pyramid the number of investors grows. The group of initial promoters at the top of the pyramid require a large base of subsequent investors at the bottom to support the scheme so that they can provide profits to the earlier investors. These schemes always collapse and are illegal in New York. A Ponzi scheme, named after Charles Ponzi, who ran the first highly-publicized scheme, is a pyramid scheme where the promoter has no product to sell and does not pay a commission to investors who recruit new investors. Instead, the promoter collects payments from the investors and promises them a high rate of return on a short-term investment. Pyramid schemes are often confused with legitimate multilevel marketing arrangements. Participants in these arrangements have an actual product to sell to the general public, as opposed to most pyramid schemes where products are sold within the group of investors. Furthermore, in multilevel marketing arrangements commissions are paid to investors for retail sales, not for recruiting new investors.

Keep the following tips in mind to avoid falling victim to a pyramid scheme. First, beware of any selling or investing plan that makes larger-thanlife earnings claims, especially those that promise such earnings over a short period of time. Stay away from any plan that offers commissions for recruiting new members, especially if there is no product involved or if there is an up-front membership fee required to join the plan. If a plan involves the selling of products, determine whether new members must buy costly inventory, or whether members make the majority of their "sales" to other members

as opposed to the general public. Look out for schemes that claim to have a secret plan, overseas connection or special relationship with a business or other entity. Many pyramid schemes will ask for delays in meeting its commitments while urging members to stay with the scheme. Recruiters may advertise that

they are in a "pre-launch" stage, but in reality there never will be a launch. If you find any of the above conditions, assume that the plan is a pyramid scheme. Lastly, if you are approached by a trusted friend or relative about an investment scheme that sounds like a pyramid scheme, it very well may be, as your friend or relative may have been misled by another investor caught up in the scheme.

As with any purchase, when considering a potential investment, you should do your homework, ask questions before signing any agreement, and be especially wary of schemes that exhibit any of the characteristics described above.

For more information on pyramid schemes, you may want to visit the Attorney General's website on the subject at: .

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