Federal regulation of the U.S. securities industry was prompted in part by the success of the fraudulent investment schemes perpetrated by Charles Ponzi and his imitators.
Charles Ponzi achieved immense but short-lived success marketing investments of dubious merit to the public in the 1920’s. In what came to be known as “Ponzi schemes,” although the method was first used by other swindlers, Ponzi attracted gullible investors by promising high yields over short periods of time. In general, Ponzi scheme promoters develop an ever-widening circle of customers for a nonexistent investment by paying interest and dividends from the client’s own funds or from contributions of subsequent investors. The schemes involve paying early investors with money received from later investors; the promoter can then point to high dividend payments to encourage new investors. Ponzi’s most notorious and successful scheme involved taking advantage of exchange-rate disparities in the trading of international reply coupons, which are negotiable postage stamps used to facilitate international correspondence. He managed to attract thousands of investors from all the social and economic strata of Boston in 1920.
Ponzi was born Carlo Ponsi in Parma, Italy, in the 1880’s. He failed to meet the expectations of his wealthy family and spent much of his youth in aimless pursuits. Hoping he would find success in the New World, Ponzi’s family gave him a thousand lire (about two hundred dollars) and a one-way ticket to the United States in 1902. Ponzi spent the next fourteen years holding an assortment of odd jobs as he traveled throughout the United States and Canada. In 1917, he settled in Boston, where he worked with his father-in-law as a fruit dealer.
Ponzi received a business letter from Spain in 1919 that contained an international reply coupon that had cost the sender the equivalent of one cent in Spain. The Universal Postal Union issued international reply coupons to enable senders to prepay reply postage. Immigrants in the United States often sent such coupons in letters to European relatives. A coupon could be exchanged at any U.S. post office for a six-cent stamp, enough to send a letter back to Spain.
Charles Ponzi.
Ponzi discovered that the pricing disparity existed in several European countries, and thus the profit potential was theoretically enormous. He began a speaking tour of the Boston area in August of 1919, giving investment seminars designed to raise capital for the Securities Exchange Company, a firm he created to perform the international reply coupon transactions.
Advertising a 50 percent return in forty-five days, he initially attracted small sums from Boston’s Italian immigrants. Word of the phenomenal promised returns reached the elite of Boston society, and Ponzi was soon collecting hundreds of thousands of dollars daily. Potential investors either waited for hours in long lines outside his School Street office or simply mailed him cash. His clerks were forced to store cash in baskets and in closets as contributions flooded Ponzi’s rented offices.
Ponzi used some of the proceeds to gain control of several Boston businesses, including area banks that had made loans to him. Ponzi quickly adopted a lavish lifestyle and became a hero to the immigrant community and small investors. His success inevitably attracted the attention of Boston’s legal authorities. Police Commissioner Edwin U. Curtis sent three investigators to Ponzi’s office in the summer of 1920. Two of them bought shares in the scheme after speaking with Ponzi. Postal inspectors, the district attorney’s office, and federal attorneys paid visits to Ponzi’s operation. No evidence of illegal activities was uncovered and Ponzi, a public relations genius, used these official pronouncements to mitigate any suspicions potential investors might have held. Ponzi had collected nearly fifteen million dollars by August of 1920.
Richard Grozier, publisher of the Boston Post, doubted Ponzi’s claims and set out to prove that Ponzi was engaged in a massive fraud. Grozier interviewed Clarence W. Barron, founder of Barron’s Weekly, about Ponzi’s operation for a July 25 article. The article iterated Barron’s opinion that it would be impossible to turn over more than a few thousand dollars worth of coupons in the manner described by Ponzi.
The article resulted in a run on the Securities Exchange Company that Ponzi stemmed by offering a full refund to anyone who requested it. Ponzi admitted that the coupon scheme was simply a ruse to cover an even more inventive plan he had developed that he sought to keep secret from Wall Street speculators. These developments, to Grozier’s chagrin, only caused more investors to entrust Ponzi with their money; Grozier had unwittingly promoted Ponzi’s operation. Grozier ordered his staff to widen the investigation of the immigrant millionaire.
The Boston Post, exploring an anonymous tip, discovered that Ponzi had been convicted of forgery in Canada in 1908 for activities strikingly similar to the reply coupon enterprise. Publication of these allegations on August 11 prompted federal postal inspectors to focus attention on Ponzi’s activities. He was arrested by a U.S. marshal on August 13 and charged with mail fraud. Six Boston banks that were closely tied to Ponzi failed, including Hanover Bank and the Tremont Trust. Investigators soon discovered that Ponzi had also been convicted of smuggling illegal aliens into the United States from Canada after being released from Canadian prison.
Ponzi was tried and convicted in Boston’s federal court and was sentenced to five years in prison. Because federal facilities were unavailable, Ponzi was incarcerated in the Plymouth County Jail and was paroled after serving forty months of the sentence. Massachusetts then tried him on state charges, with twenty-two counts of conspiracy and larceny against him. Found guilty, Ponzi was sentenced to seven to nine years in prison in February of 1925, but he escaped while free on bail. He resurfaced in Florida in 1926, selling swampland for ten dollars an acre to naïve investors. He was convicted of fraud and sentenced by a Florida court but again escaped while on bail. He was rearrested in New Orleans in 1927 and was returned to Boston to serve his sentence. In 1934, he was released and deported to Italy, where he had achieved celebrity status.
Italian dictator Benito Mussolini asked Ponzi to manage the Brazilian offices of Italy’s new airline, but he was fired in 1942 after allegations surfaced that he was involved with currency smuggling. He retired to a pauper’s life that was interrupted briefly by efforts at finding renewed glory. He reportedly tried to swindle the Soviet Union in a gold-smuggling operation in the late 1940’s. Ponzi died of a stroke in a Rio de Janeiro hospital’s charity ward on January 18, 1949, leaving an estate of seventy-five dollars, which was used to cover his burial expenses.
Few concrete steps were taken in the 1920’s to stem the proliferation of investment scams that helped define the decade. Although the more outrageous schemes received intense press coverage, victims found little recourse at the federal level. It is ironic that, like Ponzi before them, many promoters experienced increased demand for their securities as the level of media coverage intensified, regardless of whether the reporting was salutary or critical.
The 1920’s was a decade of rapid income growth coupled with amazing returns for holders of stocks of both established and new corporations. Given these conditions, a novice investor could rationalize looking past risk in the hope that a token investment could be parlayed into a fortune. Some social historians have attributed the speculative fever that infected the United States in the 1920’s to consequences stemming from World War I.
Ponzi’s success spawned countless imitators who profited throughout the 1920’s. For example, hundreds of itinerant Russian immigrants invested half a million dollars in a fictitious gold and platinum mine on the Hudson River. Brazen Chicago swindlers sold shares in the League of Nations. Midwestern investors purchased uninspected wetlands under the Mississippi River, land that was advertised as already having running water. Countless investors contributed millions of dollars to fraudulent oil well ventures. Hundreds of entrepreneurs sold Florida real estate at seminars held in cities throughout the eastern half of the United States.
Few in government had the inclination or power to stop Ponzi and his imitators. Beginning with Kansas in 1911, states passed laws that attempted to regulate investment sales. New York’s Martin Act stood out because it provided for criminal proceedings against fraud. The investment regulation laws of most states—especially the “blue-sky” laws
Federal investigative units had the greatest success prosecuting investment fraud cases in the 1920’s. Postal inspectors successfully collected evidence for local prosecuting attorneys and had the power to stop the flow of mail to operators of investment scams. Postal investigations, however, typically consumed a year or more before completion, and federal prosecutors often took months or years to press charges against the promoters once they received evidence. Even when promoters were convicted, prison terms were generally short and fines were small. Large fines often went unpaid.
State and local efforts at interdiction generally stopped at political borders. It was a relatively simple matter for an investment scheme operator to move to a new community when local authorities responded to complaints and initiated investigations. The lack of a national tracking system ensured that a criminal’s past was easily buried with each relocation.
The newly created Federal Trade Commission
The speculative boom of the 1920’s died with the 1929 stock market crash, so the legal impact of Ponzi’s international reply coupon swindle was not immediate. It took many other investment frauds, a stock market crash, and the near collapse of the banking system before Congress acted in the early 1930’s and passed the Securities Act of 1933
The SEC is an independent bipartisan administrative agency that enforces compliance with laws against false and misleading investment disclosures and unethical securities sales practices. Learning from the difficulties Massachusetts had in convicting Ponzi of fraud, the SEC found it easier to derail Ponzi schemes by citing technical violations of SEC regulations instead of focusing on fraud allegations.
Ponzi schemes continue to surface on a regular basis, despite increased investor sophistication and enhanced legal weapons for prosecution. Instances in the late twentieth century included the Moses Lake commodity futures scheme, the J. David currency trading scandal, the ZZZZ Best penny stock scam, and the Memory Metals affair. Each of these plans paid interest or dividends to investors from the capital of later investors. Many investment industry observers have attributed the continued success of Ponzi scheme promoters to the SEC’s tendency to concentrate on “big fish” (for example, insider traders who victimize small circles of investors for large sums) instead of scams that defraud large numbers of investors of relatively small amounts. It has also been argued, however, that Ponzi schemes systematically surface because there will always be some investors who lose sight of economic reality when faced with the prospect of immediate wealth.
-
Dunn, Donald H. Ponzi: The Incredible True Story of the King of Financial Cons. 1975. Reprint. New York: Broadway Books, 2004. Authoritative biography highlights major events in Ponzi’s life and gives the reader an idea why Ponzi was driven to succeed. -
Evans, D. Morier. Facts, Failures, and Fraud. Reprint. New York: Augustus M. Kelley, 1968. Case history of financial fraud in Victorian England makes it clear that Ponzi’s scheme was innovative but not original. -
Kahn, Ely J. Fraud. New York: Harper & Row, 1973. Comprehensive and entertaining account of the long history of the U.S. Postal Inspection Service. Covers major fraud investigations from the 1700’s to the early 1970’s in a case format. -
Olien, Roger M., and Diana Davids Olien. Easy Money. Chapel Hill: University of North Carolina Press, 1990. Examines investment schemes of the 1920’s, with a particular emphasis on oil promoters. Provides an interesting psychological perspective on the Jazz Age and presents theories on why so many investors were duped. Includes glossary. -
Russell, Francis. “Bubble, Bubble—No Toil, No Trouble.” American Heritage 24 (February, 1973): 74-80. Provides a historian’s perspective on Ponzi’s impact on Boston. Examines both political and social tensions related to Ponzi’s rise and fall. Includes several photographs and political cartoons reprinted from the Boston Post. -
Shapiro, Susan P. Wayward Capitalists: Target of the Securities and Exchange Commission. New Haven, Conn.: Yale University Press, 1984. Scholarly work provides detailed information on how the SEC detects securities violations and prosecutes offenders. Thoroughly documented, with excellent references and footnotes. -
Zuckoff, Mitchell. Ponzi’s Scheme: The True Story of a Financial Legend. New York: Random House, 2005. Sympathetic portrait of Ponzi conveys his likable persona and the context of the time and place within which he carried out his greatest fraud. Includes select bibliography and index.
Federal Trade Commission Is Organized
Black Sox Scandal
Scandals of the Harding Administration
Teapot Dome Scandal
Police Apprehend Bonnie and Clyde
Securities and Exchange Commission Is Established