This column is on record as a purist regarding the term “ponzi scheme.”
The click-hungry media has come to use it to describe any of the growing numbers of financial frauds emerging in this over-securitized economy, and even many perfectly legal high-risk investments. But we like to keep its definition to the scams that work as old man Ponzi intended.
A true ponzi scheme involves:
- the sale of a security;
- the payment of dividends, interest, or some other distribution to the security holder, either in cash or in scrip, and;
- the misrepresentation to the security holder that the distribution was the proceeds of the business they invested in.
Without #3, it isn’t a true ponzi scheme. Plenty of cashflow-negative companies borrow money to pay dividends, or pay them out of cash on hand, because failing to pay them would hurt the equity value, but those aren’t ponzi schemes, because they aren’t representing that the dividend is a profit that doesn’t exist.
Richmond Hill, Ontario-based syndicated mortgage lender Fortress Real Developments, whose principles were charged last week with various securities-related fraud offenses, is flying close to the ponzi line in a way we’ve never before seen. This company put the fact that investors’ money may be used to pay off previous investors right in the investor literature.
