Dipankar Jakharia
“Honey, our neighbor Singh family bought a new sedan car” said my wife.
“They are also going for a trip to Europe” she added.
Feeling happy at Singh family’s good fortune, I felt fortunate that my wife didn’t start: when are you going to……????
Wife further said that Mrs. Singh had talked about an investment scheme in an offshore Gold company that guarantees a return of 20% per month.
I had almost forgotten about the whole story for a few days till I saw a nice new maroon-coloured sedan polished and parked in Mr. Singh’s porch. That evening Mr. & Mrs. Singh paid us a visit, where they enthusiastically discussed about their forth-coming trip to Europe.
“You know Mr. Jakharia, last two months had been a good month for us” said Mr. Singh.
“I have been introduced to an elite club, an exclusive one by my friend. And I am expected to induct six new members. I want to offer you a membership, of our elite club” said Mr. Singh again.
In the conversation, they told us how they had enrolled, invested and won this trip from the company that had a multi-level marketing system. Before leaving,
they left us with few brochures of the particular scheme and encouraged us to enroll in the scheme of the said company.
“Try investing with a small amount in the beginning, and test its credentials” said Mr. Singh, confidently before leaving.
That evening I decided to go through their brochures along with my “excited wife”. The brochures promised a return of 20% a month with the return of the capital invested.
“A return of 20% a month seemed quite a good return”, I thought.
“How much would that amount be, if I reinvested my interest and capital every month for a year”, I wondered?
I brought out my pen and paper and the calculations left me astounded - I would be getting an annual return of 891%! I start calculating again: If I invest one lakh Rupees, in eight years time I would be the richest man in the world, surpassing Mr. Bill Gates.
No point for guessing that from this point on, I became suspicious about this whole scheme. I have known Mr. and Mrs. Sing for the last fifteen years. They are simple and honest people who would never try to dupe us. I was perplexed.
That same night my brother-in-law, who happens to be a cop, called me up. Out of curiosity, I asked him if he has heard about this scheme.
“Beware brother-in-law, these are fraudulent schemes” said my super cop.
These fraudulent schemes run their businesses by paying profits to its investors from their own money or money paid by subsequent investors or down-lines or leg. The schemes usually tempt new investors by offering a profit that no other investments can guarantee, in the form of short-time returns that are either abnormally high or unusually consistent.
The continuation of the returns that a fraudulent scheme promises and sometime pays requires an ever-increasing flow of money from new investors to keep the scheme going. The system is destined to collapse because the earnings of the company are lesser than the payments given to the investors. As more people become involved, it increases the chance of attracting the attention of the authorities. So from any way you look at it, the system will eventually end under its own weight.
The Northeastern States of India, are no strangers to these types of schemes. Here it is common to come across advertisements that promise extraordinary returns on investments — for example, 20 percent on a 30-day contract! A good example is the recent case, where many innocent people were duped by a fraud who promised to double their money within a month. The main objective of these frauds is usually to deceive common people who have no in-depth knowledge of finance or financial lingo with verbal constructions that sounds impressive or overwhelming but are essentially meaningless. The promoter will then proceed to sell stakes to investors — who are essentially victims of a confidence trick by taking advantage of a lack of investor knowledge or competence. How and where the profit or return will be gained is always kept under secrecy to ensure a competitive edge; it may also be used to hide the true nature of the scheme.
Initially without the benefit of proper information or objective about the investment, only a few investors are tempted, usually for small sums say Rs.1000. Thirty days later, the investor receives the original capital plus the 20 percent return (Rs.1200). At this point, the investor will have more incentive to put in additional money and, as word begins to spread; other investors grab the “opportunity” to participate, leading to a mad rush to make quick money from the promise of extraordinary profit. However, in the real sense the “return” to the early investors are paid out of the capital investments of the new entrants and not out of profits by investing in genuine business.
One reason that the scheme initially works so well is that early investors (the early birds), those who actually were paid the large returns, commonly reinvest their money in the same scheme (it does, after all, pay out much better than any alternative investment). Thus, those running the scheme do not actually have to pay out very much (net); they simply have to send statements to investors showing them how much they earned by keeping the money, maintaining the deception that the scheme is a fund with high returns.
Promoters also try to minimize withdrawals by offering new plans to investors, often where money is frozen for a longer period, in exchange for higher returns. The promoters see new cash flows as investors are told that they cannot transfer money from the first plan to the second. If a few investors do wish to withdraw their money in accordance with the terms allowed, the requests are usually processed promptly, which gives the illusion to all other investors that the fund is solvent.
The catch is that at some point one of these things will happen:
1. The promoter will vanish, taking all the remaining investment money (minus the payouts to investors) with him or her.
2. Since the scheme requires a continual stream of investments to fund higher returns, once investment slows down, the scheme will begin to collapse under its own weight as the promoter starts having problems paying the promised returns (the higher the returns, the greater the risk of the fraudulent scheme collapsing). Such liquidity crises often trigger panic, as more people start asking for their money.
To make matters worse, I came across Mr. Singh a few weeks later looking distraught. He broke down in front of me and told how the company had duped thousands of people and run off with their investments without fulfilling any of their glossy promises.
“You know Mr. Jakharia, the car and the Europe trip was nothing but a gimmick”, Mr. Singh somehow uttered. “It is to motivate investors to bring in more investors who were susceptible.”
“You were lucky not to have invested unlike some of my close relatives, friends and colleagues. Now I have to live in shame and guilt for the rest of my life for making them loose their hard earned money and also their life savings.”
Mr. Singh, without any doubt, has not only lost his money, but also his precious reputation and peace of mind on account of his gullibility and short-sightedness.
