Ponzi did not invent the pyramid scheme, but his name will forever be associated with it.

Ponzi Emigrates to North America Flat Broke

Charles Ponzi arrived in America with two dollars and fifty cents in his pocket, having gambled away the rest of his life savings playing cards during the boat trip. In Boston, he took a job at a restaurant, initially as a dishwasher and then, after he had learned to speak English, as a waiter. He was fired after being caught short-changing customers.

In 1907, Ponzi moved to Montreal, Canada, and took a job at a bank that catered to other Italian immigrants. Starting out as an assistant teller, he worked his way up to bank manager. In that position, he discovered that the bank was in serious financial trouble. Its owner promised high interest rates on savings accounts, but was funding the interest payments with money from new accounts. The bank’s owner packed up and fled to Mexico, taking a portion of the bank’s money with him.

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Of course, the bank folded leaving Ponzi without a pay check. For some reason, he went to the office of one of the bank’s depositors. When he found it empty, it dawned on Ponzi that he could still get a slice of the pie. Locating the man’s checks, he simply wrote one to himself. It was not a particularly smart move, and Ponzi wound up doing 3 years in a prison near Montreal.

When once again he became a free man, his emancipation would not last long. He became involved in a scheme to smuggle illegal Italian immigrants into the United States, was caught, arrested, and sentenced to two years in an Atlanta prison.

Ponzi Returns to Boston, and Stumbles on to the Con that Would Immortalize Him

Ponzi took a wife in Boston, but was still searching for a scheme that would make him rich. He hit on the idea of publishing a list of business advertisements, similar to the Yellow Pages. To his chagrin, not enough businesses were interested to make the venture profitable. Then he received a mail inquiry about the listing from a company in Spain. The letter did not pique his interest, but what was enclosed with it did. This was an international reply coupon (IRC), something he had never seen before.

An IRC was commonly included as a courtesy in international mail to which a reply was anticipated; it was redeemable at a post office for enough stamps to facilitate return correspondence. IRCs are still available today, but are used far less often. It was now 1919, and Ponzi knew that in the wake of World War I many European nations were experiencing rampant inflation, and this meant that IRCs issued by those nations were more valuable in the US. Using borrowed money, Ponzi had some of his Italian relatives purchase IRCs and send them to him.

He then started a business he called the Securities Exchange Company whose stated purpose was to engage in arbitrage. Arbitrage is the purchase of a commodity in one part of the world and the sale of it in a location where it has a greater value. This kind of business has never been illegal.

Yet when Ponzi tried to redeem the coupons for cash, he soon found this a difficult thing to do. It did not take him long to realize that the overhead for his venture would eat up the profits. Ponzi would not be deterred, though, so he started to engage in, well, a Ponzi scheme.

Ponzi Builds a Pyramid Khufu Would Have been Proud Of

Charles Ponzi did not invent the con that bears his name. Charles Dickens described such a scheme in his novel Little Dorrit published in 1857, decades before Ponzi was born. Brooklyn bookkeeper William F. Miller made a million dollars using a similar con back in 1899. It is doubtful that Ponzi read Dickens, but he may well have been inspired either by Williams or the owner of the bank he managed in Montreal. Whatever the case, Ponzi brashly announced that investors in his arbitrage plan would earn a 50% profit within 45 days, or 100% within 90 days. Nothing on Wall Street could match those numbers, so investors began lining up at Ponzi’s School Street office to get in on the deal.

The investors received the promised returns. What they did not know at the time was that the return on their investments was not funded by an IRC arbitrage, but by new investors, which is the identifying characteristic of the Ponzi, or pyramid, scheme. Ponzi became known as a financial wizard, the Warren Buffet of his time. It was not until later that the fact emerged that Ponzi had purchased only $30 of the international reply coupons. While the average investment was about $350 dollars, some people were mortgaging their homes to generate money to invest with the School Street wizard. Ponzi’s business snowballed and between February and July of 1920 he made millions.

Storm Clouds Move In

The word on the street was that such returns were ’impossible,’ but when investors got nervous Ponzi paid them off. After all, he was not only raking in cash from new investors but prior clients were re-investing their gains.

Then a Boston financial writer claimed Ponzi could not legally generate such returns. Ponzi sued the columnist for libel and won a verdict of $50,000. This was prior to the US Supreme Court’s decision in New York Times Co v Sullivan, 376 US 254 (1964) which drastically increased a plaintiff’s burden of proof in defamation cases against the press.

On July 24, 1920, a Boston Post writer authored a piece favorable to Ponzi, and this increased the number of his investors. It is estimated that at this juncture he was taking in about a quarter of a million dollars a day. He was spending it, too, on a house with air conditioning (rare in those days) and a heated swimming pool (not all that common today).

Ponzi’s scheme was about to come unglued. One of the reasons Bernard Madoff was able to keep his con going for so long is that he never explained how he was making his money. Ponzi had a cover story, and that would lead to his undoing.

Despite the Boston Post’s favorable piece on Ponzi, its publisher and city editor were skeptical. They began running a series of articles that asked some tough questions about the Securities Exchange Company. They also asked Clarence Barron, whose financial magazine bears his name, to look into Ponzi’s company. Barron found out that Ponzi was not investing in his own company, a big red flag. Barron also noted that to cover his investments, 160 million postal reply coupons would have to be in circulation, but that only 27,000 actually were. Following hard on the heels of Barron’s report, the US Postal Service added that no large transfers of IRCs between countries had taken place.

Ponzi Fights Back, Only to Accelerate His Downfall

This time, instead of retaining a lawyer. Ponzi hired a publicist, one William McMasters. Yet in a matter of weeks, McMasters threw Ponzi under the trolley. Though Ponzi told the publicist about the coupon arbitrage, McMasters found only a few of them at Ponzi’s School street office. He found no accounting system, but he did discover some incriminating documents. McMasters would later describe his client as a “financial idiot” who did not seem able to add.

McMasters sold his story and the documents to the Boston Post for $5,000. In his piece he claimed that Ponzi and his SEC were insolvent.

Ponzi wanted to continue doing business but the press pieces had exposed him as a charlatan. His office was raided, and he was soon facing indictments from both the federal government and the state of Massachusetts. His scheme had been short-lived, from December of 1919 to August, 1920, but during that time he had duped thousands of investors out of millions. Ponzi admitted to taking in $10 million, but some thought it may have been 15 or more.

On August 12, 1920, Ponzi was charged by the feds with 86 counts of mail fraud and was eventually sentenced to five years in a federal penitentiary. Following his release he was prosecuted by the state on 32 counts of larceny and received a 7-9 year sentence. Compared to the sentence Bernard Madoff received, which would take two lifetimes to work off, the Italian con man got off easy.

Swamp Land in Florida

A common aphorism on gullibility goes: ‘If you believe that, I’ve got some swamp land in Florida I’ll sell you.’ After being released from the state pen, Charles Ponzi did just that. He started a real estate company in Florida that sold small parcels of land as investment properties, sight unseen, promising investors a 20% return in 60 days. All of the parcels were swampy and some completely covered with water. In 1926 he was charged by the state of Florida with securities fraud and spent one year in prison.

Ponzi Returns to Italy

Charles Ponzi was deported and took a job in the finance section of Benito Mussolini’s government. What happened next is the subject of conflicting stories. Some claim Ponzi fled to Brazil, taking part of the Italian treasury with him. Others say Ponzi was sent there to do a job, but either way he wound up running the Italian commercial airline in Rio.

However, when World War II began Brazil sided with the allies and closed down the Italian airline business. Ponzi stayed in Brazil, occasionally taking a job as a translator, but never again having even a glimpse of the kind of wealth he enjoyed during the spring and early summer of 1920. He became infirm and passed away in the charity ward of a Rio hospital in 1949; his sole legacy was the application of his name to a confidence scheme.

As the Bernard Madoff scandal demonstrates, every generation has men or women who want to get wealthy by ripping other people off. It is wise to remember Charles Ponzi’s ultimate lesson: if something seems too good to be true then it most likely is.