RACY CASES –39
V Pattabhi Ram and Vivek Kaul
Wafers had a problem with her Accounting Standards. She decided to surf the net to find a solution. And lo, she ran into the arresting story of Charles Ponzi. The dapper Italian immigrant had landed in the US in 1903 and in the years ahead had become enormously famous for the wrong reasons!
The story ran thus: Ponzi launched an export magazine and, among others, invited a person in Spain to subscribe to it. The subscriber sent Ponzi an international postal reply coupon. This coupon could be exchanged at the American post office for the American stamps that were needed to dispatch the magazine to Spain. The coupon in Spain cost the equivalent of one American cent. In America when Ponzi exchanged the coupon, he got six cents worth of stamps! Sensing a huge arbitrage opportunity, Ponzi decided to float his scheme in 1919.
The scheme promised to double investors’ money in 90 days flat. Little wonder, money started pouring in. Ponzi’s plan was to raise American dollars, convert them into foreign currency, buy international postal reply coupons from various countries including Spain, convert them into American stamps and sell them for a windfall. So far so good. But on 10th Aug 1920, Ponzi defaulted and most investors lost their shirt. Investigations revealed that only two stamps had been purchased! The early investors had profited -– but that was because money brought in by the new investors was used to pay off the earlier investors!
Wafers was very excited when the following day she met China at the coffee pub. She knew that for once she would score over him. “Have you heard of Ponzi?” she asked. “You mean Charles Ponzi?” replied China, stumping Wafers for the nth time. “Does this guy know everything?” wondered Wafers. China interrupted her thoughts saying, “You see, there are many Ponzi schemes in India. Actually, there is one which is now circulating that gives you an opportunity to make Rs 149 lakh on an investment of Rs 10,000! Here’s how”.
“You become a member of ‘the club’ by buying a membership form for Rs 10,000. To recover this Rs 10,000 you canvass to enroll four new members to the club. Let us call them Patron A, Patron B, Patron C and Patron D. Each of the patrons will buy a club membership form for Rs 10,000. The Rs. 10,000 is paid through a demand draft in the following manner. Rs 2,500 to the person who canvassed to enroll their patron member. Rs 750 to the club. Rs 500, Rs 750, Rs 1000, Rs 1250 and Rs 3250 to the person whose name appears in Rung 5, Rung 4, Rung 3, Rung 2 and Rung 1 of the club membership form respectively”. The smart CA trainee that she was, Wafers took in all the numbers in one go. She wasn’t foxed.
China continued, “The moment you enroll the four Patrons you have recovered your Rs 10,000. Patron A (so will Patrons B, C and D), to recover his Rs 10,000, will canvass to enroll four new members. Let’s call these new members as Layer 1 members. When these Layer I members (there will be 4 X 4 = 16 of them) receive the club enrollment form they will make the payment in the manner indicated above. Your name will appear in Rung 5 in their form. That is, they pay Rs 2,500 to Patron A (Patron B, C or D as the case may be), Rs. 750 to the club, Rs 500 to you and the other indicated sums to the persons whose name appear in Rungs 4,3,2, and 1 of the form. When Layer 1 members canvass to enroll four new members each, it generates 64 Layer 2 members. Your name moves up to Rung 4 in the club membership form which the Layer 2 members receive. And you will receive Rs 750 from each of the Layer 2 members”.
Quick on the uptake, Wafers realized what was on. She said, “Layer 2 members now canvass to enroll 4 new members. This generates a total of 256 (64 X 4) Layer 3 members. When Layer 3 members buy the club application form, my name would have moved up to Rung 3. And I would receive Rs 1,000 from each of these members. Layer 3 members then enroll four new members each and thus generate 1,024 new members. And when these 1,024 Layer 4 members buy the forms my name moves up to Rung 2. I receive Rs 1,250 from each of them. Similarly, when the Layer 4 members canvass four new members each, it generates 4,096 Layer 5 members and my name moves atop the rung and I collect a cool amount Rs 3250 from each of these Layer 5 members”.
China was impressed. “Bravo, Wafers”, he said. And added, “After this you cease to be a member. If all the members, from Patron to the Layer 5 members, could enroll 4 new members you stand to pick up a cool Rs 149 lakh. This is how it goes. From Patrons (4 @ Rs 2,500 each) Rs. 10,000/-. From Layer 1 members (16 @ Rs 500 each) Rs. 8,000 /-. From Layer 2 members (64 @ Rs 750 each) Rs. 48,000/-. From Layer 3 members (256 @ Rs 1,000 each) Rs. 256,000/-. From Layer 4 members (1024 @ Rs 1,250 each) Rs. 12,80,000. From Layer 5 members (4,096 @ Rs 3,250 each) 133,12,000/- Total Rs. 149,14,000”.
Suddenly Wafers looked suitably confused. “Look, I do not lose money as long as I enroll just 4 new members. Isn’t that right? So what’s Ponzi in the scheme?” she asked. “Well, that’s the Ponzi,” said China, tongue firmly in cheek. “As the number of members snowball, those who join late may find it increasingly difficult to collect 4 new members and could hence lose out. Remember close to 90 per cent of your Rs.149 lakh is brought in by the Layer 5 members. Or, if the club, which makes nearly Rs. 41 lakh on every full circle closes shop, all those who are yet to enroll their quota of new members lose out”.
It hit Wafers like a lightening. “So, the success of Ponzi schemes lie in the fact that they appear to be a genuine investment opportunity?” she asked. China replied, “Yes. People running Ponzi schemes understand human psychology. They know that the public wants to live up to the Joneses. Because their neighbour made money on a Ponzi these guys too want to. When the rest of the world is going mad, the investors must imitate them to some extent!” For once, Wafers matched China word for word. “There are other reasons as well, I suppose. I think everyone wants to become rich. The rich want to become richer. Even the richest people are at Level I of Maslow’s hierarchy!” China remarked, “First there is greed. Then there is the individual’s belief that no one can defraud him. Over confidence and over optimism together fuel Ponzi Schemes”.
Wafers had the last word. “A Ponzi scheme can keep running only till the money entering the scheme is more than the money leaving it. At some point the bubble bursts. Then the money flow dries up. And presto the scheme folds up”.
The captain at the table overhearing the conversation said, “So from 1921 to date investors have elected to be robbed! Qayamat se qayamat thak”.
First published in the HBL