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Bernie Madoff’s guilty plea today makes him the latest confirmed proprietor of a ponzi scheme, adding him to the long list dating back to the original namesake Charles Ponzi. Charles himself wasn’t the first to use the technique, but his was the first large scale use in the US and so his name is infamously linked to the scheme. So what exactly is a ponzi scheme and how do they work?

A ponzi scheme pays returns to investors either from their own money or the money of other investors rather than from profitable investments. High returns in the scheme typically make early investors more likely to reinvest their returns and also attracts new investors. As the scheme grows it becomes more and more difficult to maintain, since an increasing number of new investments or reinvestments are required to keep it afloat. This is similar to a pyramid scheme except that ponzi schemes tend to have a flat hierarchy where the fraudster deals directly with victims and is the only one to profit.

Most ponzi schemes have at their core a seemingly plausible business or investment idea. Investors are sold on this idea and believe that this is how their money will be invested. When profits and supporting documentation start rolling in the credibility of the business idea is further enhanced, which probably inspires them to reinvest their returns or invest even more.

Suppose a schemer promised 10 people a return of 25% on their $1000 investment within 30 days. After the 30 days they could tell each of those people that their return had been achieved. Given the option of having their money (with profit) returned, or reinvested most would probably choose the reinvestment option. Some might even want to invest more or bring in friends to get in on such a good deal. Even if half want to get out, the schemer could easily pay them $1,250 each ($6,250 total) from the $10,000 they had originally received. Since the claimed returns are so great and investors are shown the appearance of success, payouts would likely remain very low. As long as payouts remain lower than the money taken in, the scheme is able to continue.

Bernard Madoff Guilty Of Ponzi Scheme, SEC Charges Two Others

After Bernie Madoff is pleaded guilty in a Ponzi Scheme and ordered to jail SEC has charged two others from California in a multi-million dollar Ponzi scheme type of investment fraud.

The Securities and Exchange Commission today charged Northern California residents Anthony Vassallo and Kenneth Kenitzer for orchestrating a multi-million dollar investment fraud. Vassallo agreed to a court order freezing his assets. The SEC is seeking an emergency court order to also freeze the assets of Vassallo’s company, Equity Investment Management and Trading, Inc. (EIMT).

According to the SEC’s complaint, Vassallo and Kenitzer raised more than $40 million from about 150 investors from approximately May 2004 to November 2008. Vassallo told investors, many of whom he met through his church, that he had a proprietary computer software program that allowed him to buy and sell stock options and generate returns of 3.5 percent per month with little risk of loss. The SEC alleges that Vassallo and Kenitzer instead used investors’ money for unauthorized purposes, including a variety of other schemes never disclosed to investors.

“Today’s action reaffirms that the SEC will take immediate steps to preserve assets for investors victimized in fraudulent investment schemes,” said Marc Fagel, Director of the SEC’s San Francisco Regional Office. “The defendants’ deception went so far as fabricating computer ’screen shots’ for investors that purported to show more than $50 million in securities holdings, when in fact they had completely emptied the brokerage accounts.”

The SEC’s complaint, filed in federal court in Sacramento, alleges that Vassallo told investors that their money was being invested in securities pursuant to a proprietary trading strategy that promised high returns with minimal risk. From September 2007 through approximately November 2008, Kenitzer, who participated in EIMT’s day-to-day operations, posted false trading results on the company’s Web site and distributed phony investment reports to investors that led them to believe EIMT was achieving consistent, positive returns. According to the SEC’s complaint, EIMT actually had not conducted any stock trades since at least September 2007, when its brokerage firm terminated Vassallo’s trading privileges. The SEC alleges that Vassallo and Kenitzer kept the scheme going by using money raised from new investors to pay earlier investors, a classic hallmark of a Ponzi scheme.

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Investor David Booth, who credits his success to the “life-changing” experience studying at the University of Chicago Graduate School of Business, donated $300 million to the school, the largest gift in the university’s history.

The business school, which will be renamed in honor of Booth, may use the funds for any purpose, such as attracting new faculty and expanding its campuses overseas, the university said yesterday in a statement.

Booth, 52, is the chief executive officer of Dimensional Fund Advisors Inc., with $140 billion under management, according to the investment company’s Web site. He received a master’s degree in business administration from Chicago in 1971. He said the theories he learned from Eugene Fama, a finance professor at the school, inspired him to start his Santa Monica, California- based company in 1981, and have been instrumental in its success.

“It would be hard to find anyone who benefited more from a University of Chicago education and from the faculty at Chicago than I have,” Booth said in the university’s statement reporting the gift. “The school is already in a strong position. This gift is intended to help it keep moving forward.”

The University of Chicago, like other universities, is concerned the current financial crisis may hurt its endowment by lowering returns and deterring donors, said Steve Kloehn, a spokesman for the school, in a telephone interview.

Topping Rockefeller

Booth’s gift is three times as large as the $100 million that retired banker David M. Rockefeller Sr. gave to Harvard University in Cambridge, Massachusetts, in April to finance studies abroad and advance the arts, and more than twice the record $125 million that the Swiss philanthropist Hansjoerg Wyss gave Harvard last month to fund a bioengineering institute. It is the largest gift to any business school, Kloehn said.

Other major gifts to universities from individual donors include $400 million in 2007 from John W. Kluge, former chairman of Metromedia International Group Inc., to Columbia University and $350 million from International Data Group Inc. founder Patrick J. and Lore Harp McGovern to the Massachusetts Institute of Technology in 2000 to fund research on the human brain.

The University of Chicago business school’s past and current students and faculty have won 25 Nobel Memorial Prizes in economics led by the late Milton Friedman, the late Friedrich Hayek, and Paul Samuelson.

`Life-Changing’

“The very first course I took at the University of Chicago was taught by Eugene Fama and it was a life-changing event for me,” Booth said in the statement. “I remember Professor Fama standing up the first day of class and saying `This is the most practical course you will ever take,’ and it turned out to be true. We built Dimensional Fund Advisors around his set of ideas.”

Fama, 69, who has been referred to as the father of modern finance, is best known for his theory that capital markets are so efficient they embody the collective wisdom of all buyers and sellers, according to the university. In 1980, Fama accepted Booth’s invitation to put his theories to work as a member of the management committee of Dimensional Fund Advisors. He thanked Booth today for what he called an incredible gift.

The company, founded in a brownstone in Brooklyn, promotes itself as investing in “the science of capital markets” rather than speculation about how the market will perform, according to the Web site.

Booth is a trustee at the University of Chicago. He is also a trustee of the endowment association that raises funds for the University of Kansas in Lawrence, where he obtained his undergraduate degree.

The University of Chicago dates from 1892, when it was founded by John D. Rockefeller, who was then embroiled in an intense public debate over monopolistic business practices at Standard Oil Co.

Friedman Looms Large

For 30 years, starting in 1946, the university’s economics department was dominated by Friedman. He won a Nobel Memorial Prize in economics for showing, among other things, that consumers decide to save money on the basis of expectations for what they’ll earn over their entire lifetime, not on short-term fluctuations that may be prompted by government attempts to fine- tune aggregate demand. He also advised such free-market, limited government advocates as Barry Goldwater, Ronald Reagan, and Margaret Thatcher.

After Friedman left for the Hoover Institution at Stanford University in 1977, the limelight shifted to such finance professors as Fama.

Booth’s donation isn’t related to the proposed Milton Friedman Institute for the study of economics, the subject of a faculty controversy. While advocates of the institute wish to honor Friedman, critics say the institute would represent a misuse of university funds and may fail to embrace a range of economic ideas.

Friedman’s influence still made itself felt during a ceremony today announcing the gift.

“Together, we will do great things for the world’s market- oriented economies,” Ted Snyder, the business school’s dean, said today while thanking Booth.

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FIVE top executives at RBS and HBOS lost their jobs yesterday.

Royal Bank of Scotland chief executive Sir Fred Goodwin, chairman Sir Tom McKillop and investment banking boss Johnny Cameron are all going.

And the chairman and chief executive of HBOS, Lord Stevenson and Andy Hornby, confirmed they would leave after Lloyds TSB’s takeover.

Both HBOS men waived their right to a year’s compensation pay — around £940,000 for Mr Hornby, 41, and £708,000 for Lord Stevenson, 63.

But Mr Hornby was paid a £450,000 bonus last year.

Sir Fred, a 50-year-old Scot, is waiving his entitlement to a year’s salary of £1.29million.

The engineer’s son from Paisley got a £2.86million bonus last year.

He said: “I feel sad more than anything. I’ve had the support and friendship of a lot of people.”

Sir Fred took the bank from being a little-known UK player to the world’s sixth-biggest earlier this year.

His successor will be Manchester-born Stephen Hester, of British Land property company.

For the first time in its 281-year history, RBS will not have a Scottish chairman or chief executive.

All five axed bosses are expected to receive generous pensions.

Cameron, 53, earned £988,000 last year, plus a £1.9million bonus. Sir Tom, 65, was paid £750,000.

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