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Tips on how to avoid Ponzi and pyramid schemes

Feb. 12, 2013 @ 12:00 AM

The Kentucky Department of Financial Institutions has released the information on how to avoid Ponzi and pyramid schemes.

A Ponzi scheme involves a ploy where earlier investors are paid with funds given by subsequent investors, a release from the agency said. Often in this scam, the underlying investment is bogus. The con artist may pay out some money to the longer-term investors as "returns," but it is often simply some of the money from new investors -- the rest of the money goes to the Ponzi scheme leader rather than to any investment.

A pyramid scheme works in a similar way, except that it relies on recruitment, the release said. New recruits pay the person who recruited them, and they in turn must share the proceeds with those at the top of the pyramid structure.

Here are some tips to avoid the schemes:

Beware of the promise of unrealistic returns. Any legitimate investment involves risk. "Guarantees" and promises that sound "too good to be true" should be considered a red flag.

Diversify -- everything. Consider diversifying not only your assets but also your money managers, accounts and financial institutions. Spreading your money around will limit your exposure to the financial problems of any one institution.

Don't rely on reputation or word of mouth alone -- understand your investment. Con artists are experts at building networks of trust, making investors think they are getting an "inside" track on a hot investment.

Verify the investment details. Ask questions about the investments and the sellers, and get clear and direct answers before you invest. If you don't understand an investment, don't invest.

Check if the company's financial statements are audited. Audited financial statements have been reviewed for accuracy relative to the company following generally accepted accounting principles.

Report fraud. If you're a victim of a Ponzi or pyramid scheme or you suspect fraud, contact authories. It may help prevent others from being victimized by the same scam.