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The RunIn the summer of 1920, Charles Ponzi and his Boston-based postal coupon enterprise was the talk of the East Coast. Was he truly a financial wizard, or merely an accomplished swindler? The latter was eventually revealed to be true, but before his investment bubble burst, Charles Ponzi had collected $9,500,000 from 10,000 investors by selling promissory notes paying "fifty per cent. profit in forty-five days."
Ponzi claimed he was giving investors just a portion of the 400 per cent. profit he was earning through trade in postal reply coupons. As Ponzi paid the matured notes held by early investors, word of enormous profits spread through the community, whipping greedy and credulous investors into a frenzy. Investigation later revealed that there were no coupons or profits--earlier notes were paid at maturity from the proceeds of later ones. The simplicity and grand scale of his scheme linked Ponzi's name with a particular form of fraud. A swindle of this nature, once a "bubble," is now referred to as a "Ponzi scheme." While the postal coupon scheme earned Ponzi his place in history, it formed only the middle of what Justice Taft referred to as "the remarkable criminal financial career of Charles Ponzi" [Cunningham v. Brown, 265 U.S. 1,7 (1923)].
Immigrating from Italy in 1903, Ponzi went on to Canada, was convicted of forgery, and served a prison term there. Within ten days of his release, he was arrested for smuggling aliens into the United States and served a term in an Atlanta Prison. He went on to develop his namesake postal coupon scheme, earning a federal prison term and larceny charges in the state of Massachusetts. Released from federal prison while his state larceny conviction appeal was pending, he went to Florida, running afoul of authorities there with a real estate pyramid scheme. After losing his Massachusetts Larceny appeal, he fled the country on a ship bound for Italy. When the ship docked in New Orleans, Ponzi was lured ashore, illegally kidnapped by a Texas deputy sheriff, and taken to the Lone Star state. Extradited from Texas to Massachusetts, Ponzi served out his term there and was deported to Italy. He later went to Brazil, dying in the charity ward of a Rio de Janeiro hospital in 1949, leaving an estate of $75 to cover funeral expenses.
The engine of Ponzi's postal coupon fraud was a simple accounting misclassification. Money paid to investors, described as income, was actually distribution of capital. One need not, however, invoke accounting terminology to describe the fraud. Bankruptcy Referee Olmstead observed: "It was another instance of robbing Peter to pay Paul, of which the past affords examples," and wryly described Ponzi's business as that of "Borrowing money from investors at usurious rates of interest" [In re Ponzi, 268 F. 997, 1000 (D. Mass 1920)]. Circuit Judge Anderson explained: "His scheme was simply the old fraud of paying the earlier comers out of the contributions of the later comers" [Lowell v. Brown, 280 F. 193, 196 (1922)].
Although the economics of such schemes are simple, contemporary swindlers conceal this fact with sophisticated marketing. Bankers, lawyers, and wealthy investors are routinely taken in by multi-million dollar Ponzis. While Ponzi was not as sophisticated as latter day practitioners, his skills were certainly commensurate with his contemporaries ["Sufficient unto the day is the evil thereof." Matthew 6:34]. Exuding a relaxed confidence before investors as he frantically scrambled behind the scenes for funds, Ponzi showed himself the peer of swindlers from all ages. Let us turn our attention, then, to the adventures of neither the first nor last perpetrator of a "Ponzi scheme," but certainly one of the most notable.
Charles Ponzi was born around 1882. The only account of his early years is this fanciful tale he spun for reporters during the peak of his notoriety:
My family was well to do in Italy and my education was the best. We had considerable money but were not extremely wealthy. However, we had plenty. I never had to do any work of any kind and felt that it was beneath me in my own country to engage in labor of any kind. So I kept at school at Parma Italy, and then went into the University of Rome.
I'll be frank with you. In my college days I was what you call over here a spendthrift. That is I had arrived at that precarious period in a young man's life when spending money seemed the most attractive thing on earth. Such a game is like a balloon--it went up all right, but sooner or later has got to come down.
To make a long story short, I felt that I must get to work, and not wanting to do so with all my acquaintances around me I decided to come to America. I did not have much money then, and came to this country right here to Boston, just like any immigrant and when I arrived my total wealth was $2.50. As I say, I landed in this country with $2.50 in cash and $1,000,000 in hopes, and those hopes never left me. I was always dreaming of the day I would get enough money on which I could make more money, because it is a cinch no man is going to make money unless he has got money to start on.
I saved a bit of money from the odd jobs and had the time of my life for a couple of weeks. Then my cash was gone. So into the big town of New York I went to find a job. Up at one of the big hotels they needed some waiters, and they even furnished me with the tuxedo service coat. Yep, I've carried tons of food on the old waiter, and with the small salary and tips I made enough to live. I went from one waiting job to another worked in various hotels, small restaurants, and did my dish washing stunt [sic] from necessity at times. I got tired of New York and began to travel, getting jobs all along the way.
Once, when I was in Florida, I got it into my head that I could make something painting signs. So I bought some cardboard and paint and started in. No, I never had the slightest experience, but I got away with it, satisfied folks, and made a little cash. And all the time I kept dreaming of the time I was going to do big things.
It was small jobs, and small jobs, up to the year 1917, when I headed for Boston. Once more, saw an advertisement in a Boston newspaper, answered it, and took a job with J. R. Poole, the merchandise broker. My salary was $25 a week.
And then I found my inspiration. She was Rose Guecco, daughter of a wholesale fruit merchant of Boston, and the fairest and most wonderful woman in the world. All I have done is because of Rose. She is not only my right arm, but my heart as well. We were married in February 1918. [N. Y. Times, July 29, 1920, at 15, col. 1]
Ponzi did neglect to mention a few items of interest from this period. When he first entered the United States in 1903, at the age of 21, he went straight into Canada. In 1909, Ponzi was convicted of forgery in events surrounding the collapse of the Montreal banking firm of Zrossi & Co., of which he was a member. For this he was sentenced to a three year term in the St. Vincent De Paul Penitentiary in Montreal. A man associated with Ponzi in the scandal, one Gianetti, committed suicide, and another, Antonio Salviati, jumped bail and was re-captured in August 1920 after Ponzi's postal coupon arrest.
Released from Canadian Prison after only twenty months because of good behavior, Ponzi entered the United States again on July 30, 1910, and within ten days of his release he violated immigration laws while bringing five Italians over the border from Canada. For this offense he served two years in Atlanta, Georgia during 1911 and 1912.
After his release from the Atlanta prison, he made his way to Boston and toiled in relative obscurity until he seized upon the postal reply coupon scheme and formed the Securities Exchange Company. He admitted to being arrested for some reason in Boston, at the time claiming it was his only brush with the law. He said the case was dismissed in municipal court, but refused to elaborate.
Although the most prominent swindler of that period, Ponzi had plenty of contemporaries:
Since the armistice Boston has been infested with agents seeking to interest small investors by promising big profits. High wages in industrial centres, anxiety of many to increase their incomes in keeping with the climbing cost of living, along with below-par quotations on Liberty Bonds, helped make New England a fertile field for those who promised quick and big returns.
In many cases these agents found their best argument in the assertion that while old banking houses made very small returns to their depositors, the banks themselves were able to make enormous profits by frequent turnovers of the money of their depositors. It was proposed by some agents that small investors share in these big profits by permitting their savings to be invested for them. [N. Y. Times, August. 16, 1920, at 4, col. 1.]
Ponzi adopted from contemporaries the notion of sharing enormous profits with investors, adding his own twist: trade in postal reply coupons. This "trick," the keystone of his swindle, was made more plausible with tales he spun about how he received the brilliant inspiration. On one occasion he said that in August of 1919, when he was considering issuing an export magazine:
I wrote a man in Spain regarding the proposed magazine and in reply received an international exchange coupon which I was to exchange for American postage stamps with which to send a copy of the publication. The coupon in Spain cost the equivalent of about one cent in American money, I got six cents in stamps for the coupon here. Then I investigated the rates of exchange in other countries. I tried it in a small way first. It worked. The first month $1,000 became $15,000. I began letting in my friends. First I accepted deposits on my note, payable in ninety days, for $150 for each $100 received. Though promised in ninety days I have been paying in forty-five days [N. Y. Times, July. 30, 1920, at 1, col. 7.].
This sketch lays out the essentials of the scheme, and may well be the clearest explanation of its reply coupon underpinnings.
On another occasion "He related how he had hired a small office, used his capital in various business schemes, and then, with an international reply coupon always in front of him on his desk, 'began to do some thinking.'"
Ponzi opened his postal coupon business in December of 1919. On the 26th, he filed a certificate with the city clerk describing himself as sole manager of "The Securities Exchange Company." In the beginning of the enterprise, Ponzi described himself as "everything from President to office boy." He related that on the second day of operation he explained his business to a visitor from the Chamber of Commerce, and the man believed Ponzi's enterprise could succeed. A postal inspector stopped by and expressed doubts about the legality of redeeming millions of coupons. Ponzi claimed this problem was solved by having the coupons redeemed overseas, outside of the federal government's jurisdiction.
At first Ponzi issued notes of different colors depending on the denomination, but beginning in March, 1920, all notes were yellow with the dollar amount written in. Later problems with forgers raising the face value of notes showed the advantage of the multi-color scheme. The notes were negotiable and written in the following form:
The Securities Exchange Company, for and in consideration of the sum of exactly $1,000 of which receipt is hereby acknowledged, agree to pay to the order of ___________, upon presentation of this voucher at ninety days from date, the sum of exactly $1,500 at the company's office, 27 School Street, room 227, or at any bank.
The Securities Exchange Company,
Per Charles Ponzi.
Ponzi started his business essentially penniless, and in December of 1920, he borrowed $200 from Joseph Daniels, a furniture dealer. Ponzi used most of the money to purchase furniture from Mr. Daniels, keeping the rest for spending money. Ponzi paid the note at maturity, but Mr. Daniels later claimed Ponzi had also agreed to share half of all future profits in his business as part of the deal.
Bankruptcy Referee Olmstead provides a glimpse of Ponzi's operations during this early period:
Up to April, 1920, Mr. Ponzi seems to have kept the accounts himself by a system of cards. In April he employed a Miss Meli [Her name is normally reported as Miss Lucy Mell, and I believe her full name was actually Lucy Martelli], and later on, as the business grew to a great volume, there were employed about 30 in the office. He also had an office on Hanover street, next to the Daniels & Wilson Furniture Company, on the corner of Washington and Walter streets. Miss Meli was his confidential clerk, and seems to have had pretty general charge of the business. [In re Ponzi, 268 F. 997, 998 (1920)]
From these modest beginnings the business expanded, and on May 28, Ponzi purchased, for $35,000, a home in the banker's colony of historic Lexington. This home, described as pretentious by envious reporters, was to become a tourist attraction when Ponzi's activities captured the public imagination later that Summer.
Mr. Daniels claimed that at the end of June, after hearing about Ponzi's success and "swell house," he visited Ponzi seeking a share in his profits. After Ponzi refused, Daniels retained Mr. Isaac Harris to pursue the matter, which, much to Ponzi's discomfort, he did with considerable success.
Although Ponzi never realized any profits from dealings in postal reply coupons, much of the debate prior to his 1920 arrest involved questions about whether it was possible to make enormous profits trading in such coupons, and even if it were possible, whether he was actually doing so. Let us then divert a moment and consider the nature of the obscure postal reply coupon.
On May 26, 1906, the United States and over 60 other countries assembled in Rome, Italy, and revised the Universal Postal Convention of June 15, 1897, which provided for the administration of postal services among signatory countries.
Ponzi seized upon the mechanism provided by Article 11(2) of the revised Convention:
Reply coupons can be exchanged between the countries of which the Administrations have agreed to participate in such exchange. The minimum selling price of a reply coupon is 28 centimes, or the equivalent of this sum in the money of the country which sells it.
This coupon is exchangeable in all countries parties to the arrangement for a postage stamp of 25 centimes or the equivalent of that sum in the money of the country where the exchange is requested. The Detailed Regulations contemplated in Article 20 of the Convention determine the conditions of this exchange, and in particular the intervention of the International Bureau in manufacturing, supplying, and accounting for the coupons. [35 Stat. 1639 (1907-1909)]
This provision, with a built-in 3 centime loss on the sale of each coupon (a centime being a hundredth of a franc), clearly did not contemplate profitable arbitrage through these coupons. The purpose of the reply coupon was simply to facilitate the prepayment of return postage when sending mail to another country.
The recipient of a reply coupon would exchange the coupon for the appropriate stamp in the recipient's country, such stamp not being available in the sender's country. The value of the coupon was intended to be constant throughout all countries forming the Postal Union, and regulations defined the rate of exchange between each countries' currency and postal reply coupons.
Because of economic dislocations caused by World War I, however, some currencies became devalued relative to others, and the postal regulations had not been updated to reflect this. For instance, Ponzi claimed "The same amount of American money will buy more value in coupons in Bulgaria in than in the United States."
There did seem to be potential for profit here, and although the aggregate volume of coupon redemption did not indicate abnormal trading activity, postal authorities took steps to prevent speculation. On July 2, 1920 the Post Office Department issued regulations limiting redemption of coupons to ten at one time. The Post Office Department announced new conversion rates on July 28, to be effective August 15. Prior to this, the rates had not been changed since before the war. With characteristic government candor, postal officials denied that the changes were the result of concerns about speculation in reply coupons. On August 9, the Post Office Department again denied that the rate changes resulted from Ponzi's activities. Acting Third Assistant Postmaster General Barrows noted foreign countries had also taken steps to prevent speculation. Of course, these measures did not hamper Ponzi's operations, as he was not trading in coupons anyway.
The flaw in a coupon trading scheme as Ponzi proposed was that while an individual stamp transaction may indeed yield a 400 per cent. profit, the amount of that profit would be minuscule in absolute terms. In order to earn the millions of dollars Ponzi claimed, astronomical quantities of coupons would have to be handled. One can imagine hordes of Ponzi agents, pushing wheelbarrows full of coupons to post offices, unloading them with shovels or pitchforks.
Intuitively, we can see that the transaction costs of purchasing, transporting and redeeming the coupons would exceed any profits from sale, and it is not inconceivable that Ponzi actually made some trades early on and discovered this. Ponzi recognized that the problems of handling large volumes of coupons was a matter of concern to investors and authorities, incorporating this into the mystique of his scheme: "My secret is 'How do I cash the coupons?' That is what I do not tell."
Because the coupons were merely a cover, alluding to a mysterious mechanism worked fine. But when his notes started bringing in wheelbarrow-sized quantities of cash, he must have found he had a similar problem. Shifting millions of dollars from later investors to earlier ones required, or at least suggested, the mundane administrative services provided by traditional banks. Ponzi turned to an institution with ethical standards compatible to his own, the Hanover Trust Company.
On May 20, 1920, Ponzi opened a deposit account with the Hanover Trust Company. The bank was to become the financial hub of his multi-state network, and would figure significantly in his demise. He would likewise figure significantly in Hanover's simultaneous demise.
The use of banking services in his enterprise brought Ponzi within the purview of yet another law enforcement authority, Joseph C. Allen, the Massachusetts Commissioner of Banks. While Ponzi sparred publicly with federal and state prosecutors, the behind-the-scenes drama involving the Hanover Trust Company and the Commissioner of Banks proved decisive in Ponzi's demise. The Commissioner of Banks took a timely interest in Ponzi's reply coupon business:
In July, 1920, the operations of Charles Ponzi had reached extensive proportions and were widely advertised. The Commissioner desired to make an inquiry in the nature and conduct of his business, but was advised by the Attorney-General that under the law he had no right to make such examination.
On July 15, 1920, the Hanover Trust Company notified the Commissioner that in compliance with the law relating thereto it had increased its capital stock from $200,000 to $400,000, and its surplus from $50,000 to $100,000. Learning that Ponzi had established banking connections with the Hanover Trust Company, and having reason to believe that he had bought stock in the corporation, the Commissioner sought to determine to what extent, if any, the bank had become involved by Ponzi's relations to or transactions with the bank.
He learned, as a result, that Ponzi had acquired some $150,000 par value of the new stock of the trust company" [Annual Report of the Massachusetts Commissioner of Banks (1920) at vii].
Ponzi had purchased 38 percent of the bank's stock. William S. McNary, treasurer of the institution, later made the self-serving claim that he had prevented Ponzi from acquiring a controlling interest. Absent Ponzi's controlling interest, the bank nonetheless became an instrument of his criminal enterprise. Justice Rugg, writing for the Massachusetts Supreme Court, recounted:
As early as the first part of June, 1920, the managing officers of the trust company knew that Ponzi's deposits in that bank, carried under different names, consisted of sums which he had received from purchasers of his notes. They also knew that the face of said notes represented the amount which had been paid therefore increased by 50 per cent. of said amount, that such notes were payable in 90 days from date, and that [Ponzi] was making it a practice to pay them in full in 45 days from their date. [Ponzi's] account with the trust company indicated that he was not employing the money received from the enterprise, but was using it, without interest, for the purpose of paying his notes as or before they matured, and that such was the fact was, or should have been, known to the officials of the trust company. [Cunningham v. Comm'r of Banks, 144 N.E. 447 at 450, 451 (Mass. 1924)].
Knowing of Ponzi's fraud and yet desirous of maintaining a profitable relationship, bank officers sought to protect the bank from possible Ponzi overdrafts in two ways:
On July 12, 1920, at the request of a vice president and with the knowledge of the other officers of the trust company, [Ponzi] signed an agreement under seal authorizing the trust company at any time to declare any note or notes, upon which his name appeared, to be due and payable without demand and to charge the same to his account under whatever name carried.
On July 22, 1920, in return for valid checks of [Ponzi] aggregating that amount, the trust company issued a certificate of deposit payable to his order 30 days after notice in writing for the sum of $1,500,000. [Cunningham v. Comm'r of Banks, 144 N.E. 447 at 451 (Mass. 1924)].
When the end came, these agreements did nothing to protect the bank, as it collapsed precisely forty-eight hours after Ponzi's first overdraft. Following his arrest, the $1,500,000 certificate of deposit turned out to be Ponzi's most significant asset, and his receivers in bankruptcy were able to recover some of it for the benefit of creditors. The financial underpinnings of the trust company were only slightly more sound than Ponzi's, its officers only slightly more prudent. When Ponzi's affairs became desperate, bank officers would violate both the law and the direct order of the Commissioner of Banks in assisting Ponzi.