Ponzi schemes are white-collar investment frauds. These types of crimes are often detailed in the media (for example, the recent Bernie Madoff case). The easiest example is when an investment supervisor takes cash from new investors to compensate older investors. This is done instead of compensating older investment returns with profits that were truly earned by the company. This creates a vicious cycle of money flow.
The fraud is named after Charles Ponzi of Boston, Massachusetts. In the early 1900s, Ponzi initiated a system that guaranteed investors a 50 percent profit on investments. Ponzi paid back initial investors; however, the overall plan fell apart when he was unable to repay subsequent backers.
Many investors fail to discover that they have been a victim of a scheme because they continue to receive returns. This type of federal criminal activity often involves several players. However, in the end, the plan breaks down when the main operator flees with all of money collected from investors or when no more new investors can be found to perpetuate the continued payment of fake dividends.