In our last blog post, we looked at the white collar crime of investment fraud faced by the founders of the green energy company Mantria. However, the young Temple graduates behind the company are also facing other allegations of fraud, as well. Among those charges were claims that they ran a Ponzi Scheme to defraud investors.

Here's what a Ponzi Scheme is, and why it's illegal.

Mantria Founders Accused of Running a Ponzi Scheme

Two recent graduates from Temple University in Philadelphia created a green energy company called Mantria and claimed to be able to make green energy called “biochar” from trash. They could not follow up on those claims, though, because the technology to make “biochar” does not exist.

The focus of the subsequent criminal investigations was on how Mantria solicited investment money using those misleading claims. Those investigations led to guilty pleas on charges of investment fraud.

However, it was what Mantria did with some of the $54 million that they raised that led to other fraud charges, including the allegation that Mantria was just a Ponzi Scheme: Mantria used some of the money to pay off its first round of investors and strengthen its claim that other people should invest in the company.

How Ponzi Schemes Work

Ponzi Schemes are fraudulent investment “opportunities” that pay off early investors with the money provided by later investors.

All Ponzi Schemes rely on the same inherent structure: Someone creates the scheme by soliciting investment from a small handful of other, often innocent, people – the “first wave” of investors. The first wave of investors and the head of the scheme then solicit other investors. The money that comes from those other investors – the “second wave” – gets distributed to the first wave. Encouraged by the return they are seeing, both the first and second waves of investors seek out more people to give money to the head of the scheme. Subsequent waves of investments are used to distribute money to earlier waves or are kept by the head of the scheme.

This is why Ponzi Schemes are also known as pyramid schemes – when you diagram the structure of the investors, it looks like a pyramid.

Why Ponzi Schemes are Illegal

A Ponzi Scheme is one of the rare investment structures that is per se illegal – it cannot be formed in a non-fraudulent way. The reason it is always illegal is actually fairly straightforward: Because the only assets in a Ponzi Scheme are the funds from its investors, in the aggregate, the investors are guaranteed to lose. No matter how many waves of investors there are, there will never be more money in the scheme than the amount that has been invested in it.

This is why using subsequent investment money to distribute to earlier investors can quickly lead to fraud charges and allegations that you are running a Ponzi Scheme.

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