Comparing Check Kiting and Ponzi Schemes
By Alycia Watt and Rachel Organist
Although check kiting and Ponzi schemes aren’t normally compared, we’re continuously looking for patterns and commonalities in our work--leading our CEO, Leah Wietholter to notice just how similar the two schemes actually are. While there are important differences in how the schemes are run, the core of the scheme remains the same. Both check kiting and Ponzi schemes ultimately involve an artificial inflation of the fraudster’s actual assets.
Check Kiting
Check kiting is a term that first came into use during the 1920s as the related practice of issuing bonds and IOUs with no collateral was known as “flying a kite.”
Check kiting is a systematic process where a person issues a check on an account with insufficient funds and then deposits the check into a different account under their control. This is usually done with two or more accounts. The scheme only works if the fraudster makes multiple deposits every day; the one day they miss will be the day the scheme collapses. With the rise of electronic transactions and decrease in check processing time over the last 20 years, this scheme has become fairly obsolete.
When we consider the fraud triangle and examine the “pressure” element of a check kiting scheme, we often find that rather than looking to get rich, check kiters are business owners trying to keep their business afloat during difficult times. They may have every intention of paying the money back once they have the funds. Even with the best intentions, however, check kiting is still illegal under 18 U.S.C. § 1344, obtaining a bank’s money under false pretenses. Although the bank may never see a loss, the individual still committed a crime.
Ponzi Scheme
The term “Ponzi scheme” was originally coined in 1919 after Charles Ponzi. Ponzi began a service that allowed people to pre-purchase stamps for the postal service when sending a letter. Initially the business wasn’t illegal, but as Ponzi grew more greedy and started to expand his business he began convincing people to invest in nonexistent assets. Ponzi promised his investors returns of 50% in 45 days or 100% in 90 days. In reality, Ponzi was soliciting new investors to pay his old investors and still keeping most of the money for himself in the end. A Ponzi scheme relies on new investors adding money in order to subsidize the float. When the schemer can’t get more people to invest, the scheme falls apart. The Ponzi scheme is often compared to the pyramid scheme and while the structure is the same there are important differences. Unlike a pyramid scheme, the victims of a Ponzi scheme are completely clueless as to what their money is being used for--investors may believe they’re buying stakes in stocks, bonds, hedge funds, oil and gas deals, precious metals, or any number of business or investment concepts. Pyramid schemes typically involve a large number of people, and unlike a Ponzi scheme (which is always illegal), pyramid schemes may be legal.
Comparing the Schemes
Though many elements of check kiting and Ponzi schemes are different, as mentioned earlier, the core of both schemes relies on an artificial inflation of what the schemer actually has. Put another way, both schemes require an initial lie that is maintained by funds that don’t actually exist. Both schemes are fairly labor intensive--while a check kite requires a daily dedication to the scheme, a Ponzi scheme requires manpower and the constant recruitment of new investors. Each takes a considerable amount of the fraudster’s time and energy to perform and essentially becomes a full time job.
From the fraud investigator’s point of view, the context in which each scheme occurs is different--check kiting is a form of financial institution fraud (where the victim is a bank or other financial institution), while Ponzi schemes are a form of investment fraud (where the victims are consumers). You may uncover check kiting while investigating on behalf of a bank, or while examining the fraudster’s accounts in the course of another investigation. Unusually frequent deposits, especially from accounts under the control of the suspected kiter, are one red flag indicating a potential check kiting scheme. Large amounts of cash “in float” in an account (cash that has yet to clear the paying bank) compared to the overall balance of the account are another.
Ponzi schemes are often not uncovered until the flow of new investors dries up and the scheme is on the brink of collapse. However, investors may become suspicious when profits stop materializing as promised. On the other hand, some investors may be so unwilling to accept their own misjudgment of the Ponzi schemer that they maintain faith in the scheme until the last possible moment. From the consumer’s point of view, red flags indicating a potential Ponzi scheme include promises of low risk and high reward that seem too good to be true, secretive or complex investment strategies that can’t be readily explained by the investment promoter, and investments that aren’t registered with the SEC or with state regulators. From a fraud investigator’s point of view, these cases typically involve collaboration with law enforcement and federal agencies. Unlike in a check kiting scheme, fabricated financial records may complicate the investigation, and interviews may provide significant information.
Learn more about these schemes on an episode of our Investigation Game Podcast!