Lou Pearlman was the creator of two of the most famous young bands (The Backstreet Boys and N’Sync), but he was recently sentenced to 25 years in prison after being convicted of the federal crimes conspiracy, money laundering and making false statements, according to the Orlando Sentinel. Pearlman defrauded more than 1,000 people and banks out of approximately $500 million. The prison sentenced ordered by the U.S. District Court Judge in Orlando, Florida was agreed to by federal prosecutors. Pearlman would normally serve 85% of his prison sentence, however the judge did give Pearlman an opportunity to reduce his sentence by one month for every million dollars he returns to the victims of his crimes.
The federal crimes Pearlman committed were part of what is commonly called a Ponzi scheme. A Ponzi scheme occurs when someone, presumably a good communicator and seemingly savvy businessperson or investor, makes claims that he/she can make excessively high financial returns for potential investors. The Ponzi schemer is typically someone who appears to have a lot of money giving the impression that he/she can do for others what he/she has already done for him/herself. Once a few victims are attracted to the scheme and pay their initial investments, the offender typically pays part of the promised profits to some of the initial investors. This serves the purpose of gaining trust and also generates some third party advertising.
However, the problem, and the crime, is that there are no high yield investments. The initial money that was returned to investors 1, 2 and 3 as profits are really the initial “investment money” that was paid to the Ponzi schemer by investors, or victims, 4, 5 and 6. So, going forward, initial victims are paid periodically from the funds of subsequent victims. Ponzi schemes while effective initially, depending on the skill of the person running it, are generally destined to fail. The obvious flaw is that victims are going to eventually want their money back plus the promised profits. As the Ponzi schemer runs out of new investors, or victims, he/she also runs out of money to pay his investors since there were never any real investments or legitimate source of profits. Ultimately, the victims will figure out the scheme and talk to other victims as well as the police. At that point, the Ponzi scheme collapses and often, unfortunately, the victims find that the money they thought they invested is gone.