Financial Scams Through Ponzi Schemes: The Case of CIS Countries

Introduction

Following the collapse of the USSR, most of its former states are united in a union called the Commonwealth of Independent States (CIS). Even though each CIS country has chosen its own transition path which differs from the previous Soviet style command economy, the countries still share common economic history and heritage. These include low level of financial literacy among the public and underdeveloped financial industries. A large gap in the public’s financial literacy level and their understanding of the market economy and financial markets existed since the early years of independence. This is true for all CIS countries particularly during the initial economic transition phase from a planned to a market economy. Nevertheless, during those early years, some quickly adopted to the new economic reality and learned the rules of the game, while a vast majority of the population still depended on their old knowledge in economics and financials for survival. Thus, those with first-mover advantage became rich quickly, but at the cost of others who were financially illiterate and lacked business skills.

The Soviet Union also did not have a sophisticated financial system. It mainly relied on state owned commercial banks to primarily finance public enterprises, while financing for the other parts of the economy was either underdeveloped or non-existent. Commodities, forex or stock exchanges were not required given the absence of large private corporations which would raise funds through stocks or bonds; and the state controlled the commodities and foreign exchanges prices. The financial markets and institutions were mainly at very primitive stages or even lacking in most CIS countries in the early years of independence. It is disheartening to see that financial sector development has not progressed much in some of these countries, even after almost three decades of so-called ‘economic transition’ since their independence.

In the post-Soviet era, despite widespread financial illiteracy of the general public, there was a strong urge for new income sources in addition to the low salaries being earned, which formed a fertile ground for financial scams. Due to the lack of viable investment opportunities, Ponzi schemes were set up by some opportunists that had unfortunately led to many naive citizens of the CIS countries becoming victims (Aris, 2011; Koker, 2012; Witt, 1994). For example, one of the most infamous schemes which took place in early 1990s in the Russian Federation was the MMM Ponzi scheme. The scheme was promoted in many different ways by promising annual returns up to 2000%. It deceived the financially illiterate population of ex-Soviet Russia with an estimated 5 to10 million ‘investors’ becoming victims. It was reported that most investors did suspect the fraudulent nature of the MMM scheme, but voluntarily took part in it with the hope of profiting quickly; and would withdraw their money before the scheme collapsed (Witt, 1994).

Citizens from the other countries of the CIS did not escape from such fraudulent schemes either. Countries such as Armenia, Georgia¹, Kyrgyzstan, Uzbekistan and many others have experienced Ponzi schemes (Arminfo, 2013; EurasiaNet, 2016a, 2018; TI, 2012). If this was only a thing of the past, we would be relieved and satisfied with the lessons learned. Unfortunately, we are still witnessing such schemes until today. What is more worrying is that with the development of financial technology (fintech) and financial deregulation (DeFi), we can expect even more similar schemes taking place, particularly in dealing with cryptocurrencies and crypto assets (Hess & Soltes, 2018; Levenson, 2019; SEC, 2013a,b; Rafay, 2019).

The author sees financial illiteracy and underdeveloped financial infrastructure in the CIS countries as the main causes of the Ponzi scheme formation. Increasing financial education and developing the financial sector are viewed as possible cures for the problem. Unfortunately, despite years of financial illiteracy, most CIS countries still exclude financial education as part of their secondary education curriculums (Andreff, 2019; Filippova et al., 2016; Koker, 2012). Most youths in these countries are still financially illiterate as their parents were. In view of this, the author suggests to improve financial education and to instil it into the education system as early as possible. Such measures would serve to eradicate financial illiteracy in the CIS countries to a certain degree, which could potentially reduce the frequency and extent of financial frauds. As witnessed in the developed countries, financial literacy plays an important role to educate the general public in making correct investment decisions (Younas & Rafay, 2021).