Spotting a Pyramid Scheme Can Save Your Future

Bernie Madoff’s arrest in December of 2008 brought renewed attention to the concept of a Ponzi scheme. The close cousin of the Ponzi scheme, named for Charles Ponzi who swindled investors in the 1920’s, is a “pyramid scheme.” Similar to a Ponzi scheme, a pyramid scheme is a form of fraud that promises participants payment for enrolling other people into the scheme, rather than from any legitimate investment or sale of services or products. It is important to distinguish between the characteristics of a pyramid scheme and a Ponzi scheme:

  • In a Ponzi scheme, the schemer acts as a main point of contact for the victims (i.e., Bernard Madoff) while in a pyramid scheme, those who recruit additional participants benefit directly.
  • A Ponzi scheme claims to rely on some obscure investment approach and usually attracts high-net worth individuals whereas pyramid schemes explicitly claim that new money will be the source of payout for the initial investments.
  • A pyramid scheme is prone to collapse much faster because it requires the number of participants to increase exponentially in order for it to be sustainable. A Ponzi scheme, by contrast, can survive simply by persuading most existing participants to “reinvest” money, and does not require as many new participants.

An example of a pyramid scheme is as follows: You are asked to make an initial investment of $500 to become an independent agent for a discount long distance phone company and earn hundreds or thousands of dollars a week. Your job is to sell the service AND recruit a sales force to increase returns. Under this scenario you would be required to sign up a certain amount of people for a specific period of time, such as six months or one year. Most agents usually find few new recruits and end up losing money because the amount of new agents needed for you to actually see a profit is massive.

So, how can you spot a pyramid scheme before it’s too late? Victims are often vulnerable to “get rich quick schemes” and include the elderly, recent college graduates, or new immigrants, all of whom are asked to recruit family and friends. Any company that presents itself as a multilevel marketing business (MLM) is worth taking a second look at. An MLM is a marketing strategy whereby a salesperson not only receives compensation for his/her sales but also for the sales of those he/she was responsible for recruiting, creating a down-line of distributors and a hierarchy of multiple levels of compensation (hence, the pyramid).

Additionally, these businesses also generate hype and frenzy in hopes that in the midst of the excitement, potential recruits will ignore the downside of the business model. In other words, be weary of a company that promises quick returns and thrives on high charged meetings. Many of the businesses engaging in pyramid schemes recruit on the Internet and lure victims to the table by selling high tech ideas or New Age health and environmental products.

Companies or participants that are guilty of pyramid schemes normally do not have a marketable service or product. In other words, if you cannot trace the company’s revenues back to tangible sales rather than just entry fees, training programs and recruitment, you are likely being taken for a ride. According to the Direct Selling Association of America (DSA) if agents of a business are not able to sell inventory, some states require buy-backs at a percentage of the original cost. If you are being recruited to sell products on behalf of a company, make sure to inquire whether the company will buy back unsold inventory. If not, this is a red flag.

Any business model that promotes “getting in on the ground level” and forces you to make a quick investment decision is probably attempting to distract you from what is really going on: a scam. Provided you do your research, it is easy to spot a pyramid scheme. The Better Business Bureau is a good place to start. The DSA also distributes brochures on how to spot pyramid schemes. Don’t let yourself be fooled. Getting rich quick is always worth dreaming about but chances are, it’s not likely to happen so easily.

Published or Updated: September 7, 2011

Comments

  1. Richard Hurt says:

    I agree with 99% of what you have said here, and unfortunately many innocent people are falling for these schemes at a time when they are looking for anyway they can to provide for themselves and their families. They are either unemployed or under-employed. Not all are just looking to get rich fast. But one thing we can’t do is lump all MLM companies into the pyramid scheme category. There are several legitimate MLM companies out there, even if they are companies I or you might not want to work for (i.e. Amway Global). MLM is not my bag, but it can be legit. Good article.

    • Michael says:

      Rich

      Funny you should mention Amway Global, because when I was 15 working at McDonalds, a co-worker approached me about Quixstar (which was Amway Global at the time). I ended up meeting “a guy” at the local Pizza Hut who tried to sell me on the idea but I came out of it thinking “100% scam”.

      As of today, I really don’t know how Amway Global works (although I see commercials everyday) but my impression will always be scam.

  2. David says:

    A Ponzi scheme is like Social “In”Security. The people that initially put into the Communist program got the greatest the greatest return though they put very little into it, whereas later in the scheme those putting the most into it are getting the least return.
    A pyramid is any corporation (P&G, GE, ING, etc) that has 1 person at the top making the big bucks and then a few senior management and fewer at mid level mgmt and many at entry level mgmt and many more at supervisory level and gobs more at ground floor thus a pyramid where many are willing to stab others in the back to claw their way to the top. It is ugly.
    However a direct sales, network mktg, MLM company is just the reverse with the top wide open for anyone willing to work in order to achieve financial wealth and freedom. Even corp America’s sales depts recruit and the regional and district mgrs get a cut off of the sales efforts of all the sales reps in their region or district. What about insurance agencies? The same thing.
    Please wake up and THINK!

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