Pyramid Scheme

What Is a Pyramid Scheme?

A pyramid scheme is an unlawful investment scam based on a hierarchical setup of network marketing. The most renowned sort of pyramid scheme is, maybe, the Ponzi scheme.

Newcomers make up the base of the pyramid and give the funding, or somewhere in the vicinity called returns, as new money outlays to the prior investors/recruits structured above them in the scheme. A pyramid scheme doesn't ordinarily include the selling of products. Rather, it depends on the steady inflow of money from extra investors that works its direction to the highest point of the pyramid. This means that [multilevel marketing](/staggered marketing) schemes are not classified as pyramid schemes and are not really fraudulent.

How a Pyramid Scheme Works

An individual or a company starts a pyramid scheme by enrolling investors with an offer of guaranteed high returns. As the scheme starts, the earliest investors truly do receive a high rate of return, yet these gains are paid for by newcomers and are not a return on any real investment.

From the moment the scam is initiated, a pyramid scheme's liabilities start to surpass its assets. The main way it can generate wealth is by promising extraordinary returns to newcomers; the main way these returns receive payment is by getting extra investors. Perpetually, these schemes lose steam and the pyramid breakdowns.

History of Pyramid Schemes

The main noted pyramid scheme was made by Italian-American, Charles Ponzi in 1919. Ponzi established the Securities Exchange Company that year with the guarantee to investors of doubling their money in 90 days or less. As Ponzi kept on attracting new investors, he utilized that money to pay the earliest investors double their investment. As the company became noted, Ponzi was getting $1 million per week.

In July 2020, papers in the end pointed out the blemishes in Ponzi's "business" and that year he was ultimately [bankrupt](/chapter 11). He had brought in $15 million from the scheme. Ponzi went to jail for his fraud and afterward went silent for a decade, just to reappear in Florida where he ran one more pyramid scheme zeroed in on land bargains.

In spite of Ponzi being the one whose name is associated with this type of pyramid scheme, apparently, the act was first committed by Sarah Howe in Boston in 1879. Howe made the Ladies' Deposit fully intent on assisting ladies with investing their money. She claimed that investor deposits would be doubled in nine months. The Boston Daily Advertiser uncovered her scam and Howe at last served three years in jail, just to wager let out and begin one more scam that she ran for a very long time.

In 2019, there were 60 major Ponzi schemes in the U.S. with total investments of $3.25 billion.

Since these early Ponzi schemes, little has changed. Investors are energized by the commitment of large and fast returns, investing without completely understanding the vehicle in which they are putting their money.

Essential Pyramid Schemes

A pyramid scheme is a variation of the Ponzi scheme, which offers a commitment of high investment returns that are not available from traditional types of investments. In practice, the structure of pyramid schemes actuates others to enlist casualties and collect money that in the end advances toward the highest point of the pyramid.

In a regular setup, one person recruits a second person to invest a certain amount of money. The second person recuperates their investment by selecting individuals under them to invest in the scheme.

The more individuals they can enroll under them, the greater their profit, and a certain percentage of the profits of all selection representatives move gradually up the pyramid to enhance the scouts before them. Every person must enroll a certain number of individuals. The cycle go on until there are less individuals at the lower part of the pyramid, and it implodes under its own weight.

Generally, just individuals close to the highest point of the pyramid create any critical gains, and individuals close to the base never recuperate their investments.

Business Pyramids

On their face, multilevel marketing companies are structured like a pyramid. Individuals have the opportunity to invest in their own businesses, which, apparently, convey a product. Nonetheless, for certain companies, the real profit opportunity comes not from selling products but rather from initiating others into buying into their own business, with a percentage of the investment moving up the hierarchy of selection representatives.

These companies incorporate any semblance of Amway, Rodan + Fields, and Tupperware. Among the more high-profile multilevel marketing companies to be investigated as a pyramid scheme is Herbalife Ltd. Herbalife wholesalers can bring in money just by selling the company's products, however they must purchase and sell huge number of dollars worth of the products before they realize a profit. Pundits claim that the company's top enrollment specialists receive by far most of profits.

Regulators have established that a multilevel marketing structure isn't fraudulent assuming the company makes the majority of its profits from selling products or services to end-client consumers, rather than enlisting new sales agents and requiring those agents to purchase their own inventory.

Illustration of a Pyramid Scheme

A recent and notable pyramid scheme, of the Ponzi assortment, involved the fall of Bernie Madoff, who guaranteed and frequently satisfied apparently extraordinary investment returns by enrolling new individuals to part with their money. Madoff admitted to his crimes and was condemned to 150 years in prison, yet solely after a great many investors collectively lost billions of dollars in the fraud. Madoff passed on in the slammer in April 2021, at 82 years old.

Madoff claimed his investment strategy was the parted strike conversion strategy. Nonetheless, he was really just depositing client funds into one account that he was utilizing to pay current clients that wanted to redeem their money. There is no certainty when Madoff started his scheme, yet accounts point to 1991. A few close partners of Madoff claim that it had started before. Madoff himself claimed he was convinced into it.

Madoff had the option to reliably attract new investors to pay off recovering investors due to various reasons. His primary, public portfolio just comprised of safe, blue-chip stocks. His returns were high, roughly somewhere in the range of 10% and 20%, and steady, which was a key point. What's more, he stated he was utilizing a collar strategy (split-strike conversion) that limits risks.

The Securities and Exchange Commission (SEC) began investigating Madoff and his firm in 1999. It was principally financial analyst, Harry Markopolos, that raised worries, saying that Madoff's returns were unrealistic, as well as giving a rundown of different inconsistencies, and claiming that Madoff was running a Ponzi scheme.

At last, Madoff's firm nearly lost it all when reclamations were high in 2005 however it was only after the market turned in 2008 towards a recession that it was outside the realm of possibilities for Madoff to keep running the scheme. Altogether, Madoff defrauded investors in the amount of $17.5 billion, or $65 billion including fictitious profits.

Pyramid Scheme FAQs

Is a Sou a Pyramid Scheme?

Indeed, a sou, a type of informal savings club, has been utilized as a pyramid scheme by scammers. A sou is a rotating savings club that exists basically in West Africa and the Caribbean. It comprises normally of a small group of family and friends who pay a fixed amount into the fund or account and pivot in turns who gets compensated out. There is no interest and you don't get compensated more than whatever you put in. In this original cycle, a sou isn't a pyramid scheme, nonetheless, scammers have been pitching fake sou clubs, for example, The Circle Game, Blessing Loom, and Money Board. They guarantee higher returns than what you contribute and depend on attracting new investors to pay prior investors.

How Might You Spot a Pyramid Scheme?

To spot a pyramid scheme, have some serious misgivings of investments that offer high returns in a short period of time with little risk. In the event that you don't comprehend the investment or how the returns are being made, keep away from it. On the off chance that somebody that you don't know is welcoming you to an investment or a workshop it might actually be a fraud. Investigate any seller of an investment product utilizing different instruments, like FINRA's BrokerCheck. Guarantee the investment is registered, on the off chance that it isn't, ask why.

How Do You Get Out of a Pyramid Scheme?

In the event that you trust an investment to be a Ponzi scheme, promptly report it to specialists, including the SEC, FINRA, and your state's regulator. Pull out your money as fast as possible. At the point when you do, the scheme might offer arrangements or higher returns, however that is just a proceeded with part of the scheme.

How Do You Report a Pyramid Scheme?

You can report a scheme to the SEC, FINRA, and your state's authority. North American Securities Administrators Association gives a rundown of securities administrators that you can report to.

The Bottom Line

A pyramid scheme is a common form of financial fraud based on attracting new investors to pay off early investors. The most renowned pyramid scheme is the Ponzi scheme. There can be variations so while making an investment it is important to do your due diligence and comprehend where you are putting your money. On the off chance that anything looks off or you don't find clear solutions from the seller, it is in every case best to walk away. On the off chance that you really do think any fraud, there are numerous specialists to report your doubts.

Highlights

• Pyramid schemes are based on tiers where new individuals are at the base and the individuals at the top make the majority of the money.
• Maybe the most popular pyramid scheme is that of Bernie Madoff's Ponzi scheme that was uncovered during the financial crisis in 2008.
• The Ponzi scheme is a famous notable type of pyramid scheme named after Charles Ponzi who enacted his own pyramid scheme in 1919.
• Staggered marketing businesses are not ordinarily considered pyramid schemes since they include selling products.
• A pyramid scheme bombs once the entity running the scheme is unable to attract new investors to pay off prior investors.