A pyramid scheme promises big salaries through enticing adverts. If you were attracted to this article because of the featured image then you are halfway to being defrauded. By placing an image which was bound to attract your interest, I get a chance to promise you something you want more of!
We are not suggesting that The Lazy Trader is changing focus to pimping, but to highlight the grey area, frankly outright fraud, which are Pyramid schemes. When learning how to start investing, being aware of scams like Pyramid schemes will develop your ability to spot other bad ideas.
What is a pyramid scheme
How all of us can be entrapped by one - It could happen to you
What obvious signs you can learn to protect your money!
A pyramid scheme is where someone representing a brand convinces other people to also sell that brand’s products, whilst recruiting other sales people. In effect you are marketing that brand’s products to multiple levels of people. This explains how it can also be called Multi Level Marketing (MLMs are not necessarily illegal as this form of scheme actually has clients!).
The pyramid scheme side of it, is due to the person at the top (of which are there are very few) getting very rich, whilst the vast majority earn little. As a result the wealth is funneled upwards and not spread equally. In a pyramid scheme, there are very few actual customers, but usually only sales staff who unwittingly become clients.
What salespeople joining this scheme do not realise, is they are forced to spend their own money to buy that firms products before trying to sell it on at a profit. I emphasis the ‘trying’, because few are successful. In effect the salespeople being recruited are actually clients, because they have brought the product!
No they are not. Under the Consumer Protection from Unfair Trading Regulations 2008, you can be prosecuted for being involved with them. As a result, anyone enticing you into one or anything similar should be promptly sent away!
Pyramid schemes are illegal in many US states. Indeed at Federal level, the Federal Trade Commission will prosecute Pyramid schemes under the FTC Act. The FTC does make a clear distinction between multi-level marketing (legal) and Pyramid schemes (illegal).
Both are scams. Let’s be clear about that. A pyramid scheme involves making money by convincing salespeople to buy your product, and then recruit others to do the same. These salespeople are actually clients without realising it.
A Ponzi scheme is when someone is refunded their investment using money which has only just been invested by someone else. I.e. if person A invests $1m and person B asks for their (for example) $1m back, then the firm running the Ponzi scheme just transfers the $1m from the account of person A to person B!
One of the most famous ones was by Ruja Ignatova who founded the cryptocurrency One Coin. She set up famous events around the world, including in Wembley arena, and made wild predictions on how one coin would be ‘the biggest out there’. People were also encouraged to invest using some intelligent marketing. She highlighted her education at Oxford university (which is seen as part of the ‘British establishment’), and even used a paid advert in Forbes magazine to suggest she had been on their front cover! It netted her an alleged $5billion!
She mysteriously disappeared shortly before her brother was arrested by the FBI. They have both been charged by the US Department of Justice with running an international pyramid scheme.
Canadians may remember Business in Motion where members were supposed to earn by selling holidays. The problem is, you had to hand over CAD $3,200 to ‘join the club’. You were also constantly reminded to ‘recruit’ others, which is illegal in Canada. Eventually investors were awarded CAD $6.5m by the Canadian Court of Appeal.
In 1979 in the USA, Amway managed to get away from being accused a pyramid scheme because there was no cash payment for signing up new recruits. Forbes has ranked Amway as one the US largest private companies.
Problem is (that one again), in 2020 a class action was filed in court in California which forced them to pay out considerable damages. The dispute was brought by people who felt they were not salespeople but recruiters.
Ask yourself why should I invest if it appears to good to true. It was noticeable that Bernie Madoff’s clients did not include any of the major wall street banks. This was despite his (alleged) performance was far superior than anyone else. It is clear that these banks suspected something was untoward and kept their clients money away.
If it doesn’t feel right, it does not feel right. Get out.
Sometimes a firm can look all but like a pyramid scheme, but not be labelled as one. Even with someone with influence such as Bill Ackman accusing Herbal Life of being one, it has so far escaped prosecution. This is despite the US Federal Trade Commission criticising it for unfair practices to its distributors. Confused? so are we.
For traditional investors, such as portfolio managers, who hold a stock portfolio, pyramid schemes should be possible to spot. This is because you are used to spotting such things as creative accounting in company accounts, so a pushy-promise-all sales strategies should set off alarm bells.
For new investors who are inexperienced in the ways of the business world, Pyramid schemes can succeed by selling the latest fad and creating a Fear Of Missing Out. Just look how Reddit day trading caught on.
Whichever one you are, if you do not understand the investment and cannot verify the claims, then stay away. If you still feel it is worth the downside risk, give yourself a margin of safety by only investing a small part of your overall wealth. If it does all go wrong, the loss will be bearable!