Pyramid
Scheme
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What is a 'Pyramid
Scheme'
A pyramid scheme is an illegal investment scam based on a
hierarchical setup. The most famous kind of pyramid scheme is, perhaps, the
Ponzi scheme. New recruits make up the base of the pyramid and provide the
funding, or so-called returns, in the form of new money outlays to the earlier
investors/recruits structured above them in the scheme. A pyramid scheme does
not usually involve the selling of products. Rather, it relies on the constant
inflow of money from additional investors that works its way to the top of the
pyramid. This means that multilevel marketing schemes are not
classified as pyramid schemes and are not necessarily fraudulent.
BREAKING DOWN
'Pyramid Scheme'
An individual or a company initiates a
pyramid scheme by recruiting investors with an offer of guaranteed
high returns. As the scheme begins, the earliest investors do receive a high rate of return, but these gains
are paid for by new recruits and are not a return on any real investment. From
the moment the scam is initiated, a pyramid scheme's liabilities begin to exceed its assets.
The only way it can generate wealth is by promising extraordinary returns to
new recruits; the only way these returns receive payment is by getting
additional investors. Invariably these schemes lose steam and the pyramid
collapses.
Basic Pyramid
Scheme
A pyramid scheme is a variation of the Ponzi scheme, which offers a promise of high
investment returns that are not available from traditional types of investment.
In practice, the structure of pyramid schemes induces others to recruit victims
and collect money that eventually makes its way to the top of the pyramid. In a
typical setup, one person recruits a second person to invest a certain amount
of money. The second person recovers his investment by recruiting people under
him to invest in the scheme. The more people he can recruit under him, the
greater his profit, and a certain percentage of the profits of all recruiters
work their way up the pyramid to enrich the recruiters before him. Each person
must recruit a certain number of people. The process continues until there are
fewer people at the bottom of pyramid, and it collapses under its own weight.
Generally, only the people near the top of the pyramid make any significant
profits, and people near the bottom never recover their investments.
A recent and well-known pyramid scheme
involved the fall of Bernie Madoff,
who promised and often fulfilled apparently extraordinary investment returns by
enlisting new members to part with their money. Madoff has admitted to his
crimes and is serving a jail sentence, but only after hundreds of investors
collectively lost millions of dollars in the fraud.
Business
Pyramids (Multilevel Marketing Schemes)
On their face, multilevel marketing
companies are structured like a pyramid. Individuals have the opportunity to
invest in their own businesses, which, ostensibly, distribute a product.
However, with some companies, the real profit opportunity comes not from
selling products but from inducing others into buying into their own business,
with a percentage of the investment moving up the hierarchy of recruiters.
These companies include the likes 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 distributors can make money
just by selling the company’s products, but they must purchase and sell
thousands of dollars' worth of the products before they realize a profit.
Critics allege that the company's top recruiters receive the vast majority of
profits.
Regulators have determined that a
multilevel marketing structure is not fraudulent if the company makes most of
its profits from selling products or services to end-user consumers, as opposed
to recruiting new sales agents and requiring those agents purchase their own
inventory.
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