IF an investment is simply too good to be true, it probably is a fraud!!!
CLIVE MPHAMBELA
Zimbabweans are facing many economic hardships and as a result, it has become easier for people to be enticed by quick-win investments and opportunities that yield very high and quick returns. Unbeknown to many people, however, such easy and high returns come with commensurately very high risks. Many of the seemingly lucrative avenues for “investment” that many Zimbabweans today are falling prey to are actually cleverly designed “Pyramid Schemes” or versions of “Ponzi Schemes” (which we discussed last week) that promise investors very lucrative returns, for very little or no risk, over very short periods of time, and for very little or no effort on the part of the investor. These characteristics of an investment
How do you spot a Pyramid Scheme?
A pyramid scheme is any business venture that seeks to “recruit members” through a promise of very attractive payments or services as rewards for enrolling “new members” into the scheme. Pyramid schemes typically depend on new members joining the scheme, rather than supplying actual investments or selling tangible or useful products or services. New members “buy into the scheme” by paying contributions to existing members who joined before them. As new recruits grow and multiply, the recruiting of new members very quickly becomes impossible, and most of the members suddenly are caught out when they discover that they are unable to get initially promised sweet profits. Pyramid schemes inevitably collapse when new members can no-longer be found to “join” the scheme. For these reasons pyramid schemes are unsustainable and in most countries including Zimbabwe, they are illegal.
How do pyramid schemers steal from their members?
Pyramid schemers are organisations that entice individuals (new members) to join and make a payment to their recruiters or to other members who are already in the scheme. In exchange, the organisation promises those new members a share of the money paid in by any additional members that they recruit and those that will join after them. The organisers or directors of the organisation, who typically are positioned at the top of the pyramid, will usually, also receive a share of the payments made by the new recruits. For this reason, pyramid schemes benefit early entrants and are potentially lucrative for early birds.
Such organisations are rarely involved in the sale of real products or services with a real value. Without creating any real goods or services, the only way for a pyramid scheme to generate revenue is to recruit more members or to solicit more money from its current members. Eventually, recruiting new members becomes increasingly difficult or impossible and scheme members find themselves unable to profit from the scheme or to recover their initial contributions.
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Some pyramid schemes are also referred to as franchise fraud or chain referral schemes and are essentially marketing and investment frauds in which individuals are offered a distributorship or franchise to market a particular product. The real profit is earned, not by the sale of the product, but by the sale of “new distributorships”, which is a form of recruitment. Such schemes emphasise on selling new franchises rather than selling the actual product or service and this eventually leads to a point where the supply of potential new franchisees or investors is exhausted and the pyramid scheme collapses.
Pyramid scheme fraud, therefore, usually involves an unsustainable underlying business which rewards participants for enrolling others into a business scheme which itself offers a non-existent or worthless product or service with no commercial value.
Pyramid scheme fraudsters will usually advertise a multi-level investment or social financing scheme that offers extraordinary profits/returns for very little or no risk to participants. They also make it seem very easy to recruit new members and in fact in the early days it may actually be easy for early entrants to recruit new participants but this becomes increasingly difficult over a short period of time.
Most if not all pyramid schemes require a new recruit to pay some sort of joining fee to enter the investment scheme. The fee is typically paid to the earlier recruiter or recruiters in the chain and occasionally there is a administration charge that is paid to a central agent, or lead agent.
Money invested in a pyramid scheme is not actually invested in any product, but instead, it is simply passed up the chain of investors. Because pyramid schemes are illegal and make no profits, they do not have any assets and you are very unlikely to recover any lost investment. While the fraudsters at the top of the pyramid will collect most of the profits, those who entered the scheme later end up losing out.
Legitimate trading schemes rely on tangible goods and services, while pyramid schemes simply thrive on recruiting more and more new participants at the bottom of the pyramid.
Can MLM or network marketing schemes end up as pyramid schemes?
It is useful for members of the public to understand that all pyramid schemes use network marketing and multilevel marketing tools and can easily be disguised as Multi Level or Network Marketing business ventures. However, not all MLM, or network schemes are pyramids, but people need to be very careful as a number of seemingly legitimate investment vehicles or strategies, can also become the backbone of pyramid schemes.
How are pyramid schemes and Ponzi schemes similar/different?
Last week we discussed the pyramid schemes evil cousin, the “Ponzi scheme”. Whilst pyramid schemes as a form of fraud are very similar in some ways to Ponzi schemes, because both types of financial fraud rely heavily on a mistaken belief by gullible “investors” in a nonexistent financial reality, which includes the hope of extremely quick and high rates of return. The underlying tenet why both schemes work is because humans are inherently greedy. They both thrive on a concept in behavioural finance called “the greater fool theory”. However, several characteristics distinguish pyramid schemes from Ponzi schemes.
In a Ponzi scheme, the scamsters act as a central “hub” and interact directly and actively with all the victims. In a pyramid scheme however, the recruiter benefits directly from his or her recruits. Each higher level of beneficiaries in the pyramid hierarchy reaps directly from those that join or are recruited after the. It is for this reason that pyramid schemes collapse quickly as the failure to recruit new participants typically means that you will not get an investment return.
A pyramid scheme will usually collapse much faster than a Ponzi scheme because it requires an exponential increase in new participants to sustain it. By contrast, Ponzi schemes can survive simply by persuading some of the existing participants to reinvest their money, and can run for long periods with a relatively small number of new participants.
Always seek the help of an expert before investing in any financial investment?
The best way to protect yourself from pyramid schemes and similar types of financial scams is to check facts with an independent person. Your banker or financial advisor for example, will be able to tell a typical Ponzi or pyramid arrangement. Don’t fall prey, smarten up.
