Eileen works closely with investors in securities cases and has over a decade of experience in the legal world. She received her law degree from American University in 2005.
A pyramid scheme is a non-sustainable business model that generates profit by recruiting more and more participants, rather than by providing valuable goods, services, or investments. These schemes can result in substantial investor losses. If you believe that you, or someone you know, has fallen victim to a pyramid scheme, contact us immediately. You may be able to recover your investment losses.
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What is a Pyramid Scheme?
A pyramid scheme is a type of investment scam that is often disguised as a sale or investment opportunity. But the profit of these scams does not actually come from the sale of products or investments. Instead, the scheme makes money off of the recruitment of new investors. Those already in the scheme are encouraged to recruit new investors causing the number of investors to increases at each level, hence the name “pyramid scheme.”
Pyramid schemes can grow rapidly, but inevitably collapse when there is a shortage of new recruits. When a pyramid scheme collapses, almost all of the newer investors, the ones at the bottom of the pyramid, lose their investments.
Types of Pyramid Schemes
While there are many different pyramid scheme examples, pyramid schemes typically fall into two categories: naked and product-based. In both types, participants profit primarily by recruiting new members rather than by selling a product, service, or investment. However, they differ slightly in their approach, as explained below.
Naked Pyramid Schemes
In a naked pyramid scheme, participants charge recruits a fee to participate in an “investment opportunity” claimed to return a large lump sum once the recruit finds enough new members. In this scheme, there is no product or service being sold, only the opportunity to profit by recruiting new participants.
Product-Based Pyramid Schemes
The product-based scheme differs from the naked scheme because, as its name hints, the scheme typically uses the sale of a product or service to mask its true nature. In product-based schemes, new participants typically purchase a starter-kit or pay an initiation fee in order to become a distributor for the product or service. However, participants do not profit by selling the product, which is typically difficult to sell and yields narrow profit margins. Instead, participants profit by recruiting new participants who also pay to join the scheme.
How to Spot a Pyramid Scheme
Because they are often disguised as legitimate opportunities, pyramid schemes can be hard to spot. Here are a few simple characteristics that may indicate an investment opportunity is actually a pyramid scheme:
- The promise of quick and high returns: Most investments require a certain level of risk, and take time to produce returns. If an opportunity promises you high returns in a relatively short period of time, this may be a sign of a pyramid scheme.
- It is hard to find past and present information on the investment: Legitimate investments should be registered, and you should be able to find relevant information about how the investment has done in the past. Additionally, as an investor, you should be able to see valid documentation and keep track of the investment’s performance. If the business refuses to give you this vital information, this could be the sign of a scam.
- The business does not sell useful or genuine products or services: If the opportunity is asking you to sell products such as mailing lists or reports, this may be a red flag. These types of products are often only useful to those who buy them in order to also join the pyramid scheme. You should be able to sell product that you can make a profit off of selling, such as home appliances or makeup.
- You have to recruit others to make a profit: In a legitimate business you should be able to make a profit based off of your sales. If your profit is wholly dependent on your recruitment of new participants, this is a sign of a pyramid scheme.
- You don’t know where your money will be invested: In a legitimate investing opportunity, you should be able to understand exactly where your money is being invested. Giving your money to someone without knowing their investment strategies may increase your likelihood of becoming involved in a pyramid scheme.
- You are told that there is little or no risk: All investments require some level of risk. If you are promised high returns with little or no risk, this may be a red flag.
- You are rushed into the investment or told that this is a once in a lifetime opportunity: With any investment, you should be able to take your time to think over the opportunity before investing your money. A “rare” investment that must be invested in quickly may indicate a pyramid scheme.
- There are complicated rules regarding withdrawing your money: Exit strategies that are extremely complicated may be a sign that something is not right. Investors should research and understand the policies around getting out of the investment before deciding to invest.
Because they are often disguised as legitimate opportunities, pyramid schemes can be hard to spot. Our investment fraud lawyers can help you figure out whether or not you have fallen victim to a pyramid scam. Contact us today for a free evaluation.
Pyramid Schemes vs. MLMs
Investors considering putting money into multilevel marketing (MLM) investments should understand the difference between MLMs and pyramid schemes. Without the right information, investors may be tricked into investing, not in MLMs, but in illegal pyramid scams.
MLMs are business models which sell products or services person-to-person. You can make a profit through MLMs either by selling the business’ products yourself to customers not in the MLM, or by earning commission based off of the buying and selling of other distributors which you recruit.
Pyramid schemes often disguise themselves as MLMs in order to entice investors. MLMs differ from pyramid schemes in that profit is made off of the sale of actual products. An MLM that does not pay you for the sale of products, but only pays when you recruit new distributors, may actually be a pyramid scheme. Investors should be aware of this difference when deciding whether or not to get involved.
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