Pyramid schemes appear in so many forms that they may be difficult to recognize. In the classic "pyramid" scheme, participants attempt to make money solely by recruiting new participants into the program. The hallmark of these schemes is the promise of sky-high returns in a short period of time for doing nothing other than handing over your money and getting others to do the same.
The fraudsters behind a pyramid scheme may go to great lengths to make the program look like a legitimate multi-level marketing program (MLM). But despite their claims to have legitimate products or services to sell, these fraudsters simply use money coming in from new recruits to pay off early stage investors. But eventually the pyramid will collapse. At some point the schemes get too big, the promoter cannot raise enough money from new investors to pay earlier investors, and many people lose their money.
Beware of Pyramid Schemes Posing as Multi-Level Marketing Programs
In an MLM program, you typically get paid for products or services that you and the distributors in your "downline" (i.e., participants you recruit and their recruits) sell to others. However, some MLM programs are actually pyramid schemes -- a type of fraud in which participants profit almost exclusively through recruiting other people to participate in the program.
Pyramid schemes masquerading as MLM programs often violate the federal securities laws, such as laws prohibiting fraud and requiring the registration of securities offerings and broker-dealers. In a pyramid scheme, money from new participants is used to pay recruiting commissions (that may take any form, including the form of securities) to earlier participants just like how, in classic Ponzi schemes, money from new investors is used to pay fake "profits" to earlier investors. Recently, the SEC has sued the alleged operators of large-scale pyramid schemes for violating the federal securities laws through the guise of MLM programs.
When considering joining an MLM program, beware of these hallmarks of a pyramid scheme:
- No genuine product or service - MLM programs involve selling a genuine product or service to people who are not in the program. Exercise caution if there is no underlying product or service being sold to others, or if what is being sold is speculative or appears inappropriately priced.
- Promises of high returns in a short time period - Be leery of pitches for exponential returns and "get rich quick" claims. High returns and fast cash in an MLM program may suggest that commissions are being paid out of money from new recruits rather than revenue generated by product sales.
- Easy money or passive income - Be wary if you are offered compensation in exchange for little work such as making payments, recruiting others, and placing advertisements.
- No demonstrated revenue from retail sales - Ask to see documents, such as financial statements audited by a certified public accountant (CPA), showing that the MLM company generates revenue from selling its products or services to people outside the program.
- Buy-in required - The goal of an MLM program is to sell products. Be careful if you are required to pay a buy-in to participate in the program, even if the buy-in is a nominal one-time or recurring fee (e.g., $10 or $10/month).
- Complex commission structure - Be concerned unless commissions are based on products or services that you or your recruits sell to people outside the program. If you do not understand how you will be compensated, be cautious.
- Emphasis on recruiting - If a program primarily focuses on recruiting others to join the program for a fee, it is likely a pyramid scheme. Be skeptical if you will receive more compensation for recruiting others than for product sales.
Sources: U.S. Securities and Exchange Commission