Pyramid Scheme Definition
A pyramid scheme is a business model that recruits members via a promise of payments or services for enrolling others into the scheme, rather than supplying investments or sale of products. As recruiting multiplies, recruiting becomes quickly impossible, and most members are unable to profit; as such, pyramid schemes are unsustainable and often illegal.
Pyramid Scheme Key Points
- A pyramid scheme is a fraudulent investment strategy, usually defined by the promise of an extraordinarily high return on investment for early participants.
- The structure of pyramid schemes is based on recruiting an ever-increasing number of “investors”.
- The primary goal of a pyramid scheme operator is to exploit the personal financial relationships between family and friends.
- Pyramid schemes are illegal in many countries, including the United States, Canada, and the United Kingdom.
- While some people call MLMs in general “pyramid selling,” others use the term to denote an illegal pyramid scheme masquerading as an MLM.
What is a Pyramid Scheme?
A pyramid scheme is a type of investment where each participant recruits two further participants, with returns being given to early participants using money contributed by later ones. Pyramid schemes are deemed illegal in many countries as they resemble a form of investment where the income of the participants is derived primarily from recruiting new participants, not from any real investment or sale of goods or services to the public.
Why are Pyramid Schemes Considered Fraudulent?
Pyramid schemes are considered fraudulent because they are based on an unsustainable business model: for every person to profit, there would need to be an infinite pool of potential participants. In reality, the number of potential participants is limited, and each layer of the pyramid requires exponentially more recruits. This means that most participants will not be able to recruit the required number of people and will lose their investment.
Who Participates in Pyramid Schemes?
Anyone can be targeted by pyramid scheme operators. However, these schemes often target communities or groups of people who know and trust each other, such as religious or ethnic communities, social clubs, or professional groups. The idea is to exploit the trust within these groups of people to recruit new participants.
When did Pyramid Schemes Start?
The concept of pyramid schemes has been around for centuries, but the actual term “pyramid scheme” was first used in the 1970s during the trial of Glenn W. Turner. He was accused of operating a pyramid scheme through his company, Koscot Interplanetary, Inc.
Where are Pyramid Schemes Illegal?
Pyramid schemes are illegal in many countries, including the United States, Canada, the United Kingdom, Australia, and many European and Asian countries. However, the specific laws and definitions vary from country to country.
How to Spot a Pyramid Scheme?
There are several red flags that can help you identify a pyramid scheme:
- Emphasis on recruiting: If a program primarily focuses on recruiting others to join the program for a fee, it is likely a pyramid scheme.
- No genuine product or service: Pyramid schemes often involve the sale of a product or service, but it is often of little value or there are no real customers.
- Promises of high returns in a short time period: Be skeptical of promises of high returns in a short time period. If it sounds too good to be true, it probably is.
- No demonstrated revenue from retail sales: Ask to see documents, such as financial statements audited by a certified public accountant (CPA), showing that the company generates revenue from selling its products or services to people outside the program.
