Wednesday’s Word: Pyramid Schemes

By Brittany DeDiego, Fall 2014 Student Intern

pyramidA pyramid scheme is a classic type of investment fraud where participants attempt to make money on their investments by recruiting new investors into the program. These pyramid schemes are typically sold to investors claiming that you will make extremely high returns in a short time period for little effort. Some of these schemes attempt to disguise themselves as legitimate businesses selling some product or service, however, what the fraudsters are really doing is using the money from the new investors to pay off the old investors. These schemes eventually collapse when the fraudsters cannot raise enough money to continue to pay off their investors, resulting in huge losses for the later investors.

Many pyramid schemes are disguised as multi level marketing (“MLM”) programs and are commonly advertised online, in brochures, and at presentations. These schemes claim to be recruiting investors to sell some type of product or service, however, there is little or no effort to actually market the product or service. The emphasis in these schemes is recruiting new investors. Some of the commonalities in pyramid schemes disguised as MLM programs including having no genuine product or service, having promises of very high returns in a short period of time, offering passive income, having no demonstrated revenue from retail sales, requiring a buy-in, having a complex commission structure, and having an emphasis on recruiting.

The SEC has taken emergency enforcement action to stop alleged pyramid schemes that violate securities laws. Potential investors should educate themselves on the product or service being offered, and be aware of the other red flags of pyramid schemes. Interested in learning more? The SEC has some great information on pyramid schemes here.