Pyramid Schemes: This Classic Scam is Fooling People by Taking on a New Shape

The chance to strike it rich has long been an important part of the American dream—and, with so many opportunities for online businesses, it seems more possible than ever to achieve.

However, not every opportunity is legitimate. How can you determine what’s a safe bet and when to run the other direction?

As we shared in “Do Multi-Level Marketing Companies Differ From Pyramid Schemes?” the answer depends a lot on whether your income is based on selling products or recruiting other people. If it’s the latter, then you’re likely being presented with a pyramid scheme.

You’ve probably heard of a pyramid scheme, sometimes called a Ponzi scheme, and know to stay away. But, what exactly is one, how did they get started, and how do people still fall for them today?

Ponzi’s First Scheme

The original pyramid schemer was Carlo Ponzi, an Italian immigrant who floated from job to job in Boston’s hard-scrabble economy of the 1920’s. According to historical records, Ponzi was a bit of a loser who dreamed of being rich, but couldn’t put in the effort or elbow grease, and instead, ended up serving several stints in prison for check fraud.

He got the idea for the first pyramid scheme when writing letters of his predicament to family back in Italy. In those days, a person could enclose a coupon within a letter that would save the recipient the cost of return postage—even internationally. An organization called The International Postal Union would issue the coupons, which could then be traded for postage stamps around the world.

Ponzi’s idea was a rough form of currency exchange speculation. Basically, he figured that these postage coupons could be bought for cheap in nations with weak economies, then redeemed for a profit in the United States.

Of course, it only took one try for Ponzi to realize that the scheme was much more trouble than it was worth, since the red tape among postal organizations absorbed most of his profits. Additionally, business wasn’t exactly speedy back then, and delays meant that Ponzi couldn’t continually move enough money through the system to make his plan really work.

While that idea fell flat in practice, it didn’t stop Ponzi from bragging about his ingenuity. Pretty soon, friends and family were asking him how the scheme was going unprovoked—they were also interested in the opportunity, since it made so much sense on the surface.

How Ponzi Schemes Work

Ponzi discovered that it was a lot easier to talk others into investing than to work through the bureaucracy of moving postage coupons. So, with a capital of just $150, he started borrowing money on promissory notes—basically IOUs—from friends and acquaintances by claiming that he was making a 100% return, but lacked the liquid cash to fully exploit the international postal coupon exchange.

The first round of investors handed Ponzi $1,250. Ninety days later, he paid out $750 in interest on their loans. This, of course, garnered some attention.

With a promise to repay $150 in 90 days for every $100 loaned, Ponzi was able to convince thousands of people to loan him millions of dollars. He eased investors fears by paying 90-day promissory notes after just 45 days, which earned him a loyal following.

Within the first year, Ponzi had taken in $9 million. However, he had outstanding notes promising $14 million, so he had to keep gaining investors. To do so, he started paying agents a commission of 10 percent.

The catch? Ponzi told his investors that he’d gotten the return on their investment through his international postal coupon idea, but really, he was just forking back over a percentage of what they’d paid him for the purpose of keeping up appearances.

This is important to note because so many pyramid schemes work the same way today—and elicit similar feelings of opportunity. The problem being that, even though our heads are telling us something is fishy, it’s difficult to ignore the impulse to invest when cold hard cash is actually exchanging hands.

The Cycle of a Modern Pyramid Scam

While pyramid scams have moved on from touting the opportunities of exchanging postal coupons, modern schemes still share many similarities with Ponzi’s first venture.

The first is that pyramid scams usually start off at a grass-roots level. You may hear of an opportunity through family, friends, or neighbors.

Next, you’ll rarely be asked for cash up front. Instead, you’ll be invited to a home meeting or seminar, where, similar to MLM opportunities, potential members will be exposed to a frenzy of excitement and big promises.

After recruits have been riled up with promises of striking it rich and made to fear missing the opportunity, they’ll be asked for a payment. Though, this isn’t always an outright request for cash.

Sometimes promoters will hide their true intentions by introducing products that have little value or are difficult to sell. This could be an actual product or an investment opportunity.

For example, I was once taken on a date that turned out to be a real estate pyramid scheme. Hundreds of curious potential investors had been suckered into attending under the promise of a free dinner, then told a tale of how the man on stage had a tip that some big-name company was looking to purchase a particular plot of land. We were all invited to invest in a minute parcel, perhaps five square feet, in the promise that we could combine our investment property into one big sale months down the road. 

Of course, it was a scam. And, while the freeze-dried fries I was served were a poor way of disguising your fraudulent get-rich-quick pyramid scheme, scammers have started to get a lot more creative—appealing to a sense of community.

The “Women Empowerment Circle” Pyramid Scam

More recently, a female friend called me up and asked to meet for lunch. After a few minutes of chatting, she told me that her friend had brought her to something called a “flower circle meeting,” that she had been apprehensive at first, but now thought that it might be a great idea and wanted to know if I’d like to join.

Despite her excitement, I couldn’t get a clear explanation for what this flower circle was supposed to be. Only that it was also called a “secret gifting group,” and her experience went something like this:

  1. My friend was invited by another friend to a house meeting.
  2. After arriving, she was invited to write down a list of things she wanted. These could be material possessions, or opportunities that required capital.
  3. New members then “gifted” the tier of women above them the equivalent of $5000 under the guise of empowering these women to afford their list of wants, and as a thank you for being invited to join the club.
  4. Those who didn’t have the $5000 were offered a loan by a more senior member. However, instead of interest, they were required to forfeit an amount from future recruits until the loan had been paid in full.

To be allowed to join the group, my friend had to bring in two new recruits of her own—in the name of empowering more women. However, whether it’s called a flower, circle, tree, or some other shape, the structure of this scam simply isn’t sustainable.

That’s because the eight women investing at the bottom of the pyramid would have to recruit eight times that number, or 64 women, to get the payoff. Those women, in turn, must recruit 512 new people. The numbers keep climbing exponentially until investors dry up and the pyramid crumbles.

The scary thing is that at least 40 women had already bought into the idea of empowerment via the gifting circle. Even more so, a little research showed that it’s not limited to my community. Despite being illegal in the US, and despite state agencies and media sharing warnings not to buy in, they’re still rapidly growing.

How to Spot a Pyramid Scheme

Pyramid schemes often disguise themselves as legitimate multi-level marketing plans, and spotting the difference can be difficult. If you find yourself presented with a questionable opportunity, use this checklist of tell-tale warning signs to ascertain whether or not it’s a scam designed to take your money:

1. You’re required to pay up-front to join.

Both multi-level marketing plans and pyramid schemes can require an up-front cost, which can make it difficult to spot the difference.

Because the goal of an MLM is to sell products, the cost of a legitimate multi-level marketing business should be limited to purchasing inventory. (Though, it’s up to you to determine whether or not those products are fairly priced and meet market demand.)

Related: Do Multi-Level Marketing Companies Differ From Pyramid Schemes?

Pyramid schemes almost always require you to pay before joining. This could be framed as a cash “gift,” investment, or as a large quantity of inventory. However, just because a company says it sells a product, doesn't guarantee it's legit—the FTC warns that some schemes can simply use claims of product sales to hide their pyramid structure.

No matter how high the promised pay-off, be wary of any opportunity that requires you pay to join, even if the fee appears small.

Remember to ask: “Are there upfront fees to join?”

2. You’re required to recruit new members to make money.

Multi-level marketing plans may give bonuses to reward distributors for bringing in new members, but there should always be the opportunity to earn an income from selling products alone.

On the other hand, pyramid schemes might masquerade as a legitimate business behind the sales of products. However, your compensation will actually be based on the recruitment of new members.

Be concerned if your income will be based mainly on the number of people you recruit, and the money those new recruits pay to join the company—not on the sales of products to consumers.

Remember to ask: “Can I make a sustainable profit just from selling the product, and without having to recruit a single person?” 

3. You’re being pressured to invest more.

No fees to join? A company may tell you that investing more of your cash by buying up inventory means the potential to earn more profit. While this can be true in any business, there should be no pressure for you to do so.

In a legitimate (and legal) multi-level marketing business, it’s sales to customers, not members, that should be able to sustain the company.

Watch out for opportunities that put pressure on you to invest more—particularly in the form of large amounts of product. This means that the company is making more money from internal sales, and not from actual customers.

Remember to ask: Does the company require that I buy inventory to qualify for a more senior position in the network or to receive bonus checks?

4. You’re asked to pay for training.

It’s not enough that a company provides you with a Youtube training video to help guide you through your first sales. A legitimate multi-level marketing company should have an official website with information as well as training that you can physically attend.

And, while seminars about leadership, motivation, and marketing techniques are useful, they should always be free—just like ordinary companies provide for their employees.

Remember to ask: “What kind of training will I receive, and is there any cost to do so?”

5. Your questions are never fully answered.

You’ve been told about the potential for high returns and heard their get rich quick claims, but still have some questions. This might include:

  • How long does it take to start making money?
  • How many distributors do you need to recruit to make money?
  • What is the average compensation for part-time involvement? Full-time?
  • Are the costs higher than the average compensation?
  • What’s the failure rate?

If you ask these questions (and you should), how a presenter responds is just as important as what they say. Were your questions answered clearly with sufficient examples or did the presenter try to dodge the question by changing topics?

Because pyramid schemes depend on maintaining a high level of hype, asking questions at a seminar or meeting can cause that momentum to come to a halt. To discourage more questions, the presenter might try to discredit you or make a joke of your concerns. If this happens, consider your questions answered and run in the other direction.

Another sign of a pyramid scam is that promoters will work hard to convince you that it’s anything but, reassuring recruits that it’s “not a scam” and “not illegal”—a big red flag that it’s definitely both.

Remember, if you can’t get straight answers to any of your questions, you may want to consider another line of work.

How to Protect Yourself If You’re Recruited for a Pyramid Scam

If you’ve never been exposed to a pyramid scam, you’ve likely read all the information above and thought, “There’s no way that I'd ever fall for one of those!” You’re not alone—most people can’t believe that they’re fallen for a pyramid scam. In fact, we’re downright hardwired to believe that we’re too smart for such shenanigans.

Related: Cognitive Biases: How Your Brain Affects What You Buy

However, having actually been to one of these things, it’s my experience that there are so many layers of psychological swindling happening that it’s downright disorienting. For that reason, should you ever find yourself being pressured to invest in an opportunity that gives you a case of the doubts, remember these tips to protect yourself:

Know how you’ll make your money.

Remember that pyramid schemes are loosely defined as basing commissions off of recruitment, not sales. But, that doesn’t mean that there won’t be products involved. It’s up to you to learn what percentage of your income will come from sales to customers outside the company, and how much will depend on bringing in new members.

Learn about the products.

If there aren’t any products to sell, then it’s definitely a pyramid scheme! But, that doesn’t mean all products are worth selling. Consider, is there a demand for the product? If so, are there already other products on the market to meet this demand? How does the pricing of your products compare to the competition? Are other companies selling this product doing well?

Be wary of any opportunity that claims you’ll get rich quick, or for little effort.

If high returns and fast cash exist, it’s likely that those commissions are being paid by recruiting new members, and not the sale of actual products.

Most importantly, remember that genuinely good opportunities don’t require others to be convinced, nor are they generally marketed through family and friends.

Bottom Line: Honest Opportunities Don’t Lead With a Defense

People selling legitimate products and services don’t start off by telling you what their business is not. They don’t have to, because they’re generally too busy selling you on what value they can provide.

Pyramid scams by any name work the opposite way: They try to dazzle you with too-good-to-be-true promises while simultaneously reassuring you nothing suspicious is going on. Even the friends and family that recruit you are likely not being totally honest about their earnings, but instead feel pressured to claim that the money is coming in so as not to scare off new recruits.

Bottom line: The only real way to earn money is working for it, not scamming someone else into handing over their savings. If you find yourself introduced to one of these schemes, run the other way—and do your best to take your friends and family with you.

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