Pyramid scheme

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The unsustainable exponential progression of a classic pyramid scheme

A pyramid scheme is an unsustainable business model that involves promising participants payment or services, primarily for enrolling other people into the scheme, rather than supplying any real investment or sale of products or services to the public.[1][2]

Various forms of pyramid schemes are illegal in many countries including Albania, Australia,[3][4] Austria,[5] Brazil, Canada, China,[6] Colombia,[7] Denmark, the Dominican Republic,[8] Estonia,[9] France, Germany, Hong Kong,[10] Hungary, Iceland, Iran,[11] Italy,[12] Japan,[13] Malaysia, Mexico, Nepal, the Netherlands,[14] New Zealand,[15] Norway,[16] the Philippines,[17] Poland, Portugal, Romania,[18] Russian Federation, South Africa,[19] Spain, Sri Lanka,[20] Sweden,[21] Switzerland, Taiwan, Thailand,[22] Turkey,[23] Ukraine,[24] the United Kingdom, and the United States.[25]

These types of schemes have existed for at least a century, some with variations to hide their true nature. Multilevel marketing plans have also been classified as pyramid schemes.[26][27][28][29]

Concept and basic models[edit]

A successful pyramid scheme combines a fake yet seemingly credible business with a simple-to-understand yet sophisticated-sounding money-making formula which is used for profit. The essential idea is that a "con artist" Mr. X, makes only one payment. To start earning, Mr. X has to recruit others like him who will also make one payment each. Mr. X gets paid out of receipts from those new recruits. They then go on to recruit others. As each new recruit makes a payment, Mr. X gets a cut. He is thus promised exponential benefits as the "business" expands.

Such "businesses" seldom involve sales of real products or services to which a monetary value might be easily attached. However, sometimes the "payment" itself may be a non-cash valuable. To enhance credibility, most such scams are well equipped with fake referrals, testimonials, and information.

The flaw is that there is no end benefit. The money simply travels up the chain. Only the originator (sometimes called the "pharaoh") and a very few at the top levels of the pyramid make significant amounts of money. The amounts dwindle steeply down the pyramid slopes. Individuals at the bottom of the pyramid (those who subscribed to the plan, but were not able to recruit any followers themselves) end up with a deficit.

The "Eight-Ball" model[edit]

Many pyramids are more sophisticated than the simple model. These recognize that recruiting a large number of others into a scheme can be difficult so a seemingly simpler model is used. In this model each person must recruit two others, but the ease of achieving this is offset because the depth required to recoup any money also increases. The scheme requires a person to recruit two others, who must each recruit two others, who must each recruit two others.

The "eight-ball" model contains a total of fifteen members. Note that unlike in the picture, the triangular setup in the cue game of eight-ball corresponds to an arithmetic progression 1 + 2 + 3 + 4 + 5 = 15. The pyramid scheme in the picture in contrast is a geometric progression 1 + 2 + 4 + 8 = 15.

Prior instances of this scheme have been called the "Airplane Game" and the four tiers labelled as "captain", "co-pilot", "crew", and "passenger" to denote a person's level. Another instance was called the "Original Dinner Party" which labeled the tiers as "dessert", "main course", "side salad", and "appetizer". A person on the "dessert" course is the one at the top of the tree. Another variant, "Treasure Traders", variously used gemology terms such as "polishers", "stone cutters", etc. or gems like "rubies", "sapphires", "diamonds", etc.

Such schemes may try to downplay their pyramid nature by referring to themselves as "gifting circles" with money being "gifted". Popular schemes such as "Women Empowering Women"[30] do exactly this.

Whichever euphemism is used, there are 15 total people in four tiers (1 + 2 + 4 + 8) in the scheme—with the Airplane Game as the example, the person at the top of this tree is the "captain", the two below are "co-pilots", the four below are "crew," and the bottom eight joiners are the "passengers".

The eight passengers must each pay (or "gift") a sum (e.g. $5,000) to join the scheme. This sum (e.g. $40,000) goes to the captain who leaves, with everyone remaining moving up one tier. There are now two new captains so the group splits in two with each group requiring eight new passengers. A person who joins the scheme as a passenger will not see a return until they advance through the crew and co-pilot tiers and exit the scheme as a captain. Therefore, the participants in the bottom three tiers of the pyramid lose their money if the scheme collapses.

If a person is using this model as a scam, the confidence trickster would make the lion's share of the money. They would do this by filling in the first three tiers (with one, two, and four people) with phony names, ensuring they get the first seven payouts, at eight times the buy-in sum, without paying a single penny themselves. So if the buy-in were $5,000, they would receive $40,000, paid for by the first eight investors. They would continue to buy in underneath the real investors, and promote and prolong the scheme for as long as possible to allow them to skim even more from it before it collapses.

Although the "captain" is the person at the top of the tree, having received the payment from the eight paying passengers, once they leave the scheme they are able to re-enter the pyramid as a "passenger" and hopefully recruit enough to reach captain again, thereby earning a second payout.

Matrix schemes[edit]

Matrix schemes use the same fraudulent non-sustainable system as a pyramid; here, the participants pay to join a waiting list for a desirable product which only a fraction of them can ever receive. Since matrix schemes follow the same laws of geometric progression as pyramids, they are subsequently as doomed to collapse. Such schemes operate as a queue, where the person at head of the queue receives an item such as a television, games console, digital camcorder, etc. when a certain number of new people join the end of the queue. For example, ten joiners may be required for the person at the front to receive their item and leave the queue. Each joiner is required to buy an expensive but potentially worthless item, such as an e-book, for their position in the queue. The scheme organizer profits because the income from joiners far exceeds the cost of sending out the item to the person at the front. Organizers can further profit by starting a scheme with a queue with shill names that must be cleared out before genuine people get to the front. The scheme collapses when no more people are willing to join the queue. Schemes may not reveal, or may attempt to exaggerate, a prospective joiner's queue position which essentially means the scheme is a lottery. Some countries have ruled that matrix schemes are illegal on that basis.

Connection to multi-level marketing[edit]

The network marketing or multi-level marketing (MLM) business has become associated with pyramid schemes. According to the U.S. Federal Trade Commission, many MLM schemes "simply use the product to hide their pyramid structure.".[31] While some people call MLMs in general "pyramid selling,"[32][33][34][35][36] others use the term to denote an illegal pyramid scheme masquerading as an MLM.[37]

The Federal Trade Commission warns, "It’s best not to get involved in plans where the money you make is based primarily on the number of distributors you recruit and your sales to them, rather than on your sales to people outside the plan who intend to use the products."[38] It states that research is your best tool and gives eight steps to follow:

  1. Find—and study—the company’s track record.
  2. Learn about the product.
  3. Ask questions.
  4. Understand any restrictions.
  5. Talk to other distributors. Beware of shills.
  6. Consider using a friend or adviser as a neutral sounding board, or for a gut check.
  7. Take your time.
  8. Think about whether this plan suits your talents and goals.[38]

Some authorities contend that MLMs in general are nothing more than legalized pyramid schemes.[26][27][28][29]

Connection to franchise fraud[edit]

Franchise fraud (or "franchise churning") is defined by the U.S. Federal Bureau of Investigation as a pyramid scheme. The FBI website states:

Pyramid schemes—also referred to as franchise fraud or chain referral schemes—are marketing and investment frauds in which an individual is offered a distributorship or franchise to market a particular product. The real profit is earned, not by the sale of the product, but by the sale of new distributorships. Emphasis on selling franchises rather than the product eventually leads to a point where the supply of potential investors is exhausted and the pyramid collapses.[39]

One of Pearlasia Gamboa’s (president of the micronation of Melchizedek) franchise fraud schemes was described by the Italian newspaper La Repubblica as “one of the most diabolical international scams ever devised in recent years.”[40]

Notable recent cases[edit]

Internet[edit]

In 2003, the United States Federal Trade Commission (FTC) disclosed what it called an Internet-based "pyramid scam." Its complaint states that customers would pay a registration fee to join a program that called itself an "internet mall" and purchase a package of goods and services such as internet mail, and that the company offered "significant commissions" to consumers who purchased and resold the package. The FTC alleged that the company's program was instead and in reality a pyramid scheme that did not disclose that most consumers' money would be kept, and that it gave affiliates material that allowed them to scam others.[41]

WinCapita was a scheme run by Finnish criminals that involved about €100 million.

Others[edit]

The 1997 rebellion in Albania was partially motivated by the collapse of Ponzi schemes; however, they were widely referred to as pyramid schemes due to their prevalence in Albanian society.

In early 2006, Ireland was hit by a wave of schemes with major activity in Cork and Galway. Participants were asked to contribute €20,000 each to a "Liberty" scheme which followed the classic eight-ball model. Payments were made in Munich, Germany to skirt Irish tax laws concerning gifts. Spin-off schemes called "Speedball" and "People in Profit" prompted a number of violent incidents and calls were made by politicians to tighten existing legislation.[42] Ireland has launched a website to better educate consumers to pyramid schemes and other scams.[43]

On 12 November 2008, riots broke out in the municipalities of Pasto, Tumaco, Popayan and Santander de Quilichao, Colombia after the collapse of several pyramid schemes. Thousands of victims had invested their money in pyramids that promised them extraordinary interest rates. The lack of regulation laws allowed those pyramids to grow excessively during several years. Finally, after the riots, the Colombian government was forced to declare the country in a state of economic emergency to seize and stop those schemes. Several of the pyramid's managers were arrested, and are being prosecuted for the crime of "illegal massive money reception."[44]

The Kyiv Post reported on 26 November 2008 that American citizen Robert Fletcher (Robert T. Fletcher III; aka "Rob") was arrested by the SBU (Ukraine State Police) after being accused by Ukrainian investors of running a Ponzi scheme and associated pyramid scam netting US$20 million. (The Kiev Post also reports that some estimates are as high as US$150M.)

Throughout 2010 and 2011 a number of authorities around the world including the Australian Competition and Consumer Commission, the Bank of Namibia and the Central Bank of Lesotho have declared TVI Express to be a pyramid scheme. TVI Express, operated by Tarun Trikha from India has apparently recruited hundreds of thousands of "investors", very few of whom, it is reported, have recouped any of their investment.[45][46][47][48][49] In 2013, Tarun Trikha was arrested at the IGI Airport in New Delhi.[50]

In popular culture[edit]

  • Stanton, a character of Charles Maturin's famous novel Melmoth the Wanderer, while put in Bedlam by his relative, finds a plan, written by some of his predecessors in the room he is placed. It is a plan of baptising all the population of Ottoman Empire, beginning with the Turkish ambassador, and is a classical pyramid scheme.
  • The feature film Children of Invention tells the story of a mother who gets entangled in a pyramid scheme.
  • The novel Welcome to the N.H.K. features a story arc wherein the main character is caught up in a crooked multi-level marketing scam called Mouse Road.
  • On the NBC sitcom The Office, it is revealed that Michael did not attend college because he lost all his tuition money in a pyramid scheme. At a later date, the same character unintentionally attempts to recruit members of his staff into selling calling cards, not realizing that he had been conned into a pyramid scheme until it is made clear by an employee.
  • Season one of the Channel 4 sitcom Peep Show, features an episode in which Jeremy becomes involved in a pyramid scheme after being ignorantly drawn into it by his neighbor Toni, whom he is trying to seduce.
  • The 2010 film The Fighter features Dicky Eklund attempting a pyramid scheme to help pay for his brother's training.
  • In two episodes of the sitcom Two and a Half Men entitled "Three Hookers and a Philly Cheesesteak" and "That Darn Priest", Alan runs a Ponzi scheme, targeting family and friends, in the name of his chiropractor business until Rose finds out and threatens to tell all his investors if he does not stop.
  • In 2014, 62 artists in Brooklyn, New York created a pyramid scheme as new way of curating a contemporary art exhibit. "The Pyramid Scheme will not only reveal patterns and themes within contemporary art, but the social support structures which enable its creation."[51]

See also[edit]

References[edit]

  1. ^ Common Fraud Schemes: Pyramid Scheme Federal Bureau of Investigation
  2. ^ Debra A. Valentine (1998-05-13). "Pyramid Schemes". United States Federal Trade Commission. Retrieved 2010-09-01. 
  3. ^ "Pyramid schemes". Australian Competition and Consumer Commission. Retrieved 2012-04-08. 
  4. ^ "Competition and Consumer Act 2010 - Schedule 2, Division 3 - Pyramid schemes". Austlii.edu.au. Retrieved 2013-04-02. 
  5. ^ Trade Practices Amendment Act (No. 1) 2002 Trade Practices Act 1974 (Cth) ss 65AAA - 65AAE, 75AZO
  6. ^ "Regulations for the Prohibition of Pyramid Sales". Tradeinservices.mofcom.gov.cn. Retrieved 2013-04-02. 
  7. ^ "Colombia scam: 'I lost my money'". BBC News. November 18, 2008. Retrieved April 12, 2010. 
  8. ^ "Proyecto De Ley Que Prohíbe La Venta Bajo El Esquema Piramidal" (in Spanish). 
  9. ^ "Tarbijakaitseseadus" [The Consumer Protection Law of Estonia] (in Estonian). §12³(8) #14. Retrieved October 11, 2010. 
  10. ^ "''Pyramid Schemes Prohibition Ordinance''" (PDF). Retrieved 2013-04-02. 
  11. ^ "Key GoldQuest members arrested in Iran Airport". Presstv.ir. Retrieved 2013-04-02. 
  12. ^ Legge 17 agosto 2005, n. 173 (Italian)
  13. ^ 無限連鎖講の防止に関する法律 (in Japanese)
  14. ^ "Sentence by the High Council of the Netherlands regarding a pyramid scheme". Zoeken.rechtspraak.nl. Retrieved 2013-04-02. 
  15. ^ Laws and Regulations Covering Multi-Level Marketing Programs and Pyramid Schemes Consumer Fraud Reporting.com
  16. ^ "Lovdata.no". Lovdata.no. Retrieved 2013-04-02. 
  17. ^ NYtimes.com, "Investors in Philippine Pyramid Scheme Lose over $2 Billion"
  18. ^ Explozia piramidelor Ziarul Ziua, 12.07.2006
  19. ^ Whitecollarcrime.co.za, Pyramid Schemes
  20. ^ Pyramid Schemes Illegal Under Section 83c of the Banking Act of Sri Lanka Department of Government Printing, Sri Lanka
  21. ^ lagen.nu - Tillkännagivande (2008:487) med anledning av marknadsföringslagen (2008:486)
  22. ^ TDSA.gov, ข้อมูลเพิ่มเติมในระบบธุรกิจขายตรงและธุรกิจพีระมิด by Thai Direct Selling Association (in Thai)
  23. ^ "Saadet zinciri operasyonu: 60 gözaltı". Cnnturk.com. 2010-05-14. Retrieved 2013-04-02. 
  24. ^ Rada at first reading passes bill on banning financial pyramid schemes in Ukraine, Interfax-Ukraine (20 November 2013)
  25. ^ [1] Debra A. Valentine, General Counsel, Federal Trade Commission
  26. ^ a b Carroll, Robert Todd (2003). The Skeptic's Dictionary: A Collection of Strange Beliefs, Amusing Deceptions, and Dangerous Delusions. Wiley. p. 235. ISBN 0-471-27242-6. 
  27. ^ a b Coenen, Tracy (2009). Expert Fraud Investigation: A Step-by-Step Guide. Wiley. p. 168. ISBN 0-470-38796-3. 
  28. ^ a b Ogunjobi, Timi (2008). SCAMS - and how to protect yourself from them. Tee Publishing. pp. 13–19. 
  29. ^ a b Salinger (Editor), Lawrence M. (2005). Encyclopedia of White-Collar & Corporate Crime 2. Sage Publishing. p. 880. ISBN 0-7619-3004-3. 
  30. ^ Tracy McVeigh (2001-08-05). "Pyramid selling scam that preys on women to be banned". Guardian. Retrieved 2013-04-02. 
  31. ^ "Pyramid Schemes", May 13, 1998, Federal Trade Commission
  32. ^ Edwards, Paul (1997). Franchising & licensing: two powerful ways to grow your business in any economy. Tarcher. p. 356. ISBN 0-87477-898-0. 
  33. ^ Clegg, Brian (2000). The invisible customer: strategies for successive customer service down the wire. Kogan Page. p. 112. ISBN 0-7494-3144-X. 
  34. ^ Higgs, Philip; Smith, Jane (2007). Rethinking Our World. Juta Academic. p. 30. ISBN 0-7021-7255-3. 
  35. ^ Kitching, Trevor (2001). Purchasing scams and how to avoid them. Gower Publishing Company. p. 4. ISBN 0-566-08281-0. 
  36. ^ Mendelsohn, Martin (2004). The guide to franchising. Cengage Learning Business Press. p. 36. ISBN 1-84480-162-4. 
  37. ^ Blythe, Jim (2004). Sales & Key Account Management. Cengage Learning Business Press. p. 278. ISBN 1-84480-023-7. 
  38. ^ a b Facts for Consumers; The Bottom Line About Multilevel Marketing Plans and Pyramid Schemes Federal Trade Commission
  39. ^ "FBI — Common Fraud Schemes". Fbi.gov. Retrieved 2013-04-02. 
  40. ^ “A trap of luxury for the victims of one of the most diabolical international scams ever devised in recent years”, “Dominion of Melchizedek” Ghost State, (”una trappola di lusso per le vittime di una delle piu diaboliche truffe internazionali mai escogitate negli ultimo anni”, 'Dominio di Melchizedek' Stato Fantasma Sull), La Repubblica, Massimo Lugli, March 15, 2002 (15 maggio 2002), page 5 (pagina 5), Section:Rome, (sezione: ROMA), [2]
  41. ^ FTC Charges Internet Mall Is a Pyramid Scam Federal Trade Commission
  42. ^ Gardaí hold firearm after pyramid scheme incident Irish Examiner
  43. ^ "National Consumer Agency Ireland". Consumerconnect.ie. Retrieved 2013-04-02. 
  44. ^ Colombians riot over pyramid scam. Colombia: BBC news. Nov 13, 2008. 
  45. ^ ACCC obtains restraining orders against operators of alleged pyramid selling scheme TVI Express Australian Competition and Consumer Commission
  46. ^ BoN warns public about TVI Express Bank of Namibia
  47. ^ BoL warns public about TVI Express Bank of Lesotho
  48. ^ South African Sunday Times on TVI Express South African Sunday Times
  49. ^ Consumer Watchdog Botswana on TVI Express Consumer Watchdog Botswana
  50. ^ "Trikha family to be investigated in online TVI Express scam". MailOnline India. 2013-04-20. Retrieved 2013-07-24. 
  51. ^ http://blogs.artinfo.com/artintheair/2014/01/29/artist-made-pyramid-scheme-hits-sunset-park/
  • The Fraudsters: How Con Artists Steal Your Money, Chapter 9, "Pyramids of Sand" (ISBN 978-1-903582-82-4) by Eamon Dillon, published September 2008 by Merlin Publishing, Ireland

External links[edit]