Ponzi Schemes vs Pyramid Schemes
Ponzi schemes and pyramid schemes typically promise their victims outsized returns on their initial investments or buy-ins. (No matter the type of investment, huge returns should always be a red flag.) Both schemes rely on bogus investment gains and eventually collapse, leaving their investors with huge losses.
Beyond these similarities, each scheme has a distinct hallmark.
- Pyramid schemes rely on charging new recruits buy-in fees to generate money. Only early participants – the ones at the top of the pyramid – ever see a return on their initial buy-in. By the time new participants are cold-messaging contacts on social media, the pyramid scheme is usually over-saturated and running out of potential recruits.
- Ponzi schemes market themselves as a typical investment vehicle – like a hedge fund or a cryptocurrency platform – and use new influxes of cash to pay off previous investors. The fraudster behind the Ponzi scheme keeps the bulk of the funds for themselves, often funding a lavish lifestyle.
Are Pyramid Schemes Illegal?
Pyramid schemes and Ponzi schemes are both illegal. Soliciting investments in a Ponzi scheme is a felony. If you suspect a Ponzi scheme or a pyramid scheme, submit a tip to the Securities and Exchange Commission (SEC). Tips that lead to final judgments or awards may come with a financial award for the whistleblower.
What’s a Pyramid Scheme?
Pyramid schemes are illegal businesses that rely on buy-in fees and recruiting to generate income, rather than a legitimate product. Recruiting is most recognizable feature of a pyramid scheme. Pyramid scheme recruiters tout the scheme as an opportunity to make a reliable, passive income and work from home. In reality, the pyramid scheme will eventually run out of new people to recruit, leading to its inevitable collapse.
How Does a Pyramid Scheme Work?
To make money, recruiters must find new participants. The new recruit’s buy-in fees are passed along to their recruiter. Part of that payment is funneled to the person who recruited them, and so on, eventually funneling money all the way to the individuals at the top of the pyramid. Recruiters are known as an “upline,” and their recruits are the “downline.”
What is the Difference Between a Pyramid Scheme and an MLM?
Pyramid schemes are also often confused with multi-level marketing companies (MLMs). Unlike pyramid schemes, MLMs are legal – although recruits should be aware that the FTC has revealed certain supposed MLMs to be illegal pyramid schemes. MLMs focus on a product, like essential oils or beauty supplies, which offers their businesses an air of legitimacy.
How Does a Ponzi Scheme Work?
Ponzi schemes typically promise investors a unique investment strategy that will result in huge returns in a short period of time. Descriptions of the money-making strategy may be extremely vague or difficult to understand. Without a clear strategy or product to sell, investors should be extremely wary. In reality, Ponzi schemes do not work – they only appear to work, as investors receive payments generated from new investors. Behind the scenes, the person operating the Ponzi scheme is absconding with the vast majority of the investors’ funds.
What’s the Difference Between a Pyramid Scheme and a Ponzi Scheme?
Both schemes require new investors or recruits to keep the fraud going. Without new influxes of cash, both Ponzi schemes and pyramid schemes inevitably collapse. That said, the methods behind these frauds are different and come with distinct red flags.
Referrals for Pyramid Schemes vs. Ponzi Schemes
Instead of an investment or a product, pyramid schemes focus on getting as many new recruits as possible, since new participants are the only real source of revenue for the company. Ponzi schemes may encourage participants to refer new investors, but they do not necessarily offer compensation for new recruits. There is no hierarchy of recruiters in a Ponzi scheme.
Participants in pyramid schemes will eventually realize they are not seeing the profits they were promised. It can be extremely difficult to recover money from a pyramid scheme or a Ponzi scheme, unless the investor was recommended the Ponzi scheme by a broker or financial adviser, in which case brokerage firms may be found liable for losses through FINRA arbitration.
Individuals can sue a pyramid scheme recruiter, but once the pyramid scheme collapses, almost everyone involved loses their entire investment–even if the fraud victim wins in court, they will have a difficult time collecting.
If an individual no longer wishes to participate in a Ponzi scheme, the individual running the scheme may simply return their capital using money they received from newer investors. Once the Ponzi scheme has dissolved, it can take years to recover any portion of the original investment, if any recovery is possible. There are legal strategies that can help–in the Bernie Madoff case, victims recovered money through “clawback” lawsuits, which go after financial institutions that attorneys allege should have noted the red flags of a Ponzi scheme.
Penalties for Pyramid Schemes and Ponzi Schemes
The SEC has charged 11 individuals in connection with their promotion of Forsage, a “fraudulent crypto pyramid and Ponzi scheme that raised more than $300 million from millions of retail investors worldwide.” The SEC alleges that Forsage employed tactics of both schemes, generating money through new recruits and using money from new investors to pay previous investors. The charged individuals have agreed to civil penalties as well as payment to the allegedly defrauded investors.
FINRA has barred a broker following allegations that she sold investment contracts as part of a pyramid scheme called Wealth Pool International – a pyramid scheme that FINRA alleged masqueraded as an MLM. Wealth Pool International (WPI) claimed to make money by selling English and Spanish language tutorial DVDs. The SEC alleges that the WPI actually made money by convincing investors to join investment pools. Furthermore, the brokers allegedly failed to inform her firm of this outside business activity, which is another violation of FINRA rules.
Not only can brokers get in trouble with FINRA for participating in Ponzi schemes–FINRA will also penalize brokers who fail to investigate outside investments that could turn out to be fraudulent investments. In 2017, FINRA fined a compliance officer with Whitehall-Parker Securities following allegations that the officer failed to investigate the outside business of one of the firm’s brokers. That outside business was Woodbridge Group, an alleged $1.3 billion Ponzi scheme. The compliance officer allegedly should have caught on that Woodbridge investment constituted private securities transactions, sold away from Whitehall-Parker. Selling away is against FINRA regulations precisely because these outside investments are often highly risky.
Our Ponzi Scheme Attorneys Can Help
If your broker recommended an investment that turned out to be a pyramid scheme or a Ponzi scheme, our investment attorneys can help. Reach out today–even if you are not certain why you lost money, our attorneys provide free case evaluations and advise you on the next steps to take. Call (877) 600-0098 or email email@example.com.