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Pyramid schemes: What they are and how to avoid them

Frauds and scams have been with us for thousands of years.

They are not always easy to spot, but once you know the signs (and the signs tend to be similar no matter the type of scam), you can start asking the right questions.

What is a pyramid scheme?

If you find yourself getting involved in a business venture that involves being recruited and then paying to join its salesforce, you may or may not be involved in a scam; it depends on whether that salesforce is being formed to sell a real product, service, or investment … or whether it is just taking your money to pay earlier recruits.

The latter is a true pyramid scheme—that is, a hierarchy business in which the only income is coming from new recruits who provide the "earnings" to those above them. These are illegal.

Oftentimes, the recruits themselves do not know that there is nothing actually being sold; that is part of how the originator designs it. The scheme may claim that there is one, but it will be vague or evasive about what it is. It may use sophisticated-sounding language to create a sense of legitimacy; for example, a scheme involving investments might call itself a "high-yield investment program."

A true, illegal pyramid scheme will inevitably collapse. Since it is not generating wealth from a product, service, or investment, its only income can come from additional recruits, and there are not enough people in the world for that.

Not all pyramid businesses are scams, however. Multi-level marketing, for example, uses a pyramid structure to recruit a salesforce in order to sell a real product or service to people outside the program. Also, not all pyramid schemes start out illegal; some morph into illegal ones over time.

How can you spot one?

Pyramid schemes are not always easy to spot. Regulators have to analyze them to discover how their compensation system works. Here are some typical signs:

  • You are expected to continually recruit new sellers and buyers to keep the pyramid alive.

  • It focuses much more on recruiting than on the product or service.

  • You are paid for recruiting new people.

  • A membership fee is required to participate.

  • For a small amount of work, you are promised sky-high profits.

  • If products are offered, they cost more than similar ones on the market.

  • The operation makes unrealistic claims about the product or service.

  • The company does not appear to have a permanent location.

  • The company does not seem to have a customer base.

Pyramid Scheme
Pyramid Scheme

If you have been scammed

If you suspect a pyramid scheme, research the company online to see if there are any warnings about it: type the company's name into a search engine along with the word complaints. Check with the Better Business Bureau. Check with the Federal Trade Commission here.

If you need to launch a complaint, you have several resources at your disposal:

  • The FBI: www.fbi.gov, or (202) 278-2000

  • The FTC: ftc.gov/complaint or 1-877-FTC-HELP

  • Your state's attorney general: www.naag.org, or 202-326-6000

  • The U.S. Postal Inspection Service: https://postalinspectors.uspis.gov/, or 1-877-876-2455

Dive deeper: Pyramid schemes, elder fraud, and more: How to avoid scams

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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