Ponzi and Pyramid Schemes

The real pitch, however, is that participants can reap huge profits by bringing others into the fold, earning commissions from those who bite. The next layer of recruits is supposed to go out and bring in more people, and so on, with a cut of all the fees flowing to those at the top.

Many pyramid schemes resemble multilevel marketing (MLM) businesses, which also involve a chain of adding new people to the operation. The key difference is that while a legitimate MLM focuses on bringing in people to sell the product, pyramid promoters emphasize the recruitment itself.

One hallmark of a pyramid scheme is that its leaders describe what is supposed to be the actual business — common examples include e-books, online advertising and unspecified “tech” services — in vague, fancy-sounding terms, to conceal that the company doesn’t really sell anything at all. Another is that, like Ponzi schemes, they eventually collapse, leaving investors holding the bag.

One more similarity: Both scams often take the form of “affinity fraud.” The bad actors are, or pose as, members of a closely knit group — for example, a religious congregation, ethnic community or social organization. They ingratiate themselves with respected members of the group and exploit those relationships to convince others that a sham moneymaking strategy is legitimate, perhaps dressing it up as an “investment club” or “gift program.”

Warning Signs

• An investment broker or financial adviser guarantees an abnormally high rate of return on your investment.
• A promoter or marketer promises easy money for selling a product or service.
• A supposed marketing, business or investment opportunity is predicated on you recruiting others into the program and collecting commissions on them.

How to protect yourself from this scam

• Do check out a broker’s or adviser’s background before investing. Use tools like the SEC Action Lookup and BrokerCheck, a database maintained by the Financial Industry Regulatory Authority (FINRA), for information on employment history, licensing status, and complaints and cases against a broker or firm.
• Do be wary of ploys to get you in the door, such as offering a free meal for attending an “investment seminar.”
• Do resist high-pressure sales tactics. Shady brokers will try to convince you that you’ll miss a once-in-a-lifetime opportunity if you don’t act fast. Take as much time as you need to decide if an investment is right for you.
• Do insist someone promoting a hot marketing or sales outfit provides financial statements audited by a certified public accountant (CPA) showing the company makes its money from selling products or services, not from continually luring in new members.

• Don't believe the hype. No investment is "risk-free" and there's no such thing as a "guaranteed return."
• Don’t agree to invest based solely upon another investor’s recommendation, no matter how trustworthy that person seems. They may have been misled.
• Don’t invest in a complex moneymaking strategy that you don’t completely understand.
• Don’t invest with an adviser or firm that isn’t registered with the SEC or state regulators. When a company is registered, you can access information about its management, products, services and finances.
• Don’t trust a marketing or business opportunity in which your earnings are based mostly or entirely on recruiting others.
• Don’t join a company that requires you to keep paying for new inventory of products just to remain active or qualify for bonuses or rewards.

More Resources

• Report suspected Ponzi or pyramid schemes to:
  • the SEC via its online tips, complaints and referrals system
  • the Federal Trade Commission, online or at 877-382-4357
  • your state’s securities regulator
• Call the SEC’s Office of Investor Education and Advocacy at 800-732-0330 for resources and tools to help you invest wisely and avoid fraud.
• Older investors concerned about possible mishandling of their accounts can get help by calling the FINRA Securities Helpline for Seniors at 844-574-3577.