A pyramid scheme is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme, often without any product or service being delivered.
The unsustainable geometric progression of a classic pyramid schemeConcept and basic models
A successful pyramid scheme combines a fake yet seemingly credible business with a simple-to-understand yet sophisticated-sounding money-making formula. The essential idea is that the mark, 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. Clearly, 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. Of course, the worst off are at the bottom of the pyramid: those who subscribed to the plan, but were not able to recruit any followers themselves.
Some network or multi-level marketing businesses, which sell real products and rely on the price differentials between the manufacturer's dispatch ramp and the retail counter, may verge on the borderline between "smart" and "scam". When a pyramid does involve a real product, such as Holiday Magic cosmetics in the United States in the 1970s, new "dealers" who've paid enrolling fees are encouraged, in addition to selling their products, to become "managers" and recruit more new "dealers" who will also pay enrolling fees. As the number of layers of the pyramid increases, new recruits find it harder and harder to sell the product because there are so many competing salespeople. Those near or at the top of the pyramid make a lot of money on their percentage of the enrolling fees and on commissions for the supplied products, but those at the bottom are left with inventories of products they can't sell.
"8-ball" model
The "8-ball" model contains a total of 15 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.
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.
Prior instances of this scam 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 labelled 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 "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 scams such as the "Women Empowering Women" do exactly this. Joiners may even be told that "gifting" is a way to skirt around tax laws.
Whichever euphemism is used, there are 15 total people in four tiers (1 + 2 + 4 + 8) in the scheme - 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. $1000) to join the scheme. This sum (e.g. $8000) 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 exit the scheme as a captain. This requires that 14 others have been persuaded to join underneath them.
Therefore, the bottom 3 tiers of the pyramid always lose their money when the scheme finally collapses. Consider a pyramid consisting of tiers with 1, 2, 4, 8, 16, 32, and 64 members. The highlighted section corresponds to the previous diagram.
No matter how large the model becomes before collapse, approximately 88% of all people will lose.
If the scheme collapses at this point, only those in the 1, 2, 4, and 8 got out with a return. The remainder in the 16, 32, and 64 tier lose everything. 112 out of the total 127 members or 88% lost all of their money.
During a wave of pyramid activity, a surge frequently develops once a significant fraction of people know someone personally who exited with a $8000 payout for example. This spurs others to seek to get in on one of the many pyramids before the wave collapses.
The figures also hide the fact that the confidence trickster would make the lion's share of the money. They would do this by filling in the first 3 tiers (with 1, 2, and 4 people) with phoney names, ensuring they get the first 7 payouts, at 8 times the buy-in sum, without paying a single penny themselves. So if the buy-in were $1000, they would receive $56,000, paid for by the first 56 investors. They would continue to buy in underneath the real investors, and promote and prolong the scheme for as long as possible in order to allow them to skim even more from it before the collapse.
Other cons may also be effective. For example, rather than using fake names, a group of seven people may agree to form the top three layers of a pyramid without investing any money. They then work to recruit eight paying passengers, and pretend to follow the pyramid payout rules, but in reality split any money received. Ironically, though they are being conned, the eight paying passengers are not really getting anything less for their money than if they were buying into a 'legitimate' pyramid which had split off from a parent pyramid. They truly are now in a valid pyramid, and have the same opportunity to earn a windfall if they can successfully recruit enough new members and reach captain. This highlights the fact that by 'buying' in to a pyramid, passengers are not really obtaining anything of value they couldn't create themselves other than a vague sense of "legitimacy" or history of the pyramid, which may make it marginally easier to sell passenger seats below them.
Matrix schemes
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..
Notable recent cases
Internet
In 2003, the United States Federal Trade Commission (FTC) disclosed what it called an internet-based "pyramid scam". Their complaint states that customers would pay a registration fee to join a program 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 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.
Pyramid schemes may use email to persuade others that they are multi-level marketing (MLM) business plans. MLM plans—such as Amway, ACN, Mary Kay, Tupperware, and Avon Products—are sometimes criticized, but remain legal by offering genuine products; pyramid schemes do not.
Others
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 8-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. Ireland has launched a website to better educate consumers to pyramid schemes and other scams.
On November 12, 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 economical emergency in order 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".
November 2008: The Kyiv Post reported on November 26th 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 $20 Million USD (Kiev Post also reports that some estimates are as high as $150M USD).
In early 2008, allegations of cheating were made against QuestNet India based on an unverified complaint from a single customer which received intense media attention leading to mass panic among the public. Many customers filed complaints against the company and the MD of Questnet India, Ms. Pushpam was taken into police custody where she remained for five months. Based on media reports, it is learnt that various allegations have been made about the company having defrauded people of several hundred crores of rupees. Police in Tamilnadu state are currently investigating the complaints and Ms.Pushpam has been released on bail. No charge sheet has been filed against the company so far. The company has denied all allegations against it and has stated repeatedly through advertisements in newspapers that it runs a legitimate network marketing business. The company has pointed out that due to lack of any legislation governing network marketing, direct sales or Multi-Level marketing industries in India, there is a lack of awareness about the business model and hence is open to misinterpretation and misrepresentation that leads to complaints from customers who do not fully understand what they are signing up for.
Currently in the United States and Canada a so-called multi-level marketing company by the name of Fortune Hi-Tech Marketing (FHTM) has been operating. A representative pays an initial fee from $75USD to $399CAN as well as an extra fee for the use of specialized software to keep track of the representative's "business", mostly a tracking program for the various other people the rep has convinced to pay into the scheme for their own benefit. Reps are given a variety of mixed-media presentations, mostly PowerPoint presentations and web articles, and are encouraged to go out and recruit three people. Each of these reps recruits three more, and the pyramid grows. Reps are paid a small portion of each subsequent level's fees and so accumulate a large amount of income for as long and the pyramid can be maintained. At certain points along the pyramid "bonuses" are handed out, culminating in the ultimate prize of a new car.
The attraction of this scheme is that several persons have actually managed to accumulate real prizes, but this does not alter the fact that thousands of other people had to pay in their fees for that one person to get a car. Supposedly the company is a word of mouth marketing plan, with each representative getting discounts on products and services with various brands and chains. Most of these brands and chains are US-based and so no tangible benefit is available to many Canadian representatives, forcing them to seek recompense for their fees via selling the scheme to others (often family and friends).
As of this update, FHTM has nearly three dozen open cases with the Better Business Bureau of Canada (where the company is rated F) and several closed-case legal suits against individual representatives in the United States.
