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What Is A Pyramid Scheme?

It is illegal.

Pyramid schemes are scams. They are promoted by con artists as money-making or wealth-sharing opportunities. They are illegal in all 50 states and violate federal laws.

It will fail. More than 99% of people who join pyramid scheme receive no rewards and often lose money.

The criminals who promote pyramid schemes almost always focus on getting new members into the scheme. Without fail, pyramid schemes will eventually collapse because the profits depend on recruiting new members into the scheme and, sooner or later, every scheme runs out of new recruits. The only people who may profit in a pyramid scheme are the people at the very top of the pyramid. Globally, pyramid schemes affect millions of people and cause tens of billions of dollars in losses every year.

It's been around for a long time.

Remember chain letters? In the past, pyramid schemes often operated via chain letters sent through the mail, preying on relationships between friends and family, members of a religious congregations, or business partners.

But it's changing.

On the Internet, pyramid schemes have changed shape and multiplied thanks to the ease and low cost of using email, social networking sites, chat rooms, and message boards. This makes it more important than ever for consumers to learn how to spot pyramid schemes and avoid becoming victims of them.

Ponzi Schemes

Ponzi schemes are named after Charles Ponzi, the first guy who ran the scams. The term has been getting more public attention lately due to the investment scheme allegedly run by Bernard Madoff.  

Ponzi schemes are fraudulent investment operations where investors are promised (and some actually paid) unusually high returns -- out of the money paid in by subsequent investors. Dividends come from investors buying in, rather than from the profits by any actual business. Sound familiar?

Unlike a classic pyramid scheme, investors in the scheme may not realize that their returns are based on investments made by others, and they may not be required to actively recruit others into the scheme. They are told -- and many may believe that -- their money is being invested in some kind of legitimate investment.

Signs of a Ponzi scheme:

• The schemer acts as a “hub” for the victims, interacting with all of them directly, rather than top-down, through others.

• It may involve some esoteric investment approach and insider connections, and often attracts well-to-do investors.

• These schemes can sometimes survive for long periods of time. Successful Ponzi schemers will convince the investors that returns are on the way and they should invest more. That money is used to cycle around to other investors to keep them participating.

To learn more about Charles Ponzi and Ponzi schemes, visit the Securities & Exchange Commission.

Gifting Schemes (Blessing Schemes, Gifting Clubs)

Gifting schemes are a type of pyramid that prey on people who want to know that their “investment” is going to help others, even while returning a huge profit back to them.

They usually combine some promoted connection to a charity or community fund with large up-front investments, often more than $1,000. “Investors” are promised large payouts (many times what they put in) when they recruit enough people. They are assured that their money is also going to help others.

The truth is that even if there is a legitimate charitable cause involved, often very little money goes to the charity. Like all pyramids, these schemes are doomed to collapse, leaving all but those at the very top of the pyramid holding the bag.

In the early 2000s, a number of these gifting schemes (operating under names like “Women Helping Women,” “The Dinner Party” and “The Spirit of Giving”) were the target of investigations and arrests across the country. For more information about these schemes, check your state Attorney General's Web site or your local or state consumer protection/consumer affairs office.