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If a plan offers to pay commissions for recruiting new distributors, watch out! Most states outlaw this practice, which is known as "pyramiding." State laws against pyramiding say that a multilevel marketing plan should only pay commissions for retail sales of goods or services, not for recruiting new distributors.
Why is pyramiding prohibited? Because plans that pay commissions for recruiting new distributors inevitably collapse when no new distributors can be recruited. And when a plan collapses, most people -- except perhaps those at the very top of the pyramid -- lose their money.
A pyramid scheme is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme, usually without any product or service being delivered. Pyramid schemes have existed for at least a century. In addition, other methods of conducting business known as multi-level marketing (MLM) and as "matrix schemes" often closely resemble pyramid schemes (although unlike pyramid schemes, which are almost always frauds, MLM and matrix schemes are in many cases regarded — at least legally — as legitimate business methods).
Most pyramid schemes are attempts to confuse potential consumers into complicated but convincingly fool-proof money making scams. The essential idea behind each scam is that the individual only makes one payment, but somehow they are promised to receive exponential benefits from other people as a reward. A common example might be that a victim is enticed with an offer that, for a fee, allows them to sell the same offer to other people. Each sale includes a fee to the original seller. Clearly, the fundamental flaw is that there is no end benefit; the money simply travels up the chain, and only the originator wins in swindling his followers. Furthermore, the people in the worst situation are the ones at the bottom of the pyramid: those who subscribed to the plan, but were not able to accrue any followers themselves. To embellish the act, most such scams will have fake referrals, testimonials, and information.
Although pyramid schemes have been declared illegal in many countries, they still persist in various forms.
Ponzi and Pyramid schemes as defined by SEC
THE MANY FACES OF PONZI
Charles Ponzi, born c.1882, emigrated, from Italy in 1903. At first he went to Canada where he was convicted of forgery in 1909. He served a brief prison term there and almost immediately upon his release he was arrested for smuggling aliens into the United States. He was convicted and did time in an Atlanta prison.
In 1920, Ponzi developed his postal coupon scheme which, it is purported, had collected nearly $10,000,000 from around 10,000 investors. The scheme, according to the N.Y. Times, July 30, 1920, page 1, column 7, went something like this.
Ponzi claimed that he was considering publishing an export magazine. He communicated with a man in Spain regarding this magazine. The man sent him an international exchange coupon that he was to redeem for American postage stamps and he was to use these stamps to forward a copy of the magazine to Spain. Ponzi found out that the coupon in Spain cost the equivalent of about one-cent in American money for which he got six cents in stamps here. He claimed that he furtherly investigated the rates of exchange of “coupon-for-stamps” in other counties, as well, and because those rates were also favorable, he began his “investment program” in a small and limited way. He offered his program to some of his friends; $150 return in ninety days for every $100 invested. Although he promised a return in ninety days he began paying in forty-five days.
Ponzi officially opened his postal coupon business in December 1919, by establishing his company “The Securities Exchange Company”. Through his company he issued notes of different colors to thwart problems he was having with forgers. These notes appeared with the following text:
The Securities Exchange Company, for and in consideration of the sum of exactly $1000 of which receipt is hereby acknowledged, agree to pay to the order of ____________, upon presentation of this voucher at ninety days from date, the sum of exactly $1500 at the company’s office, 27 School Street, room 227, Boston, Massachusetts or at any bank.
The Securities Exchange Company
Per Charles Ponzi
Ponzi borrowed $200 from Joseph Daniels, a furniture dealer, in order to start his Securities Exchange Company. Although Ponzi repaid Daniels in full, Daniels insisted that he was to share one-half of all future profits as part of the loan agreement. Later when Ponzi refused to acknowledge Daniels as a fifty-percent partner, Daniels retained an attorney and was quite successful in establishing legally his partnership/relationship with Ponzi. Although Ponzi eventually settled with Daniels, it became obvious to the authorities that Ponzi had been outsmarted by Daniels and his attorney. Daniels was paid off (around $50,000) by Ponzi and was not held responsible or accountable for the activities of the Securities Exchange Company. The humorous phrase used after Ponzi was imprisoned was, “Daniels got off Scott-free and Ponzi got the Scott tissues”.
Ponzi’s success was almost instantaneous and with leaps and bounds he had expanded a one-man operation to about 30 or more employees. Plus, he purchased a home for $35,000 in historic exclusive Lexington, at Banker’s Colony. Just as quickly as he had ascended the ladder of success by July 1920, he had plummeted and one month later he was arrested for his postal coupon scandal.
It has been long debated as to whether Ponzi ever realized any profits from his dealings with postal reply coupons. More importantly, is the concept he put into practice, a concept that to this day still bears his namesake, “Ponzi Scheme”.
This is the concept. Early investors are paid with money coming entirely out of money paid into the scheme from later investors. Although Ponzi schemes are similar to pyramid schemes they differ in that Ponzi schemes are promoted and operated by a central company or person. Usually there is one person or company that is collecting the money from all new investors and they use this money to pay back the old or earlier investors the exorbitant returns promised on their investments. Ponzi schemes usually do not have the hierarchical structure that pyramids have.
This is the lure. Investors are drawn into the Ponzi by the promise of tremendously high rates of interest being paid with the guarantee of “no risk” return on their investment. They usually convince the investors that this is a special opportunity for them, similar to that which is made available to the proverbial “insiders” of investment folklore.
This is the function. Funds are collected from an initial group. They are promised exceptional returns on their investment. They are, in fact, paid the returns promised. The initial group invites others to invest with them. They, too, are paid the exceptional returns with no risk. The group expands and the returns continue to roll in. This procedure is self-perpetuating until the source of potential new investors dwindles and the Ponzi collapses.
This is the reality. Funds are never invested. There is no significant source of income other than that derived from the money of new investors. Although investors believe that the yields are coming from investments it is really the re-distribution of capital.
Now remember Ponzi schemes do work. They pay the dividends and returns promised. Only the early investors enjoy these fat returns. They are happy and invite others to join with them. All those that get in on the “bottom floor”, so to write, will realize returns greater than they could have reaped from any other legitimate investments. What makes the Ponzi scheme so insidious is that they can actually pay off for a short time. The person behind the scheme generally takes the money from the forth or even the fifth tier of investors and actually pays some of it back to the previous investors. This cycle will continue until the source of new investors ceases.
Timing is the key to success of the Ponzi scheme. It works in at least two ways. First, they create a sense of urgency on the potential victim so he must “hurry” to take advantage of this “chance of a life time” opportunity. Second, just before the source of new investors dries up the sense of urgency is upon the promoter and he absconds with all the investors’ funds.
Again, remember that Ponzi schemes are pure re-distribution of money that comes from later investors to pay earlier investors. No funds are ever invested! It is an investment swindle which promises and delivers high profits from fictitious sources to earlier investors from funds that are raised from later ones. When the source of new investors dries up so does the Ponzi scheme.
There are two basic types of Ponzi schemes. The first is where the promoter invites you to invest in a High Yield Investment Program (HYIP). He clearly states that there will be an exorbitant rate of return with no risks.
Following are some of the more common pitches he will throw at you:
Some of the Faces of Ponzi.
Be Alert to the Following
The second type is where the promoter does not specifically mention the kinds of instruments that will be invested in on your behalf.
Rather he obscures his role by saying that he is part of a trust, foundation or consortium that will pool funds from many sources, and in blocks of 10 to 100 million dollars will invest them in a secret, secondary market, so secret that even your own banker will not know of it.
The scenario goes something like this:
The players:
Mr. X approaches Mr. Y (a friend of a friend) and offers him a “chance of a life time” investment opportunity. He asks Y if he and some of his friends (ten total) could invest $10,000 each in a high yield no risk project. Y responds that he thinks so. X then sets the trap. He offers to each investor who puts in $10,000, $1000 interest per week plus at the end of six months the original $10,000 will be worth $20,000. So, in reality $10,000 will “earn” $26,000 ($1000 for each week for 26 weeks), plus an additional $10,000 at the end of the 26th. week – total: $36,000 + the original $10,000 investment.
He asks Y to form a group of ten investors and they are to meet next Thursday at his apartment, which incidentally is elaborately furnished.
Y rounds up the group and they meet at X’s apartment.
X is very cordial, offers them hors d’oeuvres, and the very best beverages. He quickly gets down to business and explains the program just as he had explained it to Y earlier.
Once he is convinced that they are serious about his investment program, he gets a verbal commitment from them and then says, “My consortium has advised and authorized me to give each of you your first week’s interest on the $10,000 each of you will bring next Thursday.” He then proceeds to give each of them $1000 in 100-dollar bills neatly placed in an envelope. He tells them to enjoy the beverages and if there were any questions he would be pleased to address them.
Week One
The following Thursday the group meets again. Assuming that each of them has their $10,000 he immediately hands each of them an envelope with their $1000 for next week’s interest (in advance) on their investment. (Of course, he is developing a quasi fraternal comfort level with his potential victims as he plays on each individual’s greed factor.
So by evening’s end he will have taken in $100,000 and paid out $20,000 in interest. His profit so far: $80,000.
Week Two
On Thursday of next week they meet again and he gives them $1000 each. His profit now is $70,000.
Weeks Three and Four
When they meet the following week he stirs them a little. He explains that he will be away the next week meeting with his consortium. He gives them his cellular phone number to ease their suspicion and then says, because he will not be there on next Thursday he will be giving them this week’s interest plus next week’s interest in advance.
So to date he will have paid out $50,000 and will be holding $50,000.
Before the two weeks are up he calls another meeting explaining that he has returned earlier than expected and has great news from his consortium. During the meeting he tells them that if they can come up with another $20,000 each he can put this new money into a new consortium trust and they will now be “earning” $1000 per week from the original investment of $10,000 (from which they each will have already received $5000 back in interest), plus $2000 per week interest for 26 weeks on their new investment of $20,000, and, the new $20,000 will be worth $40,000 at the end of 26 weeks. Invariably they will agree, and on their word(s) he gives them $2000 each in advance of the $20,000 they will bring next week.
He will now be holding $30,000 after he gives them their $2000 interest on next week’s investment ($50,000 minus $20,000).
Group’s Rationale
The group’s thinking will be something like this. Each of us has gotten $7,000 return on our original investment of $10,000, and this was only in a matter of less than four weeks.
On Thursday they arrive with their new $20,000 investment. X already has two envelopes for each investor: one with $1000 representing interest on the original $10,000 investment and $2000 for the “second” week’s interest for the $20,000 which they have not given him – yet.
X has now given back $10,000 to each investor ($100,000 total) and he now is holding $200,000.
One need not get any mental exercise by jumping to conclusions, but you can be well assured that when the group arrives at his apartment next Thursday Mr. X will have evaporated with their collective $200,000, never to be heard from nor seen again. Furthermore, it is conceivable that Mr. X had more than one group working at the same time.
Now, there are many variations on a Ponzi theme (or is that scheme?). The introduction is clearly stated. The motifs are well developed. There are adequate contrasts in each section and anticipation of the “coda” is foreordained.
Charles Ponzi was a legend in his own time and is emblematic in ours. He served time during his lifetime and promoters of his schemes continue to borrow time from ours.
Some of the Many Faces of Ponzi
The United States Securities and Exchange Commission has a web site that lists official Litigation Release cases. You may want to visit their web site at: http://www.sec.gov/index.htm, then click on Litigation Releases Federal Court Actions.
Randomly selected are the following Litigation Release Cases: LR16927, 16929, 16934, 16940, 16942, 16950, that dealt with Ponzi-like schemes. After reading those you might want to scroll to the bottom of the page and view these additional cases that were also Ponzi-schematic:
January 5,1998 – March 31, 1998 Litigation Release Cases: LR15612, 15622, 15636, 15686;
April 2, 1999 – June 30, 1999 Litigation Release Cases: LR16154, 16168.
Reading these randomly selected cases should give you an indication of the prevalence of Ponzi schemes being perpetrated today by fraudsters.
Could Arthur Schopenhauer, the philosopher, have portended the role of a future Ponzi victim, who would believe in what a fraudster described rather than what the reality actually was, had he been able to see for himself when he wrote, “My desire is for wisdom, not for the exercise of the will. The exercise of the will is the strong blind man who carries on his shoulders a lame man who can see.”
Rarely is there anything more irritating than clichés. Albeit the following are apropos:
“Robbing Peter to pay Paul”…”Paying the earlier comers out of the contributions of later comers”.
Yet, the poet, Johann Schiller, seems to have said it well for those that stand in awe of Charles Ponzi’s creativeness, “It is rascally to steal a purse, daring to steal a million, and a proof of greatness to steal a crown. The blame diminishes as the guilt increases.”
Also see http://www.impulse.net/~thebob/Pyramid.html for a great write up on ponzi schemes.
The Ultimate Ponzi Scam
The word "Ponzi" is thrown around with abandon these days, yet
few people are likely to be aware of the origin and true meaning
of that word - let alone the fact they are probably unwittingly
involved in a giant Ponzi scam right now.
"Ponzi" was the name of a real person - Carlo "Charles" Ponzi,
who was born in Italy in 1882 and emigrated to the USA in 1903.
For 14 years, Charles Ponzi wandered from city to city, and from
job to job, but finally settled in Boston in 1917, where he got a
job typing and responding to foreign mail.
It was in this job he was to discover the mechanism that he
believed would make him and his investors very wealthy. The idea
was this: he noted that in some of the correspondence he received
was included an international postal reply coupon - good for
using on the letter of reply.
What Ponzi found was that he could cash this foreign coupon in
and obtain local currency - and apparently make a profit (as
compared with the cost of the coupon in the foreign currency).
For example, he could perhaps buy $100 worth of postal coupons in
Italy and cash them in for $600 in the USA.
Ponzi became very excited by this "discovery", and soon worked
out that he could make more than 400% on funds employed in this
manner. However, he didn't take into account the time delays,
exchange fluctuations, and bureaucratic "overhead". But that
didn't stop him devising a scheme to offer his idea as an
investment opportunity to others.
On December 26, 1919, Ponzi filed an application with the local
authorities to establish his business as "The Security Exchange
Company" and promised 50% interest within 90 days to prospective
investors.
Well, the flood gates opened and eager investors poured in - with
a weekly volume of over $1 million in the early days. People of
every type were getting in on the opportunity - snatching up
promissory notes from $10 to $50,000 in value. The average
investor's stake was $300 - a substantial amount in those days.
By 1920 Ponzi was a very rich man. However, it was not because
of his vaunted "stamp exchange" scheme at all. No, he was simply
paying out investors (after the 90 day period) from new funds
coming in from NEW investors. Everybody was happy - as everybody
was being paid on time, and this fact lead more people to climb
on to the bandwagon. Even the law, which was aware of what was
going on, couldn't fault him as no one had laid a complaint, and
everyone was being paid on time. That is, until July 26, 1920.
On that fateful day, a Boston newspaper ran a story questioning
the legitimacy of the scheme, and from that day on the writing
was on the wall. Ponzi was arrested on August 13. An estimated
40,000 people had invested $15 million into his scheme - a huge
amount in today's money. And of course, there was no "investment"
and no actual returns on those monies, so the bulk of people's
money was gone.
Charles Ponzi got five years in jail for his fraudulent actions,
and apparently went on to "greater" things when released - with
a fraudulent land investment deal in Florida!
Thus the Ponzi scheme/scam was invented and perfected. And it's
really simple. Just come up with a plausible investment or
business scheme and promise unheard-of returns - and watch while
hopeful investors stream in. Make sure to pay out your investors
on time (at the beginning) so they are "happy chappies" who tell
all their friends and family about their success - and thus
ensure a continuing stream of new investors, and new money.