Warning about Pyramid Schemes, Ponzi Schemes and Related Frauds

[Guest guest]

Dear Prabhus,

 

I was recently approached over the phone by a very nice devotee who has taken

up the promotion of a pyramid scheme that involves "gifting" money. Rather

than the usual 'investment' of a few dollars, the pyramid scheme he's

promoting asks participants to make a 'gift' of $2000.00!!!!! I reserved

judgment until he sent me the paperwork, but what I read was so obviously a

pyramid scheme that I thought it might be useful to warn him and anyone else

who might come under the sway of the 'get rich quick with no product and no

effort' temptation. I've copied a Web site's description of these bogus

schemes below. If you're looking for a way to make money, avoid these scams.

They're illegal, and I would say they are nothing less than a form of

gambling.

 

Please read on.

 

Your servant,

 

Pancha Tattva dasa

 

 

 

Pyramid Schemes, Ponzi Schemes, and Related Frauds

 

I'm sure you've seen them dozens of times. Messages which purport to tell

you how, for a relatively small investment, you can make huge amounts of

money. There are countless variations, but they all are based on the same

fraudulent concept. With a typical “chain-letter”-based pyramid scheme, the

process is represented to go something like this:

 

You receive a copy of a letter or an email message, making fabulous claims

about how much money you can “earn” by participating in it.

You send some amount of money to some number of people who have joined this

scheme ahead of you. Typically, you may be asked to send $5 each to four or

five people.

You alter the list of previous participants, removing the one at the top of

the list, moving all the other names up one position, and adding your own name

to the bottom of the list.

You send out as many copies of this altered letter as you can, to as many

people as you can reach.

As new people join the scheme below you, in exponentially-growing numbers,

each one will send you $5, or whatever the requested amount was. Because the

number of new participants is growing at a fantastic, exponential rate, you

should collect this payment from a ridiculously large number of people.

There are many variations on this basic scheme. There are various ploys

used to create an illusion of legality; some of these involve a set of

“reports” which you buy from those above you, and sell to those below you.

Others instruct you to create a mailing list out of the names of people below

you. Some use language which describes the money exchanged as a “gift” or a

“loan”. There are even some software-based pyramid schemes, centered around a

program which is distributed down the chain; the program keeps track of the

list of people from which you must buy the “codes” to “unlock” the program,

enabling you to create a version of the program which lists you as one of the

sources from which others must buy these codes to unlock it. There are also

variations which involve selling “self-replicating” web pages.

In every case, the basic concept is the same — you pay a relatively small

amount of money to a few people above you, with the expectation that later,

very large numbers of people will be making similar payments to you.

 

A deliberate effort is made, in many cases, to confuse prospective victims

with regard to the distinction between a legitimate “multi-level marketing”

(MLM) scheme, and an illegitimate pyramid scheme. (I'm no fan of MLM; I

regard even “legitimate” MLM schemes as ethically questionable at best. But

there is a vital distinction. I'll try to explain it once we get out of these

parentheses...)

 

An important distinction is this: With a legitimate MLM, you have a real

product, that is of significant value in and of itself. Most of your profit

comes from the sale of this product to people who will use this product

according to its own value and usefulness, and not just try to sell it to

someone below them. Though MLM encourages you to build a “downline”, so that

you can make some profit by taking a cut of the sales made by those below you,

you do not need to recruit even a single person below you in the pyramid in

order to profit; you can profit by selling the product itself, even to people

who have no interest in joining the MLM.

 

In those pyramid schemes which try to pass themselves off as MLM, your

“product” is something that has very little inherent value, if any at all,

beyond the requirement that one must buy it from you in order to join your

“downline”. The “product” may consist of worthless reports, or even

electronic codes to unlock a software-based pyramid scheme. Nobody would buy

these “products”, except as part of joining the pyramid scheme itself. The

only opportunity for profit is in getting people to join the pyramid in levels

below you. As the U.S. Postal Service warns, on one of their own pages on the

subject, “Do not be fooled if the chain letter is used to sell inexpensive

reports on credit, mail order sales, mailing lists, or other topics. The

primary purpose is to take your money, not to sell information. ‘Selling’ a

product does not ensure legality.”

 

A Few Definitions

Chain Letter: Strictly speaking, a chain letter is merely a letter, an email

message, or some other communication, which asks the recipient to send copies

of it to several other people. In and of itself, chain letters are not

illegal, but they are very annoying, and very wasteful of whatever medium is

used to carry them. When a chain letter asks the recipient to send money to

people through whom the letter passed before, with the promise that the

recipient will receive money from those that the letter reaches after he sends

it, then it has become a form of a pyramid scheme. Though not all chain

letters are pyramid schemes, and not all pyramid schemes are chain letters,

the term “chain letter” is often used to mean a pyramid scheme. For example,

the U.S. Postal Service's official statement on “Chain Letters” is really

about pyramid schemes. Even if they're not illegal, chain letters are, in any

form, very annoying to most people, and prohibited by most responsible ISPs.

A good article on the subject may be found here.

Pyramid scheme: A scheme in which a hierarchy is created by people joining

under others who joined previously, and in which those who join make payments

to those above them in the hierarchy, with the expectation of being able to

collect payments from those who join below. Pyramid schemes are prohibited by

the laws of the United States of America, by the laws of each of the fifty

individual states, and by the laws of most other nations. Pyramid schemes are

variously defined under these laws either as a form of gambling, or (more

accurately, in my opinion) as outright fraud Most of my explanations on this

page are about pyramid schemes, but have some application to Ponzi schemes as

well.

Administered pyramid scheme: A varation of a pyramid scheme in which come

central person or company is involved in “administering” the scheme, in making

sure that all participants have made the appropriate payments to those above

them, or even in collecting these payments and redistributing them to the

“upline”. The “Administrator” of such a scheme usually takes some fee for

himself. In this variation, the “administrator” is assured of some profit, no

matter how badly the scheme may work for other participants, because he gets

to collect his own fee from every other participant. These schemes usually

collapse much more quickly than regular pyramid schemes, because of their

dependence on the administrator, who is easily identified and turned in to

proper law-enforcement authorities. The one administered pyramid scheme that

I know of which has persisted is one operated out of Italy (which is

apparently the only otherwise-advanced nation in which operating a pyramid

scheme isn't a criminal offense) called Pentagono.

 

Ponzi Scheme: Named after Charles Ponzi, who ran such a scheme in 1919-1920.

A Ponzi scheme is an investment scheme in which returns are paid to earlier

investors, entirely out of money paid into the scheme by newer investors.

Ponzi schemes are similar to pyramid schemes, but differ in that Ponzi schemes

are operated by a central company or person, who may or may not be making

other false claims about how the money is being invested, and where the

returns are coming from. Ponzi schemes don't necessarily involve a hierarchal

structure, as in a pyramid scheme; there is merely one person or company that

is collecting money from new participants and using this money to pay off

promised returns to earlier participants. An interesting site about Charles

Ponzi and his scheme can be found here.

 

A Pyramid Scheme Dissected

Let's look at a hypothetical pyramid scheme, with respect to how it is

claimed to work. Suppose the list included in this scheme contains six names.

You are to send a dollar to each person listed, remove the top name, move all

the other names up one position, and send it on to more people. Let us

assume, that you get ten people to join, and each of them gets ten people, and

so on.

As the pyramid grows below you, here's what supposedly happens:

 

The first level below you has ten people. They each send you a dollar, so you

collect $10.

The next level has a hundred people. (Each of your first ten gets ten more.)

You collect $100.

The next level has a thousand people. You collect $1,000.

The next level has 10,000 people, so you collect $10,000.

The next level has 100,000 people, so you collect $100,000.

The next level has 1,000,000 people, so you collect $1,000,000.

At this point, your name drops off the list, and you collect no more.

So, for your initial investment of $6, (one dollar to each of the six people

above you), you collect a total of $1,111,110. There are, of course, many

variations on this concept.

It's very easy to understand how this kind of scheme should work. It all

seems so simple and so obvious.

 

It is, unfortunately, somewhat more difficult to understand why this kind of

scheme does not work, and why it is unethical and dishonest, and, in most

cases, very much illegal.

 

The truth is, this scheme does not work, except for those who get in at the

first few levels. The vast majority of participants in such a scheme will

only lose their original investment, and make no profit at all. In a moment,

I'll get into why this is so; but because it is so, every instance where a

person is induced to join such a scheme, based on the promise that he will

make a profit by participating, a fraud has been committed.

 

Nearly every nation, and every government, has laws against fraud. Most

have specific laws against pyramid schemes, Ponzi schemes, and similar

operations.

 

Even if the particular variation in which you might participate happens to

avoid running afoul of the laws which are relevant in your situation, I ask

you to consider that by participating in such a scheme, you would be engaging

in something that is dishonest and unethical, and which is very unlikely to

make you any profit.

 

In order to understand why pyramid schemes do not work, there are two points

which you must understand.

 

The pyramid must fail because there is a finite and limited number of

potential participants.

No new wealth is created, the only wealth gained by any participant is wealth

lost by other participants.

Now, let's see if I can explain these points.

The pyramid must fail because there is a finite and limited number of

potential participants.

Pyramid schemes depend on bringing in an exponentially-growing number of

new participants. I've used the term “exponentially” several times already,

perhaps I should explain it. Where n represents some number, if you start

with one person, who gets n people to join, and each of those people gets n

more people to join, and so on, you have the total number of people growing by

powers of n. Even where n is a fairly small number, the total number of

people involved grows to amazingly huge numbers without very many steps being

required to reach these huge numbers. Indeed, it is these huge numbers, which

you are led to believe represent the number of people who will each be sending

you $5 or whatever, that makes pyramid schemes attractive.

But these huge numbers create a problem. There are somewhere between five

and six billion people in the world. Let's suppose that every one of these

people could be induced to join a particular pyramid scheme. For how many

levels could this scheme run before it failed, for lack of new participants?

You'll be amazed when you see how quickly the number of required new

participants grows to exceed the population.

 

In the example above, I assumed that each person who joined would bring in

ten new people. How many levels can be supported by a population of five to

six billion? Let's count them...

 

1

10

100

1,000

10,000

100,000

1,000,000

10,000,000

100,000,000

1,000,000,000

That's ten levels, counting the one person at the top who started it. By

the time these ten levels are filled, there will be a total of 1,111,111,111

participants. The eleventh level would require 10,000,000,000, or ten billion

new participants to fill in. But there aren't that many people in the world.

There's only between five and six billion, minus the somewhat over a billion

who've already joined. Most of the billion people in the tenth level will not

be able to get any new participants below them, and will therefore make no

money at all. And of course, none of those who join in the eleventh level

will get any new participants below them. There aren't enough people to fill

in the eleventh level, much less to start a twelfth level below that.

At this point, the pyramid collapses. And when it does, a solid majority of

those who had joined will not have made any return at all. They will have

paid their money to get in, but the promise that they will profit as people

join below them will never be fulfilled.

 

Of course, the number of levels that can be filled depends on how many new

participants, on average, are brought in by each previous participant. But

even if each participant brings in only two new participants, the pyramid will

collapse in about 32 or 33 levels (still assuming, of course, that you can get

all five or six billion people in the world to join) with most participants

having lost money.

 

No new wealth is created, the only wealth gained by any participant is wealth

lost by other participants.

You need to understand that all legitimate business activities, in some

way, create wealth, or contribute to the creation of wealth. When you create

a product, that is worth more than what it cost to produce, you've created

wealth. When you perform a service, which is worth more than it cost to

provide, you've created wealth.

If you spend a dollar for a lemon, some sugar, and some water; and then use

this to make sufficient lemonade that you can sell twenty servings for ten

cents each, then you've created wealth. You've taken ingredients worth a

dollar, and used them to create a product worth two dollars. You've created a

dollar's worth of new wealth.

 

Pyramid schemes produce no goods of any significance, and they provide no

service. They create no wealth. All they do is move existing wealth. Every

dollar that one person gains through such a scheme is a dollar that someone

else has lost.

 

Do not be fooled if the scheme includes some form of “reports” or lists or

other pieces of “information” that you are supposedly buying from those above

you, and selling to those below you. In nearly every case, these intangible

products have no value imputed to them, other than that which can allegedly be

gained by copying and reselling them. The purpose of these reports is not to

provide valuable information, but to provide a pretext by which one

participant in a pyramid scheme collects money from other participants.

 

Conclusion

As the old saying goes, “If it sounds too good to be true, it probably is.”

Anyone who tells you you can make huge amounts of money, with very little

investment, and very little work, is almost certainly not telling you the

truth. Participating in any pyramid scheme, ponzi scheme, or any other scheme

which promises that you will get rich quickly, with little effort is foolish

at best. You will most likely only lose money to such a scheme, and you may

even find yourself subject to legal prosecution for fraud. True wealth is

only gained through honest work, and honest investment, in enterprises which

produce goods and services of value to all. There are no shortcuts, and

anyone who tells you otherwise is almost certainly out to cheat you.

Some Relevant Links

The MMF Hall of Humiliation An excellent source of information and amusement

about pyramid/Ponzi schemes, or “Make Money fast (MMF)” schemes as this site

likes to call them.

The U.S. Postal Service's official statement on “Chain Letters”.

An excellent article about MEGA$NETS, a software-based pyramid scheme.

The Federal Trade Commission (FTC) takes action against a notorious promoter

of the MEGA$NETS and MegaResource pyramid schemes!

 

An exposé on “Pentagono”, an administered pyramid scheme operating out of

Italy.

The Securities Exchange Commission takes action against Pentagono!

The Royal Canadian Mounted Police (Canada's counterpart to our FBI) issues a

warning about Pentagono!

 

 

The Better Business Bureau issues an alert about Pentagono.

 

No big deal, you think? Here's a story, from The Cincinnati Enquirer, about

some idiot who was arrested for spamming a pyramid scheme.

An excellent site discussing the exploits of Charles Ponzi, from whom the

“Ponzi scheme” gets its name.

In Ponzi We Tru$t An article in Smithsonian magazine about Charles Ponzi, his

scheme, and modern variations found today on the Internet.

As I've stated, I am no fan even of “legitimate” MLMs. Though I fully

understand the distinctions between them and illegal pyramid schemes, I

believe that even the most legitimate MLM has a lot more in common with a

pyramid scheme than with any honest, well-run business. For a very

well-researched and well-written article on the subject, follow this link:

What's Wrong With Multi-Level Marketing?