Pyramid schemes, investment clubs and multi-level marketing: A breakdown

A great business idea could make you a lot of money, but there are some schemes that eventually draw the attention of state and federal authorities. Financial fraud takes many forms, and here are a few basic ones of the pyramid variety.

Pyramid Scheme

A pyramid scheme gets its name from its structure, which typically starts with one person who remains on top of the pyramid. That person, the initial recruiter, then invites a second person make an investment. This investment goes to the first person, and the second then has to recruit more people in order to get his or her money back.

The more people the second person can recruit, the larger the potential profit. For example, imagine that the second person had to recruit ten people to stay in, then those ten people each had to recruit ten more, and so on.

The problem with this structure is that it cannot last forever. At some point, the base — or final level of investors — will become too unstable to support the rest of the pyramid. In many cases, the scheme does not create lasting wealth, and it may not even sell any products or provide any services. It is simply a matter of money changing hands with the recruits believing that by “investing” a little bit of money, they will make substantial profits.

Investment Clubs

In many cases, when people form investment clubs, the exchange of money among participants is called a gift or a loan. However, once an individual has made that loan or gift, the only way to recoup the money is by recruiting others, hence the pyramid scheme in disguise.

Multi-Level Marketing

While multi-level marketing (MLM) schemes are often legal, they involve recruiting other sales representatives as well as actually selling a product or service. You may have an option of simply selling the product and not recruiting, but many organizations promise greater rewards if you also recruit.

With illegal MLM schemes, the product or services for sale usually do not have any value outside of the pyramid. In other words, the only good reason an individual would buy the product would be to join the scheme. In this setup, the only way a participant will profit is by recruiting others.

Other Structures

Ponzi schemes usually involve a fraudulent investment plan and tend to be hierarchical instead of pyramid in structure. In this set-up, the return on investment handed down to investors could come from any number of sources and does not rely solely on recruiting new investors.

Chain letters tend to work like a moving pyramid. Often, the letter will ask a person to contribute a small amount, then that person takes the place of someone else on the mailing list and forwards the letter to a certain number of other contacts.

Make no mistake: authorities in Texas and at the federal level expend enormous amounts of energy investigating schemes like the ones described here. If authorities have contacted you, or if you believe you are under investigation, you should waste no time in speaking with an experienced white collar defense lawyer.