Do you know how to spot a pyramid scheme?
Although people often discuss pyramid schemes, many are unaware of their exact definition and how they differ from Ponzi schemes. As an accountant, you need to be aware of how to spot pyramid and Ponzi schemes so that you can advise your clients to stay clear of them.
That’s why Gusto, along with our partners at CPA Academy, hosted a webinar that went in-depth about both pyramid and Ponzi schemes. Our webinar titled, “Fraud: What CPAs Need to Know About Ponzi & Pyramid Schemes,” featured edifying information from accounting experts Greg Kyte, founder of Comedy CPE, and Caleb Newquist, Gusto’s Editor-at-Large. Specifically, they discussed the difference between Ponzi and pyramid schemes, chain letter pyramid schemes, and why pyramid schemes are illegal and unsustainable.
In addition to this article, Part Three of the webinar series, you can read Part One and Two, which are about Ponzi schemes. You can also watch the entire presentation here.
Ponzi vs. pyramid schemes and multi-level marketing
Pyramid schemes are scams where people recruit others in order to make money. You pay your dues when entering the pyramid, and the money goes to those higher up the pyramid. You then recruit other people. Once you’re no longer at the bottom of the pyramid, you make money from the new recruits at the bottom of the pyramid. In pyramid schemes, people don’t invest in legitimate products or securities—they only invest to be part of the pyramid.
Ponzi schemes occur when someone deceives investors into allowing them to handle their money under the pretense that they’ll invest it. Instead of investing it, the perpetrator pockets the money. They then use new investors’ money to pay returns to the older investors. Ponzi schemes are a type of pyramid scheme because investors aren’t actually investing their money:
“[In pyramid schemes], new recruits pay money directly to early recruits. In a Ponzi scheme, it’s similar to that. New investors pay the returns for the earlier investors. But here’s the thing: With a pyramid scheme, there is no legitimate product being bought or sold, but [in] Ponzi schemes … there’s not really investments being made, so there’s no legitimate product there. A Ponzi scheme is a type of pyramid scheme.”– Greg Kyte
The major difference between a Ponzi scheme and conventional pyramid schemes is that there’s no façade that the organization invests the money. In pyramid schemes, people know that their money goes toward older recruits:
“If you’re talking about a pure pyramid scheme, it’s a Ponzi scheme just without all the [lies about investing]. They’re not trying to say that they’re investing any money. They’re not trying to say that you’re buying anything. They’re just saying, ‘Hey, … if you pay money to that guy who was in this whole thing before you, then eventually you’re going to work your way up the rank to be that guy, and everybody’s going to pay you that money, and you’re going to make tons of money that way.’ It’s just a hundred-percent scheme.”– Greg Kyte
People often associate pyramid schemes with multi-level marketing companies. Although multi-level marketing companies are not inherently synonymous with pyramid schemes, they often become pyramid schemes because the business makes money through recruiting rather than selling products or services:
“Most multi-level marketing companies have a legitimate product that they do sell. The pyramid scheme part of it can be that you have to pay money to become a distributor for that product, and that’s often been seen as becoming the main business. It’s not selling the product but selling the opportunity to become a distributor of the product, and that’s where you see the tipping point between something being a legit multi-level marketing company and being a pyramid scheme.”– Greg Kyte
Multi-level marketing companies may start as legitimate, but if they make their income by recruiting new people to sell products or services, they’ve shifted into a pyramid scheme.
Chain letter pyramid schemes and Blessing Loom
One way that pyramid schemes spread is through the mail. People receive messages stating that they could invest and eventually receive money:
“Back in the days of snail mail, there were chain letters where [scammers would] ask you to send a certain amount of money to the person at the top of the list, and that would get you on the list. If enough people sent money along the way, eventually you would be the person at the top of the list, and you’d get money.”– Greg Kyte
A large chain letter pyramid scheme occurred in 2020 called the Blessing Loom. Scammers took advantage of the COVID-19 pandemic and began sending offers to individuals through the mail. They said people could send in money to assist other people in financial need, and they would eventually receive a return on their donation. Unfortunately, Greg’s girlfriend became involved in the scheme, so he has a lot of knowledge about the Blessing Loom process.
“They [called it] a blessing, so what you would do is you would bless someone else who’d been in this system longer than you. You’d bless them with $500. That was like your buy-in to the [Blessing Loom] system.”– Greg Kyte
When you invested $500, you gained access to the Blessing Board, which was composed of a circular shape with different tiers of names. The scam claimed that once you were on the board long enough, your name would move to the center of the board, and you receive a significant return on your investment or “blessing.”
“[My girlfriend] paid Nate, [the center name of the Blessing Board], her $500. Once there [are] eight people that paid Nate $500, the board splits into two, and everybody moves in one ring. Then, basically, eight more people have to come in behind her to pay other people off before it’s her turn to be in the middle, and then people start blessing her with their $500. She gets eight people to bless her with $500 each. So she blessed someone with 500 bucks, and then she gets blessed with $4,000 from eight other people.”– Greg Kyte
The Blessing Loom was advertised as a way to help out others during the pandemic while also eventually receiving a return on your “blessing.”
“It was like, ‘The world’s falling apart. So many people have lost their jobs, and everybody’s future finances are completely uncertain. In this weird time where people have lost their jobs [and] people are struggling to pay their rent, this is a great way that you can help somebody out. If you help somebody out, then down the road, you’ll also be helped out.’”– Greg Kyte
The Blessing Loom scam exemplifies pyramid schemes because people weren’t trading any product or service in exchange for money. Some people may have contributed “blessings” for altruistic purposes, but the return-on-investment structure functioned exactly like a pyramid scheme.
Why are pyramid schemes illegal?
Pyramid schemes are illegal in the United States. The overall severity of crime differs from state to state with some states labeling them felonies while others consider them misdemeanors.
Although some people profit from pyramid schemes by scamming and recruiting others, the idea that everyone can make money in these schemes is logically impossible. Greg discussed the absurdity of the Blessing Loom specifically:
“In one round, you have one person blessed and eight people who got screwed out of $500. … It’s basically an eight-to-one ratio. After two rounds … 64 people got screwed out of $500. … You start going through these rounds, and you see when it starts getting crazy. … You need new investors or things are going to collapse. … After eight rounds, you’d need more people than [the population] of Utah. After ten rounds, you’d need more people than in the United States, and after 11 rounds, the population of Earth couldn’t sustain your pyramid scheme.”– Greg Kyte
As more people invest in the scheme, more people are promised a return on their investment. The scheme isn’t sustainable, so it’ll eventually reach the point where new recruits can’t profit.
Sadly, pyramid schemes are still incredibly common despite their illegality. Greg noted that a major component fueling contemporary pyramid schemes is social media:
“In the day and age of social media, you’ve got people trying to recruit new people to get into [pyramid schemes] because [they want] more people to come in behind them, … so there’s a lot of recruiting going on here that happens naturally.”– Greg Kyte
People often make wild claims about investment opportunities on social media, but in reality, they’re often pyramid schemes. They attempt to recruit their social media connections in the hopes of earning a return on their fraudulent investment.
Learn more about investment schemes
Although some people have made money from pyramid schemes, they are a scam and aren’t sustainable. If you offer financial and investment guidance to your clients, you need to ensure they don’t become embroiled in a pyramid scheme or other fraudulent investments.
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