What is a Pyramid Scheme?

The unsustainable geometric progression of a c...
Image via Wikipedia

Have you ever seen Bustin’ Loose?

It’s an old Richard Pryor film in which he plays a guy on probation who has to drive a busload of special needs kids from Philadelphia to Washington (state). It’s an R-rated affair, peppered with the kind of language you’d expect from Pryor, but it’s actually kind of a sweet movie.

Anyway, there’s a great scene once they get to Washington where Joe Braxton dresses up like a cowboy (from Texarkana!) and rips off a group of men who are running a seminar for their pyramid scheme (actually, it’s a “Trap-a-zoid!“). Hilarity and a foot chase ensue, but the scene actually shows a pretty accurate view of a pyramid scheme sales seminar, insofar as the explanation of how it works is just as hazy, the pressure is just as high and the chance of losing your money is pretty much 100%. Just like in real life.

What is a Pyramid Scheme?

A pyramid scheme is a fraudulent investment scheme that works on the basis of each new member being sent out to recruit new members. Let’s say you’ve got a guy who decides to start a pyramid scheme. He gets ten people to give him $100 to “get in on this opportunity” (net profit: $1,000) then tells them to go out and recruit ten people each (so they each profit $900). The problem is, the pyramid quickly collapses because you run out of people willing to be recruited. Even if each member only has to recruit six people, by the 13th layer, you’ve already exceeded the population of the world twice over.

Some schemes are more complex, requiring each level to pay a portion of their commissions to the person who recruited them. This brings in a lot of money for the crook on top, and loses a lot of money for anyone on the bottom.

In any case, in a straight pyramid scheme, there is no product or service being sold, and there is no actual, concrete thing in which you are investing. Your only hope of a profit is if the people you recruit can get enough people to join in, which never happens.

So why not just start your own pyramid scheme, or join in one if you know you’re near the top of the pyramid? Because they’re illegal to start and to participate in. In the U.S., I’m pretty sure it’s under Federal jurisdiction. In other words: stiff penalties.

How to Avoid Pyramid Schemes

So, what are the signs of a pyramid scheme?

First, if you’re being told about an “exciting investment opportunity” by someone other than your legitimate investment guy, you’re already entering treacherous waters.

Second, is there an actual product (with actual value) being sold? Are you investing in a company, futures, or something tangible that may be seen or felt? If it’s just a “method” (another red-flag word) to make money, that’s not a good sign.

Third, if the only way you make money is by recruiting new people, it’s definitely a pyramid scheme.

Fourth, if you have to pay someone before you make any money…well, that’s just one of the general rules of fraud prevention.

Finally, if this “exciting investment opportunity,” with its revolutionary “method,” is being hawked at a free high-pressure sales seminar, avoid it at all costs. Don’t even go to the seminar, because these people are experts at deception. They will say anything to get you to buy in.