Ponzis and Pyramid Schemes
The House of Cards -Is my MLM company one of those?
If you have been around Network Marketing long enough, you have probably heard the MLM business model as being “Pyramid Selling”, or “one of those “Pyramid Schemes” or (less frequently) a “Ponzi Scheme”. How do you answer something like that? The first thing you need to do is educate yourself on what pyramids and ponzis actually are. If you don’t know what the answer is, then how will you be able to answer assuredly if the question ever does arise?
How the “PONZI” got it’s name.
Charles Ponzi was a career fraudster and scam artist. While this ‘money game’ of his was to become the most famous of his frauds, it was not his first, and ironically, not his last scam. Back in 1920 it involved money in the millions of dollars! That is a lot of money by today’s standards. Just imagine what that amount of money represented in 1920, when you consider that a Ford Model T cost around $300!
Here’s what he did. He sold investors promissory notes paying 50% profit in 45 days. He then took the money that later investors paid him, to pay profit back to the earlier investors. As long as he had an endless supply of people willing to invest their dollars, he had money to follow through on his promise, but when the number of people expecting their return grew larger than the amount of investors purchasing, the entire operation fell through.
So in other words, he took less money from more people, to pay less people more money. It doesn’t take a math genius to figure out that eventually there will not be enough people investing to pay back on the promise. It also doesn’t take any imagination to see that some people will lose while others gain. The people who invest early get paid by the people who inevitably lose.
What is key to remember about a Ponzi scheme is that it only has one official promoter.
Pyramid Schemes
Pyramid schemes on the other hand have the look and feel of a Ponzi. The difference is that they are perpetrated in a “chain letter” style with one person recruiting 2, who recruit 2, who recruit 2 endlessly (or any other number). The people recruited usually pay some money to the person at the top of the chain, which is a certain predetermined number of levels above them in the recruiting chain. There is usually no product but product alone does not determine the label “Pyramid”. Rather it is the major source of revenue that determines whether a program is labeled “pyramid” or not.
Illegal pyramid schemes may or may not have a product. If they don’t have a product then they are easy to spot. Money exchanging hands up the line in any manner, with the expectation of receiving more money from below is classicly an illegal pyramid, but what of those that actually do have some kind of product?
In this instance, law officials will determine whether the product has value, and whether it is the focus of the income. Commissions must only be paid when product is sold, and never paid on startup costs (kits, tools, fees). Companies (if asked) must also provide proof that their product has a customer base, and is not only consumed or purchased by people hoping to make money. In other words, does the organization or company need the financial contributions of new ‘recruits’ in order to survive, or is there a customer base that would continue bringing sales revenue into the company.
The Difference Between Ponzis and Pyramids
The only real difference is that a Ponzi has only one person collecting investments, and distributing profits. In a Ponzi, all of the investors, whether they have made money or lost money, are victims. In a pyramid, however, the victims become the victimizers, directly promoting a crime and in effect stealing more from others than was stolen from them.
What does the Federal Trade Commission (FTC) say about Pyramids and Ponzis
Of the people who participate in these schemes, there are a few who know that it is illegal and that they need to “get in early” to get their money, because some people are going to lose. For many others though, they have been convinced that what they are participating in is not like “those other deals” because of ‘this’ or ‘that’
Even the FTC sometimes has a hard time deciding if something is actually a pyramid or not. They have outlined some basics for you, to help in deciding whether you should participate or not.
Pyramid schemes now come in so many forms that they may be difficult to recognize immediately. However, they all share one overriding characteristic. They promise consumers or investors large profits based primarily on recruiting others to join their program, not based on profits from any real investment or real sale of goods to the public. Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure. There are two tell-tale signs that a product is simply being used to disguise a pyramid scheme: inventory loading and a lack of retail sales. Inventory loading occurs when a company’s incentive program forces recruits to buy more products than they could ever sell, often at inflated prices. If this occurs throughout the company’s distribution system, the people at the top of the pyramid reap substantial profits, even though little or no product moves to market. The people at the bottom make excessive payments for inventory that simply accumulates in their basements. A lack of retail sales is also a red flag that a pyramid exists. Many pyramid schemes will claim that their product is selling like hot cakes. However, on closer examination, the sales occur only between people inside the pyramid structure or to new recruits joining the structure, not to consumers out in the general public.
A Ponzi scheme is closely related to a pyramid because it revolves around continuous recruiting, but in a Ponzi scheme the promoter generally has no product to sell and pays no commission to investors who recruit new “members.” Instead, the promoter collects payments from a stream of people, promising them all the same high rate of return on a short-term investment. In the typical Ponzi scheme, there is no real investment opportunity, and the promoter just uses the money from new recruits to pay obligations owed to longer-standing members of the program. In English, there is an expression that nicely summarizes this scheme: It’s called “stealing from Peter to pay Paul.” In fact some law enforcement officers call Ponzi schemes “Peter-Paul” scams. Many of you may be familiar with Ponzi schemes reported in the international financial news. For example, the MMM fund in Russia, which issued investors shares of stock and suddenly collapsed in 1994, was characterized as a Ponzi scheme.
Both Ponzi schemes and pyramids are quite seductive because they may be able to deliver a high rate of return to a few early investors for a short period of time. Yet, both pyramid and Ponzi schemes are illegal because they inevitably must fall apart. No program can recruit new members forever. Every pyramid or Ponzi scheme collapses because it cannot expand beyond the size of the earth’s population. When the scheme collapses, most investors find themselves at the bottom, unable to recoup their losses.
Some people confuse pyramid and Ponzi schemes with legitimate multilevel marketing. Multilevel marketing programs are known as MLM’s, and unlike pyramid or Ponzi schemes, MLM’s have a real product to sell. More importantly, MLM’s actually sell their product to members of the general public, without requiring these consumers to pay anything extra or to join the MLM system. MLM’s may pay commissions to a long string of distributors, but these commission are paid for real retail sales, not for new recruits.
~source: Federal Trade Commission Website
What About Gifting?
People involved in gifting programs have convinced new perpetrators that gifting is “100% legal”. It Isn’t! There is NO ORGANIZED GIFTING PROGRAM THAT IS LEGAL. I am using the word “program” very specifically to talk about clubs or groups of people that send money to strangers with the expectation of receiving several times their “gift” back.
During my research into “Gifting” I came across a new blog about gifting. The person writing the blog promoting her particular gifting club is convinced that what she is doing is legal. As I read over her various entries on this, and other various websites of hers, I get the impression of a savvy young “work at home” mom, trying to make a difference in her family’s financial situation. She seems like a wonderful person, and someone I would enjoy spending time in conversation with. Surely this person wouldn’t take my money or be involved in a scam?
Well it seems she would.
Tracy Austin is one of many thousands of people who are “out in the open” about their gifting activity on the internet. Tracy believes her participation in this gifting program is legal, in part, because of the terminology used in her particular program. In her first post on her blog, Tracy says this:
Cash gifting is not a home business opportunity. There are many people online talking about cash gifting as though it were MLM. They refer to “sponsors” and “recruits.”
There are no sponsors in cash gifting, the term for the person you begin this activity with is “inviter.” When you begin cash gifting, you have not been recruited, you have chosen to participate in an exclusive activity that offers no product or service, hence it cannot be called a business.
What I have to say about the approach that some are using to cash gifting is they may be setting themselves up for a hard fall. When you approach cash gifting in this way you are implying that it is a business. The IRS law that makes cash gifting legal is worded very specifically:
“The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property,
without expecting to receive something of at least equal value in return.
“
Nobody goes into a business without expecting to make a return. Call me particular, but every cash gifting activity that I’ve reviewed has guidelines that preclude members from using the terms “sponsor” and “recruit” for a reason. Why? Because these terms
give the appearance of
commerce or trade.
For all of the gifters out there, and especially the would-be gifters who are doing research right now, trying to decide whether to participate, here is what is important for you to know. It isn’t the terminology that determines legality, it is the activity. Let me put it in an example…. If you go into the bank with a mask on, and a note demanding that the teller LEND you some money, the police are still going to call it theft. You can call it ‘borrowing’ all you want. (I dare say crooks have actually tried that as a defense over the years…. “really officer I was only ‘borrowing’ the money.”)
Let’s look at some of the answers to some Frequently Asked Questions (FAQ’s) that Tracy has on her Cash Gifting Abundance site: Please allow me to first comment that the title of her site is “Secrets to 100K a month”, which is a dead give away that she isn’t giving people $3500 out of the goodness of her heart. Gifting for profit is illegal. My further comments in RED
What is Cash Gifting?
Private cash gifting is a concept embraced by private groups of individuals and has been in existence for many years. Our private activity does not involve network marketing, multi-level marketing, or a business or commercial activity. There are no business transactions, investments and/or securities involved in this activity.
The concept of private gifting is based upon the fact that both American and Canadian citizens as well as other countries, have the Constitutional right to gift property, cash and other assets, and are subject to the rules and regulations established by the laws. The U.S. gifting rules are found in the IRS Tax Code, Title 26, Sections 2501-2504 and 2511.
The law states that one or more individuals can give a gift to another individual of up to $11,000 each per calendar year without any tax liability to either the giver or receiver of the gift, because the tax on the gift has already been paid. These gifts are not included in the gross income of the recipient.
On Tracy’s website she quotes the tax law: “The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. The entire scheme is set up with the expectation of receiving future “gifts”. How is it that gifters can not see this?
Is this a pyramid?
Not at all! A pyramid is associated with an investment scheme, a company or a business.
A pyramid is also not to be confused with “Network Marketing”. Although Network Marketing is a legal and viable source of income, when was the last time you, or anyone you know able to start at the bottom of the company and reach the top position ? This is where the logic really gets convoluted. A ‘pyramid’ is NOT associated with an investment scheme, a company or a business. Please allow me to quote from above “Illegal pyramid schemes may or may not have a product. If they don’t have a product then they are easy to spot. Money exchanging hands up the line in any manner with the expectation of receiving more money from below is classicly an illegal pyramid,….“
How does Cash Gifting work?
This activity is offered only by means of an exclusive one-to-one invitation. When someone accepts the invitation, they move through a natural progression from the giving to the receiving stage of the activity. In this activity, there is no fixed hierarchy of individuals who have an advantageous position or unfair advantage over new participants. Tracy has just very kindly given the FTC the language in the shape of a noose. There is an “expectation” of receiving which by definition makes this gifting activity illegal.
How can you give to a stranger?
How many times have you given to United Way, the Salvation Army and other charities? You don’t know who got the gift, what stranger. The only difference here is that this person will start out as a stranger, but you will get to know them as part of the team, Giving to a charitable organization is a one way gift. You give to the salvation army without expecting that the neighbor down the street will in turn give you something if you ask them to.
One final note about Tracy and her gifting pyramid. her websites say the following: (and my comment is… Tracy THERE IS NO NEED to market a gift. Only businesses and solicitations are marketed in this way.)
*SPECIAL TEAM OFFER*
*BONUS WITH A $3500 Gift*
* Your First 500
MARKETING POSTCARDS
Mailed For Yor For FREE!*
I could go on and on but I think (and truly hope) that you are getting the picture. I may not reach the people who are already indoctrinated in their belief that their gifting program is legal. The reality will come when the Attorney General in their state, or the FBI or local law enforcement agency comes knocking on their door. Hopefully, though, some of you reading this article have not yet made a fatal mistake and will really hear what I am trying to help you hear. ORGANIZED GIFTING IS ILLEGAL. Not to single out Tracy directly, there are a number of illegal gifting schemes out there right now. Here are just a small few that I am aware of (Thanks again to Tracy Austin- I really never knew the names of some of these scams!).
- ESCOV- Ecosov has been operated in one form or another for over 8 years by a guy who calls himself “Q.” There used to be three levels to join, but now there are only two: $6,600 & $18,500.
- Number One Success System (NOSS)- NOSS is a 1UP style gifting program and has been around for over 7 years. NOSS has 3 levels of participation: $500, $1,500 and $3,500.
-
Spirit of Wealth (SOW Today)- This website looks suspiciously like the NOSS website. SOW is over seven years old and has over 40,000 members in over 16 countries. Like NOSS, SOW also 3 levels of participation: $500, $1,500 and $3,500. - The Overnight Cash System (TOCS)- As an internet-based cash gifting activity, TOCS is the “baby” of online cash gifting programs since it’s only been around with it’s new structure since January of 2008. It uses a 1Up style structure like the others and has 5 levels $500, $1,000, $2,500, $5,000, and $10,000.
- Cash Arrives 365- Cash Arrives 365 is a 1UP gifting programs and has also been around for about 7 years. CA365 also has 3 levels of participation: $500, $1,500 and $3,500.
Is My MLM Illegal?
That’s a good question! To answer that let’s once again go to the Federal Trade Commission (FTC) website to find an answer.
Some people confuse pyramid and Ponzi schemes with legitimate multilevel marketing. Multilevel marketing programs are known as MLM’s, and unlike pyramid or Ponzi schemes, MLM’s have a real product to sell. More importantly, MLM’s actually sell their product to members of the general public, without requiring these consumers to pay anything extra or to join the MLM system. MLM’s may pay commissions to a long string of distributors, but these commission are paid for real retail sales, not for new recruits.
In other words, it is not even enough that a company has a product. That company needs to demonstrate that their products are being sold retail to real customers, and that the product is not just an excuse to pay people money.
In the example of the case against Jewelway it wasn’t enough that they had a product that was legitimate. The FTC “alleged that the defendants were operating a pyramid scheme because their promotional efforts focused primarily on recruiting and not on retail sales to non-participants. The FTC further alleged that the defendants made deceptive earnings claims in order to induce consumers to make a token purchase of jewelry and become a JewelWay representative able to recruit additional participants for the company.” Jewelway was successfully closed down, and a significant monetary settlement levied against the owners even though they had a legitimate product!
Questions to ask:
- Is there a product?
- Is there a consumer base for the product. (Will people who do not want to start a business want to buy this product?)
- Is there a ’start up fee’ that commissions are paid on? (Commissions must ONLY be paid when product is purchased, NEVER on start up costs, or marketing tools.
- Is the focus on the product? Or is the product secondary to the “Income claims”?
- Who is administrating the company? Can you locate a head office? Can you contact them? Do they have a past history?
- Are there income claims being made? Unsubstantiated income claims are illegal. While there are a significant number of 6 and 7 figure income earners in legitimate MLM and network marketing companies, even they can get slapped by the FTC for “enticement”. Income claims must be verifiable, and it must be made clear that your results will be different based on any number of varialbles. In other words there is no guarantee of income either stated or implied.
Don’t take the word of the person attempting to recruit you that this is a legitimate endeavor, but don’t take the word of someone who has absolutely no experience either. Nor should you speak to someone with a conflict of interest (i.e. They are in a different MLM, and would rather you joined their company with them so THEY can earn money). Call the company yourself. Use Google and search for the names of the principles, the company, research the product, look for dissatisfied or disgruntled customers and distributors. Filter all of the information you have through a logical course, and make a decision based on knowledge and understanding, not hype, excitement or partial truths.
Related posts:
{ 3 trackbacks }
{ 1 comment… read it below or add one }
I found this article very in-depth and informative between the different scam type operations now so prevalent everywhere. I particularly liked the ponzi scheme explanation as it cleared up a question for me.
Thanks for a great post!