Ponzi and Pyramid Schemes

Red Flags of Ponzi Schemes

-Sounds too good to be true; - Promise of low risk or high reward; - History of consistent returns; - Pressure to reinvent (as oppose to withdraw); - Complex trading strategies; - Lack of transparency; - Lack of segregation of duties.

Fill and Split Games (Pyramid) - Pure Cash Schemes

Best way to launch a pure cash pyramid scheme is to augment it with gaming elements. Include some kind of hook to keep players attention and focus. Dumb games. When each player buys a seat on a fictitious airplane and helps recruit passengers the plane takes off.

Speculations (Pyramid) - Product Fronts

Describes any investment that is not covered as a financial instruments or MLMs. Includes franchise offerings, work at home promotions, investments in areas like real estate or mineral rights. Don't always start out as cons.

Pure Cash Schemes (Pyramid) - Endless Chains

Don't bother to conceal true objective. Recipient of letter sends a sum of money to the person who sent the letter, then passes along to three or four others.

How did Madoff avoid detection?

He constructed his investment business to avoid most regulatory oversight and other checks and balances. The firm processed all its own trades, unlike private investment pools that use outside brokerage firm to execute trades. Kept the funds in-house. Conducted investments with great secrecy.

How was Madoff so successful in his scheme?

His ability to attract new investors. He did not promise extraordinary returns, he promised stability and long term profits. - He targeted the wealthy & charities and so he avoided unexpected withdrawals and large withdrawals.

Illegal Pyramid Scheme vs. Ponzi

In both schemes, new investor's money is used to make payoff. Key element is that in Ponzi Schemes the initial investors are paid with subsequent investor's money, with little to no legitimate commerce actually occurring. A pyramid scheme is a Ponzi scheme. In Ponzi schemes, the emphasis is on investments.

What's the key distinguishing factor in Illegal Pyramid Schemes v. Ponzi Schemes

Lies in how the operation is promoted. Illegal pyramids are promoted as pyramids (believe they'll rise through the ranks, emphasis on recruitment), whereas Ponzi Schemes are promoted as investment opportunities (emphasis on investment.

Financial Instruments (Pyramid) - Product Fronts

Like stocks, borrower's certificate, currency exchange, loan scams, etc. Perfect for fronts because most people don't get how legitimate financial operations take place.

What is an Illegal Pyramid?

Operations that generate revenue by continually recruiting new members. May offer merchandise or services for sale, the only significant revenues come from recruitment. Not always illicit.

Multilevel Marketing (Pyramid) - Product Fronts

These organizations hawk nutritional supplements, household goods, cosmetics, etc. Any organization that recruits distributors into a pyramid style compensation plan, offers big payoffs for recruiting, and spends more time extolling its distributor level than its product line is probably illegal.

Spotting Pyramid Schemes

These schemes continue because they do pay off (initial payoff keeps early players coming back). They operate mainly through preexisting affiliations, they use false logic in pitches.

Pyramid Schemes - What's the 70% rule?

To determine the legality of pyramid schemes, courts often apply this rule. It requires that at least 70% of a distributor's profits come from retail sales.

Bernie Madoff's Scheme

Unusually consistent returns, not result of investments. He initially claimed split strike conversion. But in reality, he never invested his client's money. He used investments to put into business account which he then used to pay clients who requested withdrawals. .

When does a pyramid scheme become illegal?

When the recruitment of new members takes precedent over product or services. Designed to pay off earlier investors but not later investors.

Ponzi Scheme

a form of fraud in which belief in the success of a nonexistent enterprise is fostered by the payment of quick returns to the first investors from money invested by later investors. - little or no commercial activity takes place.