The Investor’s Watchdog

The Investor's Watchdog

Uncovering the Difference between Ponzi Schemes and Pyramid Schemes

Thursday, April 25, 2019

Often confused for each other, Ponzi schemes and pyramid schemes are not the same. Discover the major difference, and learn how you can avoid becoming a victim, below.

What is a Ponzi scheme?

A Ponzi scheme is a fraudulent investment scam where money from new investors is used to pay the returns of earlier investors, disguised as profit from a legitimate transaction. Ponzi schemes rely on a constant flow of money and thus, continuous new investors. When the money runs out, Ponzi schemes often unravel.

Victims of a Ponzi scheme often believe they are earning returns based on legitimate transactions, not new investors.

How to avoid a Ponzi scheme

Simply put, avoiding a Ponzi scheme involves doing your research before making an investment. Be skeptical of high-pressure sales tactics or promises of returns that appear “too good to be true.” Ponzi schemes typically involve unregistered investments so be sure and check with the SEC or your state regulators before investing. As always, work with a credible broker who carefully explains any and all investments to you in easy-to-understand terms.

What is a pyramid scheme?

A pyramid scheme is a business model in which top-level members recruit new members, who pay large upfront fees for the privilege of joining. Those new members must then recruit others, who pay a fee to them and to the original recruiter, creating a pyramid-effect flow of money. A vast majority of pyramid schemes rely solely on profit from recruitment fees instead of the actual sale of tangible goods or services. They are not to be confused with legitimate multi-level marketing operations which often provide goods or services of value.

Victims of a pyramid scheme are aware that they are earning a profit by recruiting new participants though they often don’t know it’s an illegal or shady practice. They become part of the scheme without even knowing it.

How to avoid a pyramid scheme

Believe it or not, people are often convinced to join pyramid schemes by friends or family. Be cautious if someone asks you to join an “investment club” or “gift program.” Before investing, gather all information regarding the company and don’t hesitate to contact the Better Business Bureau. Ensure that the products or services offered are legitimate, and find out if there is truly a demand for them. Be cautious if the startup cost is extremely high, as it often is with pyramid schemes.

Questions about either of these types of scams? Feel free to contact ChapmanAlbin to speak with an attorney who can put your mind at ease.

Author: John S. Chapman

John S. Chapman is a Principal at ChapmanAlbin, the investor rights law firm. He has spent over twenty years fighting for investors who have been harmed due to broker misconduct. John and the attorneys at ChapmanAlbin have helped recover millions in lost investor savings, and continue to fight for rights of investors across the country.

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