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Pyramid Schemes

Millions of Americans have lost money participating in pyramid schemes. Pyramid schemes inevitably fail because for participants to continue making money, an endless stream of people must continue joining the scheme, which cannot happen. For that reason, pyramid schemes are also known as "endless chains."

While there are legitimate multi-level or network marketing companies, many of them are actually illegal pyramid schemes or gifting clubs. These pyramid schemes are often portrayed as business opportunities, and victims who thought they were paying the start-up costs for their own small business eventually find they have lost money or are responsible for others losing money.

A pyramid scheme is a plan in which a person pays money or buys merchandise for the chance to receive money when additional participants buy into the scheme. For example, Mr. Washington joins a scheme by paying $3,000 for cosmetics. He recruits Mr. Jefferson who also pays $3,000 for cosmetics, and to have the opportunity to recruit others. Mr. Washington gets a commission of $500 from Mr. Jefferson's $3,000 purchase. Mr. Jefferson then recruits Ms. Madison who also joins by paying $3,000 for cosmetics. From Ms. Madison’s purchase, Mr. Jefferson gets $500 and Mr. Washington gets $200. Because the distribution of these commissions is based only on the recruitment of new participants and not any legitimate retail sale to an end user, the business is an illegal pyramid scheme. There are, however, thousands of variations of unlawful pyramids.

It is sometimes difficult to tell the difference between a pyramid scheme and a lawful multi-level marketing program. Multi-level marketing can be a lawful business that uses a network of independent distributors to sell consumer products. The difference between a pyramid scheme and a legitimate multi-level marketing plan is that in a legitimate multi-level marketing plan, money is only made through the eventual retail sale of a product to an end user. In the example above, Mr. Washington and Mr. Jefferson are participating in an illegal pyramid scheme because they earn commissions only by selling the cosmetics to another distributor, who is buying the cosmetics not for their personal use, but merely to recruit others into joining the scheme.

Victims often find themselves tricked into participating. Pyramid promoters are masters of group psychology. Often unlawful pyramids are pitched at recruitment meetings that create a frenzied, atmosphere where group pressure and promises of easy money override the potential victim's rational mind by preying upon the fear of missing an investment property. Promoters also openly discourage thoughtful consideration and questioning of the scheme.

A pyramid scheme can collapse at any time because in order for everyone in a pyramid scheme to make money, there would have to be a never ending supply of new participants. This is never the case. In reality, each new level of participants has less chance of recruiting others and a greater chance of losing money. Often the new recruits are a participant's friends and family, which places the participant in the position of victimizing his or her own friends and family.

People, including participants, who promote pyramid schemes can be charged and convicted of a felony. To avoid becoming both a victim and lawbreaker, do not let anyone rush you into making hasty or unwise decisions. A good opportunity to build a business in a multi-level structure will not disappear over-night.

Take time to consider your investment before signing anything or giving someone your money. Ask questions about the company and its officers, the products, their cost, fair market value, source of supply and the potential for sales of the supposed products in your area. Make sure that the company can support any claims made about the product with reliable research. Ask about start up fees, required purchases and about the company's policy regarding the buy back of required purchases. Inquire about the average earnings of active distributors. If an opportunity sounds good to be true, be especially wary.

Finally, check with the Office of the Attorney General or Federal Trade Commission for law enforcement actions taken against the company. But remember, a lack of lawsuits is no guarantee that a company is legitimate.

Additional Resources:

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California Law

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CA Dept of Consumer Affairs

Search U.S. laws on the Internet at U.S. Code

U.S. Code

Megan's Law

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