Off The Beaten Track

How to spot a pyramid scheme

Don't get trapped by the notorious pitfalls of get-rich-quick ploys - here's a few tips on how to avoid them.

Pyramids in Egypt. Source: fronne.com

With pyramid schemes popping up in many shapes, it’s easy for those looking for a quick and easy way to riches to take advantage of unsuspecting individuals, especially in trying economic times.

As alleged pyramid schemes – such as MMM Global SA – collapse, it’s important that consumers protect themselves by knowing what a pyramid scheme is, how it operates and how to identify one.

In a pyramid scheme, one person, or a group, will recruit a handful of people to the scheme by asking them to pay a fee or invest a large amount of money.

To get a return on their investment, they must find more people to join the scheme and pay money in so that they can get their payout.

Think of a town with 10,000 people. If five individuals were to start a scheme and gather five recruits each, there would be 25 members in the second stage.

If each of those 25 recruits find five people, there are 125 in the third stage. At the sixth level you’ll need 15,625 people, which is 5,625 more than the population in the town. This illustrates the finite structure of a pyramid scheme

Pyramid schemes rely on more members joining to feed investment returns, as opposed to an investment product. In a pyramid scheme, the new recruits are that product.

  • Is it a legitimate investment?

Some people may find it hard to distinguish between a pyramid scheme and a legitimate product.

A lot of schemes nowadays operate as “stokvels”, and they’re structured in such a way that many people often do not see the danger in the way the scheme functions.

Here are some of the telltale signs:

  • The scheme relies on member recruitment rather than an underlying investment product:

Look out for frantic spam recruiters across social media platforms. Due to the dynamic nature of digital platforms, most recruiters have taken to fishing for “investors” online.

If the focus is more on recruiting people to join the scheme, that’s a red flag;

  • High returns promised in a short period:

According to the National Consumer Commission, any investment that offers a return that is 20% above the current repo rate is considered a multiplication scheme: pyramid schemes fall under this classification;

  • Recruiter success stories:

Don’t fall for the handful of success stories. Those who got in early will display their success and use the car or property they bought as proof that the scheme is legitimate;

  • Be careful of invitations to attend presentations:

You’ll probably be invited to a presentation, and it’s unlikely you’ll be given the full details until you’re sitting in it with a form in front of you, listening to success stories with unreal investment returns.

Do not sign any documents, do not share your bank details and do not hand over your money until you have done your research;

  • No notable head office or business address/business structure:

Is there a proper company structure? Is the investment form registered with the Financial Services Board? Does the firm have a head office? Fly-by-night investment companies are not uncommon. If there isn’t a discernible company structure, dig deeper; and

  • More emphasis is placed on high returns than on risk:

If risk is mentioned in passing and there isn’t a proper risk assessment carried out to ensure you understand the risk, be concerned. A great investment firm will warn you about the danger of putting all your eggs in one basket.

Report suspect pyramid schemes to the Reserve Bank at www.resbank.co.za or to the National Consumer Commissioner on (012)761-3000, e-mail complaints@thencc.org.za, or visit www.thencc.gov.za. If you suspect a registered financial services company is running a multiplication scheme, call the FSB’s fraud and ethics hotline on 0800-313-626

This article first appeared in the Sunday Times.

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