Pyramid Schemes
By: Bill E. Branscum
Copyright 1999

A Pyramid Scheme is a multi-level marketing (MLM) program that cannot support itself because earning money, and/or advancing within the system depends on recruiting other people into the operation, rather than selling a product or providing a service. A person is generally (but not always) required to pay an upfront fee to participate.

Note that although all Pyramid Schemes are multi-level marketing programs, all MLM programs are not necessarily Pyramid Schemes. The distinction lies in the source of revenue, and the independent viability of the underlying enterprise. The fundamental issue is, does the operation need the financial contributions of new members to survive, or can it stand on its own?

As an investigator, you must be able to explain “why” this sort of scheme is not legal to laymen who may not, depending upon the complexity of the program, see the problem. You do that by using a basic illustration that anyone can understand and then applying that model to your case.

The common chain letter is the most basic illustration of a Pyramid Scheme. Suppose I send you (and tens of thousands of others) a list of ten names and addresses along with a letter offering you an opportunity to realize windfall profits by sending each of the people on the list (let’s call them P1 – P10) a measly dollar each (CASH ONLY), for the privilege of participating in my “program.” I am person P10 on the list.

My letter goes on to explain that you, in turn, do as I did - delete P1 from the list, move everyone else up one space and put your name in my P10 position. You then send your list out to as many as you wish, with a photocopy of the letter containing the instructions.

The letter assures you that this is a real money maker, some of the people toward the top of the list have bought new houses, and one of the guys bought a Lamborghini a couple of months after he joined. Chain letters and other Pyramid Schemes typically include testimonials from fictitious people, or “shills” who brag about their experience. The encourages you to participate and describes a model where all you must do is sign on 10 people in your “downline” who each recruit ten, and so on. Here is what the letter says you will get for your $10.00 investment by the time your name falls off the list.

  • Initially, you receive $10 from your ten people – we call them Tier 1 since they are the top tier in your personal pyramid. They see you as P10 and, “right off the bat, you made your investment back but nobody says you gotta stop there!”

  • You then expect to receive $100 from the ten people recruited by each person in Tier 1. We call these people Tier 2 and they see you as P9. “Pretty good huh, in a matter of a few days, you recovered your initial investment and sat back to see $100 in pure profit roll in! It gets better.”

  • You can expect to receive at least $1000 from the people in Tier 3 since the guys at Tier 2 will be at least as diligent as you were in recruiting new folks – surely they will sign on at least ten and the more they sign on, they more we all make. “You’re just getting started, use that $1000 as the down payment on the car of your dreams dude – you’re at P8 with seven full cycles to go!”

  • By the time you get that new car home, and probably before you make your first payment, Tier 4 will be raining dollar bills on you to the tune of $10,000. “Imagine, you made $11,100 in a matter of weeks from a total investment of $10!”

  • The letter goes on to explain (with lots of hype that I won’t continue to bother with here) that Tier 5 sees you as P6 paying you $100K; Tier 6 sees you as P5 paying you $1M; Tier 7 pays you $10M as P4; Tier 8 pays you $100M as P3; Tier 9 pays you $1B as P2 and Tier 10 pays you $10B as P1 and you’re off the lists.

“Ok, any fool can see that you’ll make a profit of $1,111,111,100 if the people in your downline just manage to recruit ten people – with just a ten people turn around, the money will come pouring in and all it costs you is $10 and ten stamps. Here’s the really important part – this is all strictly legal because all I am guaranteeing is that YOU will make YOUR investment back if YOU recruit 10 people and that is all you will be guaranteeing them by giving them a copy of this letter which has been approved and endorsed by the Post Master General, the United States Attorney’s Office and Barbara Bush!

Now I’m not trying to make you believe in “pie in the sky,” neither of us really believes that you are actually going to become a billionaire ten times over by investing a mere $10 – life doesn’t really work like that. The potential is there, but realistically, nobody expects to make more than a few hundred thousand and you may not even make that much. Other than the people you recruit, you are counting on other people to make you successful just as I am counting on you.

On the other hand, you are in control of recovering your investment and you know you can do that right away. What have you got to lose?”

As good as it sounds, here’s the hitch. While the letter keeps reminding you to think in terms of ten people, look at the big picture. It will require more than one billion people to fill the tenth tier in your pyramid and those people must lose their investment because it would take 10 billion people to fill the eleventh tier and there are not that many people on the planet.

No matter how you look at it, a Pyramid Scheme is a fraud on somebody. It has to be, since the system relies upon the distribution of a valuable consideration, ongoing distribution requires a rapidly growing list of participants and nothing of value is created anywhere in the process.

That is the key to identifying a Pyramid Scheme – does the system’s growth, prosperity and survival depend upon the value it creates, or is the value contributed by today’s recruits distributed to pay those who were recruited yesterday?.

Participants in “chain letters” are aware of their role in the scheme. It is obvious to anyone that there is no underlying product, today's investors pay for their place on the pyramid and then solicit tomorrow's investors. Each becomes the head of their own personal pyramid, thereby exposing themselves to criminal culpability and civil penalty.

Investigation often reveals that the first ten names on the list are aliases used by the same person who controls the post office boxes or mail drops where the money is to be sent. That individual sends the list and accompanying letter to thousands of recipients. Unlike checks, a dollar bill sent to “Joe Schmoe” has cash value to whomever actually controls the box.

Pyramid promoters do not usually limit themselves to soliciting dollar bills. A look at Prosper International League's Galaxy Plan, as it was formerly hyped on the Internet, is a classic example of a “bare bones” Pyramid Scheme that required a significant investment to participate. As a consequence of our investigation, the various web sites that promoted this scheme are inactive, but a “Google” search will enable you to view cached pages.

As previously stated, the chain letter serves as the basic Pyramid Scheme model for purposes of illustration. Most Pyramid Schemes are substantially more complex, in that they are constructed to look like a multi-level marketing (MLM) operation such as Amway, where people buy in, and then benefit from their product sales and the sales of those that they recruit into the operation. In these cases, the only people who realize that the operation is a scam are those at the top of the pyramid; the other investors believe that they are involved in some sort of legitimate MLM enterprise.

A scam of this nature rocked the state of Kansas in the mid 1980's. In this scam, Activator Supply Company sold ''activator kits'' to investors that would allow them to grow milk-based bacteria cultures for resale to “Culture Farms” who, according to the marketing hype, processed them and sold them to “Cleopatra's Secret” who used them to make cosmetics.

This was a dream come true for anyone wanting to make a good living from home, everyone who joined was paid as promised and every single mom in Kansas frantically worked, borrowed or begged to raise the money necessary to buy the “activator kit” necessary to join the program. It was a real moneymaker until regulators shut them down.

Investigators determined that the program was a hoax - there was no existing market for the cultures that these home based entrepreneurs were growing. The companies involved were empty shells and no cosmetics were actually produced. The system was set up like a circle where the “cultures” the people grew and sent to “Culture Farms” were returned to the Activator Supply, Co. to be resold as “activator kits.”

The people who invested had no idea – although they were making money, and lots of it, they had no way to know that the money they made was taken directly from the investments of subsequent investors.

This case is a classic example in which the entire scheme is exposed when you peek behind the curtain. If you visualize how this system worked, you will understand Pyramid Schemes

Although it is often asserted that the social security program is a classic example of a Pyramid Scheme, this is not the case. People do not buy into the SS program believing that they can entice their friends to join and realize a major return on their investment and, unlike the classic pyramid, the SS program is not necessarily doomed to collapse since the government requires participation and the government can subsidize it as necessary.

I welcome your comments, questions and suggestions.

© Copyright 2002 - Bill E. Branscum. All Rights Reserved.