How Are Pyramid Schemes and Ponzi Schemes Different?

What is a Pyramid Scheme?

Pyramid schemes get their name because they are structured like a pyramid.  At the top is the main con artist – knowledge that the purported company is a scam may or may not extend down a few steps of the pyramid, but most of the layers are people who were duped into handing over money with the expectation that they would be paid for bringing more investors to the ‘opportunity.’ 

A hallmark of a pyramid scheme is that participants are focused on making money by bringing in more people like themselves to participate in the company.  Like it’s cousin the Ponzi scheme, the scam only survives as long as more and more people join in order to keep money flowing to people above them (higher in the pyramid.) 

Pyramid schemes typically masquerade as a legitimate company and will have some product (e.g., vitamins) or service (e.g., website services) to sell but the focus is always on an ever expanding pipeline of participants.  Like Ponzi schemes, many people are duped into participating in the scam by their network of friends and acquaintances who were duped before them. 

Pyramid schemes are also known as “endless chain” schemes and are a criminal offense in California:

Every person who contrives, prepares, sets up, proposes, or operates any endless chain is guilty of a public offense, and is punishable by imprisonment in the county jail not exceeding one year or in state prison for 16 months, two, or three years.

As used in this section, an “endless chain” means any scheme for the disposal or distribution of property whereby a participant pays a valuable consideration for the chance to receive compensation for introducing one or more additional persons into participation in the scheme or for the chance to receive compensation when a person introduced by the participant introduces a new participant.  Compensation, as used in this section, does not mean or include payment based upon sales made to persons who are not participants in the scheme and who are not purchasing in order to participate in the scheme.

California Penal Code § 327. 

Pyramid schemes tend to collapse by their own weight fairly quickly and seldom last more than a few years; however, the con artists who run pyramid schemes often pop up over and over again leaving ruined lives in their wake.  According to the SEC pyramid schemes often masquerade as multi-level marketing (MLM) companies.  If the company is more focused on money being brought in by new participants than on profits from legitimate sales to non-participants then it is a pyramid scheme.

What is a Ponzi Scheme:

Ponzi schemes are investment scams where participants are not asked to participate beyond investing money.  They are named after an infamous huckster Carlos (“Charles”) Ponzi.  In the 1920s Ponzi set up shop in the United States and promised investors 50% profit in 45 days or 100% profit in 90 days (in the modern era Ponzi schemes tend to make more modest, but still high promises of return on investment).  The hallmarks of a Ponzi scheme are unrealistically high returns on investment, promises of little or no risk, and the use of new investor money to pay old investor money – instead of the use of profits to pay investors. 

Without legitimate earnings Ponzi schemes eventually collapse; however, some survive for decades (in contrast to a typical Pyramid scheme).  Typically Ponzi schemes involve investments that have not been registered with the Securities and Exchange Commission (“SEC”) because the SEC process is about transparency to investors and about disclosure of information.  Typically the details of the “investment opportunity” are murky and secretive.  Investors are encouraged to roll-over their investments and the “interest” they have purportedly earned.  On paper the profits look to be ever increasing but many times when investors try to withdraw money they receive push back or deadlines are not met. 

Cotchett, Pitre & McCarthy, LLP has a long tradition of fighting against consumer and financial fraud.  If you are concerned that you or someone you know has been the victim of a pyramid or Ponzi scheme and you would like to have the case evaluated you can contact our firm at (650) 697-6000 or you can contact us using this link.  


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