Sadly,
there are scams everywhere we turn. While there are many variations, a couple
of themes are quite common: Ponzis and Pyramids.
Charles Ponzi may not have been the first, but he was the one who made it famous in Boston in the early 1900s. The Ponzi scheme is a way for an investment advisor/manager to attract more customers and more money. Funds received from new investors are used to pay older investors. With the older investors boasting of the enormous returns they received with superstar advisor Joe Bigbuck’s, more investors are attracted to Joe. This can be kept going for as long as high returns can be funded for the older investors with new investor money. This, of course, requires that new customers be brought on board in large numbers. However, with big publicity for "out smarting the markets", all these balls can be kept in the air for quite some time (e.g. Bernie Madoff).
A pyramid scheme is more complicated and is often disguised as a legitimate business opportunity. What it has in common with the Ponzi scheme is that it is a direct money transfer from one group to another. In other words, some people benefit at the expense of others (a zero sum game). Here, participants knowingly give money to those higher on the pyramid with the expectation that they will get to collect money from those they recruit as they are moved up the pyramid. So what brings in these new recruits? Greed! When they see how much those at the top of the pyramid have made, they cough up the money and go on a recruiting binge with family and friends.
Multi-level (or Network) marketing is probably the best known pyramid scheme. Okay, MLMs are not LEGALLY considered pyramids. Through massive lobby and compromise they have largely escaped the law. But that doesn’t change the fact that the economic function of MLM is that of a pyramid (in economics, if it looks like a duck, walks like a duck, and quacks like a duck, we still call it a duck even though politicians may call it a giraffe)
What differentiates multi-level marketing from a pure pyramid is that MLM involves the sale of a product. It really doesn’t matter what the product is because the product is merely a distraction. MLMs do, however, tend to invest heavily in the development of cosmetics and nutritional supplements because this allows them to make extraordinary claims -- that cannot be proved or disproved – and generate the hype and excitement necessary to charge multiple times the price of similar products. It is this difference in price that flows up the pyramid. Robert Fitzpatrick of Pyramid Scheme Alert sums it up:
... multi-level marketing schemes (MLMs), offer a "product" and claims that the "sale" of a product automatically makes them legal. Camouflaging the pyramid money through a "product purchase" and then calling the pyramid payments "commissions" is the preferred disguise for money-laundering in MLM pyramid scams. Usually the products are absurdly over-priced, not retailed, and are only purchased by the "salespeople." These purchases actually serve as "tickets" to participate in the pay-to-play scam.
So, why are people willing to pay extravagant prices for miracle skin creams, exotic juices, and honey made from super bees in the Sonoran Desert? Again, because they believe that they will be able to recruit others who will do the same.
The pyramid structure of MLM came to light in a big way when a law suit opened up the tax returns of Amway distributors in Michigan. In direct contrast to the claims of the MLM industry, only 1% (those at the very top of the pyramid) made significant amounts of money. Where did the money come from? It was a direct transfer from the bottom 99%. Where do these 99% come from? As you can imagine, constant recruiting is required to keep this going (another feature in common with the Ponzi).
Why MLM is legal has always been puzzling to me. On the other hand, it really shouldn’t be. An enormous amount of political contributions have been made by the MLM industry. This is the most plausible explanation as to why politicians continue to look the other way (See Marketplace video below). Also, in the early 2000s President George W. Bush placed a former Amway attorney in charge of the Federal Trade Commission. This was the fox guarding the hen house in the purest sense. Not surprisingly, Business Opportunity and Marketing Fraud exploded during this period (all in the name of free enterprise). Robert Fitzpatrick again comments:
“Anti-fraud law enforcement has become so lax and incompetent in recent years in both Canada and the United States that this is now the regular defense of fraudsters, including Bernard Madoff who ran a $50 billion Ponzi scam on Wall Street. Madoff mirrored Kippax when he had defended his scam for years on the grounds that "I can't possibly be doing anything illegal because the government has never prosecuted me."
Nowadays, MLMs do much (if not most) of their business in developing countries where pyramid laws are weak or non-existent (although they seem to be catching on as three Amway executives were recently arrested in India for running a pyramid scam). They promote themselves as an opportunity for the poor to move up the economic ladder but since all these firms do is transfer income from the bottom to the top, obviously these claims cannot be substantiated (As any economics 101 student can tell you, there is a big difference between creating wealth and merely redistributing it). While most people don’t lose large amounts of money, they do lose valuable time and effort that could have been used in productive endeavors (but in the case of the very poor – who are often primary targets of MLM marketing efforts -- even a “small” loss can be significant). Although focused on overseas business, MLMs are known to spread their gains charitably at home thus keeping the locals convinced that they “must be a good company because they are so generous”.
A great source of information is the Pyramid Scheme Alert. It is run by the aforementioned Robert Fitzpatrick who is the author of False Profits, an excellent book on the subject. See the link below.
http://pyramidschemealert.org/
This hilarious satire of MLM was never released to the theaters because a law suit was threatened by a deep pocketed Multi-Level Marketing company:
http://www.amazon.com/Believe-Larry-Bagby/dp/B001G5T6VC/ref=sr_1_4?ie=UTF8&qid=1369053354&sr=8-4&keywords=believe++dvd
The popular Canadian television program, Marketplace, investigated the outrageous claims of BIM. The link below takes you to that very interesting and informative episode: (BIM has since shut down)
http://www.cbc.ca/marketplace/2009/easy_money/main.html
Charles Ponzi may not have been the first, but he was the one who made it famous in Boston in the early 1900s. The Ponzi scheme is a way for an investment advisor/manager to attract more customers and more money. Funds received from new investors are used to pay older investors. With the older investors boasting of the enormous returns they received with superstar advisor Joe Bigbuck’s, more investors are attracted to Joe. This can be kept going for as long as high returns can be funded for the older investors with new investor money. This, of course, requires that new customers be brought on board in large numbers. However, with big publicity for "out smarting the markets", all these balls can be kept in the air for quite some time (e.g. Bernie Madoff).
A pyramid scheme is more complicated and is often disguised as a legitimate business opportunity. What it has in common with the Ponzi scheme is that it is a direct money transfer from one group to another. In other words, some people benefit at the expense of others (a zero sum game). Here, participants knowingly give money to those higher on the pyramid with the expectation that they will get to collect money from those they recruit as they are moved up the pyramid. So what brings in these new recruits? Greed! When they see how much those at the top of the pyramid have made, they cough up the money and go on a recruiting binge with family and friends.
Multi-level (or Network) marketing is probably the best known pyramid scheme. Okay, MLMs are not LEGALLY considered pyramids. Through massive lobby and compromise they have largely escaped the law. But that doesn’t change the fact that the economic function of MLM is that of a pyramid (in economics, if it looks like a duck, walks like a duck, and quacks like a duck, we still call it a duck even though politicians may call it a giraffe)
What differentiates multi-level marketing from a pure pyramid is that MLM involves the sale of a product. It really doesn’t matter what the product is because the product is merely a distraction. MLMs do, however, tend to invest heavily in the development of cosmetics and nutritional supplements because this allows them to make extraordinary claims -- that cannot be proved or disproved – and generate the hype and excitement necessary to charge multiple times the price of similar products. It is this difference in price that flows up the pyramid. Robert Fitzpatrick of Pyramid Scheme Alert sums it up:
... multi-level marketing schemes (MLMs), offer a "product" and claims that the "sale" of a product automatically makes them legal. Camouflaging the pyramid money through a "product purchase" and then calling the pyramid payments "commissions" is the preferred disguise for money-laundering in MLM pyramid scams. Usually the products are absurdly over-priced, not retailed, and are only purchased by the "salespeople." These purchases actually serve as "tickets" to participate in the pay-to-play scam.
So, why are people willing to pay extravagant prices for miracle skin creams, exotic juices, and honey made from super bees in the Sonoran Desert? Again, because they believe that they will be able to recruit others who will do the same.
The pyramid structure of MLM came to light in a big way when a law suit opened up the tax returns of Amway distributors in Michigan. In direct contrast to the claims of the MLM industry, only 1% (those at the very top of the pyramid) made significant amounts of money. Where did the money come from? It was a direct transfer from the bottom 99%. Where do these 99% come from? As you can imagine, constant recruiting is required to keep this going (another feature in common with the Ponzi).
Why MLM is legal has always been puzzling to me. On the other hand, it really shouldn’t be. An enormous amount of political contributions have been made by the MLM industry. This is the most plausible explanation as to why politicians continue to look the other way (See Marketplace video below). Also, in the early 2000s President George W. Bush placed a former Amway attorney in charge of the Federal Trade Commission. This was the fox guarding the hen house in the purest sense. Not surprisingly, Business Opportunity and Marketing Fraud exploded during this period (all in the name of free enterprise). Robert Fitzpatrick again comments:
“Anti-fraud law enforcement has become so lax and incompetent in recent years in both Canada and the United States that this is now the regular defense of fraudsters, including Bernard Madoff who ran a $50 billion Ponzi scam on Wall Street. Madoff mirrored Kippax when he had defended his scam for years on the grounds that "I can't possibly be doing anything illegal because the government has never prosecuted me."
Nowadays, MLMs do much (if not most) of their business in developing countries where pyramid laws are weak or non-existent (although they seem to be catching on as three Amway executives were recently arrested in India for running a pyramid scam). They promote themselves as an opportunity for the poor to move up the economic ladder but since all these firms do is transfer income from the bottom to the top, obviously these claims cannot be substantiated (As any economics 101 student can tell you, there is a big difference between creating wealth and merely redistributing it). While most people don’t lose large amounts of money, they do lose valuable time and effort that could have been used in productive endeavors (but in the case of the very poor – who are often primary targets of MLM marketing efforts -- even a “small” loss can be significant). Although focused on overseas business, MLMs are known to spread their gains charitably at home thus keeping the locals convinced that they “must be a good company because they are so generous”.
A great source of information is the Pyramid Scheme Alert. It is run by the aforementioned Robert Fitzpatrick who is the author of False Profits, an excellent book on the subject. See the link below.
http://pyramidschemealert.org/
This hilarious satire of MLM was never released to the theaters because a law suit was threatened by a deep pocketed Multi-Level Marketing company:
http://www.amazon.com/Believe-Larry-Bagby/dp/B001G5T6VC/ref=sr_1_4?ie=UTF8&qid=1369053354&sr=8-4&keywords=believe++dvd
The popular Canadian television program, Marketplace, investigated the outrageous claims of BIM. The link below takes you to that very interesting and informative episode: (BIM has since shut down)
http://www.cbc.ca/marketplace/2009/easy_money/main.html
MM
