Pyramid schemes explained: How to spot a scam

Have you ever been propositioned to join a business endeavour that promised a suspicious amount of lucrative income and thought — is this a pyramid scheme?

Maybe you’ve been seeing ads online or emails promising you the potential to earn thousands of dollars a week, or you may even have been approached by a friend or family to take part in a business that requires little effort with big reward. All you need to do is pay a fee upfront and recruit some members yourself, then sit back and see the money come in. But before you buy in, beware that this type of business practice is likely to be a pyramid scheme.

Pyramid schemes are illegal in Australia and Scamwatch, run by the Australian Competition and Consumer Commission (ACCC), says Australians lost more than $7 million in 2022 to pyramid schemes alone.

But how does a pyramid scheme work and what can you do to avoid losing money to one?

What is a pyramid scheme?

Scamwatch says pyramid schemes, also known as ‘get-rich-quick’ schemes, aim to generate money predominantly through the recruitment of people or businesses, even if they may still offer a product or service.

Generally, new members or participants are asked to pay a fee to join, known as a ‘participant payment’, and are told they will receive a payment for any new members or investors they later recruit, known as a recruitment payment.

In other words, to make money from the scheme you need to convince other people to join and pay the participant fee. The ability to continue to make money relies entirely on there being an ongoing stream of new members.

Scamwatch says in reality, the number of people willing to sign up — and therefore the amount of money coming into the scheme — tends to dry up quickly, leaving many people out of pocket.

As previously mentioned, pyramid schemes are illegal in Australia, as is participation in — as well as promotion of — a pyramid scheme.

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On the surface, the pitches that accompany pyramid schemes can sometimes sound tempting, even more so when coming from friends, family members or mutual contacts.

These contacts may not necessarily even realise they are participating in an illegal scheme and breaking the law.

Many pyramid schemes may also disguise themselves as a legitimate MLM (Multi-Level-Marketing) scheme, the two functioning in very similar ways with the exception that MLM schemes profit from selling products or services to the general public and not from recruiting new members.

What is a MLM scheme?

Legitimate MLM schemes are legal in Australia, but, as with any financial venture, it is a good idea to do your homework and ensure you understand the business model and contract before you join one.

People are generally recruited by others who are involved in the scheme, who will then take a percentage of their sales. Once recruited, that person can begin to recruit others and then earn a percentage of their earnings.

The products or services need to be the focus, rather than recruitment, for MLM schemes to be legitimate and legal.

Some examples of MLMs in Australia include DoTERRA, Arbonne and Herbalife.

How to identify a pyramid scheme

So how can you tell the difference between a genuine business opportunity and a pyramid scheme?

According to the ACCC, some warning signs to look out for include:

• Offers to join a group, program or scheme where you then need to recruit new members to make money.
• If the goods or services you are asked to offer have little or questionable value, predominantly serving to further promote the scheme (such as the distribution of information sheets).
• If there are big up-front payments or fees to join.
• If the scheme is accompanied by claims such as “this is not a pyramid scheme” or “this is totally legal”.
• Any promises of guaranteed income.

Industry body Direct Selling Australia (DSA), which represents organisations that deal with goods and services sold directly to consumers, says to be wary of any “get rich quick” claims or assurances of easy money and passive income. It also suggests asking what happens with unsold inventory.

“Reputable direct selling companies will buy-back unsold and marketable inventory at either the purchase or a discounted price,” it says. You can also check the company on DSA’s website to see if they’re listed as a legitimate business.

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What to do if you suspect a pyramid scheme

If you suspect you have encountered a scam, such as a pyramid scheme, the ACCC encourages you to report it via its report a scam page.

Alternatively, you can report a business you suspect to be a pyramid scheme to the Australian Securities and Investments Commission (ASIC).

It can help if you include all details of the contact you received such as the email, text message or a screenshot of any online interactions.

If you have provided any of your bank account, financial or personal details to anyone you do not know, contact your bank as soon as possible.

It may also be a good idea to warn friends and family about scams, particularly if there is a chance any of your social media friend lists or email address books may have been accessed.

You can find more information about where you can get help if you have lost money to a scam on the Scamwatch website.

Ponzi schemes vs pyramid schemes

Ponzi schemes are very similar to pyramid schemes and are also illegal in Australia. They are typically framed as ‘investments’ where the promoter generally promises high returns to investors, but in reality, any money paid out, including ‘dividends’, ‘interest payments’ or even from cashing out, is from incoming funds contributed by other investors without any real investment activities taking place.

This scheme relies on new investors joining for these payments to continue, although typically existing investors can choose to ‘invest’ more when they receive a dividend and encourage friends and family to join, according to the Moneysmart website, run by the financial regulator, the Australian Securities and Investment Commission (ASIC).

Eventually, all Ponzi schemes collapse, either when there are no new investors joining or the promoter spends the money.

Moneysmart says to be especially wary if the rate of return is suspiciously high (such as 10% per month), someone you know tries to recruit you and/or the person encouraging you to join is already invested in the scheme.

You can view Moneysmart’s list of companies you should not deal with on its website and report any suspected Ponzi schemes or pyramid schemes to ASIC.

Updated article originally by Shay Waraker.

Cover image source: Gajus/Shutterstock.com