Pyramid schemes explained: How to spot a scam

Recently an acquaintance living in the US – you know one of the people you met in passing a few years ago and have seen their highly irrelevant-to-you Facebook posts since – sent me a direct message through Facebook. I was intrigued. She asked how I was and my brain raced through the possibilities of what she may be after. Travel tips? The opportunity to compliment the photos of my so-home-cooked-we’ll-call-it-rustic attempts at baking? But no, I was being too optimistic. She wanted to introduce me to a fantastic new “program” she had discovered.

Have you ever been approached by friends or family, or even through clever online marketing, to take part in a new business that required little effort with big reward? All you need to do, they might say, is pay a fee upfront and recruit some members yourself, then sit back and see the money come in. You’re right to be sceptical and to do your research before buying in to identify if the offer is too good to be true, or in other words, if it is, in fact, part of a pyramid scheme.

Although pyramid schemes are illegal in Australia, consumer watchdog the ACCC has reported Australians have lost nearly $170,000 so far in 2020 to such scams, with the majority of cases occurring through social networking and online. But how does a pyramid scheme work and what can you do to avoid losing money in one? We take a look.

What is a pyramid scheme?

Pyramid schemes generate money predominantly through the recruitment of people or businesses, even though they may still offer a product or service, according to Consumer Affairs Victoria. Generally, new members or participants are asked to pay money to join and are told they will receive a payment for any new members they later recruit.

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

pyramid scheme
Source: Fadil6379 (Shutterstock)

How to identify a pyramid scheme

On the surface, the pitches that accompany pyramid schemes can sometimes sound tempting. And often they come from friends, family members or mutual contacts, which can delay those warning red lights that go off in our brain. These contacts may not necessarily even realise it is a pyramid scheme themselves. 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:

  • If you are offered a chance to join a group or scheme where you will 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 through information sheets).
  • If there are costs to pay up-front to join.
  • If it is promoted with claims such as “this is not a pyramid scheme” or “this is totally legal”.

Representative body Direct Selling Australia adds 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,” its website states.

Ponzi schemes and multi-level marketing (MLM) schemes

There are a number of similarities between pyramid schemes, Ponzi schemes and multi-level marketing (MLM) schemes, with the first two being illegal but MLM being legal in Australia.

Ponzi scheme

Ponzi schemes are 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 financial regulator ASIC’s Moneysmart website. 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 to ASIC.

MLM schemes

Unlike pyramid and Ponzi schemes, MLM schemes are legal in Australia, but 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. All of this sounds similar to a pyramid scheme, and the structure is much the same, only the products or services are generally more of a focus in an MLM scheme.

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

Australian Small Business and Family Enterprise Ombudsman Kate Carnell AO told the ABC that MLMs can potentially work for some people, provided they are the right fit.

“My background is in retail and I can promise you that a very large percentage of people really struggle with proactive selling,” Ms Carnell told the ABC.

“Read your contract. I’d have lots of questions if there is a requirement for upfront dollars.

“Being sold this rosy dream, working while the kids are at school and somehow you’re going to make thousands of dollars. Nope. Not happening.”

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. 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 account or financial 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 friends 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.

Related article: Scammers use dating apps like Tinder

Banner image source: Guenter Albers (Shutterstock)

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