Pyramid schemes
In a nutshell, pyramid schemes promise to make you money. You pay the person who recruits you for the right to go out and recruit your new members to the scheme. In turn they must pay you for their right to recruit their own new members.
Pyramid selling involves two payments:
| 1. | What you pay
The up front participation payment, that new members must pay to join the scheme. Generally this payment will entitle you to some goods or services. However, unlike a normal business deal, you do not get real value for money. The goods or services will be overpriced, and the only way you can recover your up front payment is by getting new recruits to pay you to join the scheme. |
| 2. | What gets paid to you
The recruitment payment, that gets paid to you for getting other people to join. This is a substantial part of the reason for joining. |
Pyramid selling schemes have involved almost all the goods and services you could possibly imagine. Sometimes they have sold nothing more than the 'right' to recruit other people into the scheme.
How schemes build and then collapse
The scheme builds up layer upon layer of recruits, forming a pyramid. Every pyramid collapses.
Most commonly, people give up because they cannot sell enough to recover the money they originally paid to participate. They find it much harder than they think to sell overpriced goods or services, especially to friends and social contacts.
Schemes also inevitably run out of new recruits, although this may take some time to happen.
To show how this occurs, let's assume a tightly controlled scheme where everyone recruits only 5 people. The founder of the scheme sits at the top of the pyramid. The first five people pay the founder to join. These five people must now go out and find a second layer of five people each to pay them. By the time you get to the third layer, you need 126 people in the scheme. At the sixth layer, that number jumps to 15,626. Just two more layers, and you've outstripped the population of Canberra with 390,626. One more layer reaches 1.9 million people. If that's when the scheme falls over, then 1.5 million people lose their money.
Pyramid selling is illegal
Commonwealth and State laws ban pyramid selling. If a pyramid scheme claims to sell financial products, then it's illegal under ASIC's own legislation. Financial products include shares, managed funds, superannuation, insurance, and credit. Please report such schemes to us.
For non-financial product schemes, contact your State office of fair trading, consumer affairs or the Australian Competition and Consumer Commission.
Is it pyramid selling or marketing?
Sometimes it can be tricky telling the difference between a pyramid scheme and other schemes that may be perfectly legal. Essentially, it boils down to whether recruitment payments form a substantial part of the reason for you to join.
Here are two useful questions to help check if a scheme is legitimate.
1. Does your participation payment bear a reasonable relationship to the value of the goods or services that you get under the scheme?
If not, it's probably a pyramid scheme.
Here's an example of how you might spot a pyramid scheme about selling car insurance.
| 1. | You must pay $1000 up front to participate. That entitles you to a discount of $40 off your $1,500 comprehensive car insurance. |
| 2. | You get promised $100 for recruiting new people to the scheme. |
Since the $40 discount goes nowhere near recovering your $1,000 up front payment, you only reason to join would be the recruitment payments. To come out ahead, you must recruit more than nine people into the scheme. This is an illegal pyramid scheme.
2. How much does the scheme emphasise the products compared with the recruitment payments?
If recruitments payments get heavily emphasised, it's probably a pyramid scheme.
Here's an example of how you might spot a pyramid scheme about selling shares in a new internet business.
| 1. | You must pay $1000 up front to participate. That entitles you to 1,000 shares. The shares can only be sold back to the company or to other participants after 12 months. So you don't really have any idea what they may be worth. |
| 2. | You get promised $100 in cash immediately you recruit new people to the scheme. |
You attend a promotional seminar for this scheme. The 90 minute seminar spends 70 minutes on how to recruit new investors and 20 minutes on the internet business. Since your shares are frozen for 12 months, and the scheme obviously pushes recruitment really hard, the recruitment payments form a substantial part of the reason for joining, making this another pyramid scheme.
More about
Schemes and scams
Investment seminars
FIDO Website: Printed 11/20/2008
