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Are Pyramid Schemes Illegal? Why a Scheme That Makes Money for Some People, Can Be Illegal?


The very mention of the phrase pyramid scheme stirs up complicated questions about whether it is legitimate and legal or illegitimate and illegal.

Almost always, the unanimous query is that are pyramid schemes illegal?

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It is perfectly plausible to question that why can a scheme that sometimes allows a reasonable number of people to make money be considered illegal?

The fact is that the pyramid schemes are almost always considered wrong.

In many ways, they are considered as an obstruction of the fair instruments of investment and also of delivering less than promised.

First, let’s talk about the reasons why pyramid schemes are illegal in general.

Then I explain how some people mix up the legitimate MLM programs with the pyramid schemes and think that they are illegal as well.

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Why Does FTC Consider Pyramid Schemes Illegal?

Are Pyramid Schemes Illegal?

At the very behest, let us understand why the FTC considers pyramid schemes illegal.

This is important.

Why?

Because in matters of investment and market-related schemes involving the average public, taking the official and the government perspective is crucial.

You must understand that how and what the government perceives them is what determines the ultimate direction of the scheme.

Additionally, chances are you are among the ones who are starting a business that sounds like a pyramid and can be categorized as an illegal program.

But the problem is that you don’t know and you think what you are doing is not against any law.

This can easily get you in trouble.

Therefore, what I am explaining below helps you to understand your own business better to make the necessary changes that make it 100% legitimate and legal.

1) Extraordinary Returns within a Short Duration

So according to the US Federal Trade Commission, the reason why are pyramid schemes illegal, is because, in general, they are extremely seductive on the basis of the return rate they promise.

The expectation of extraordinary returns within a short duration can act as a major lure for most.

That can sometimes let people rush into it without appropriate judgment.

Most pyramid schemes advertise in a way that people think they will become rich just by joining the program and paying the monthly fee.

Therefore, they join and pay every month, but they don’t make a single cent.

The reason of this kind of advertising is that the scheme owners and also the members, are at the higher levels of the pyramid.

They make money only when new members join the program and pay the monthly fee.

In most cases, they don’t even tell people that in order to make money, they have to recruit new members.

Because if they do, most people will run away as they don’t like to promote the program and recruit the others.

Therefore, being dishonest to people and the new members is one of the reasons that pyramid schemes are illegal.

2) Pyramid and Ponzi Schemes Don’t Have a Happy Ending

Another reason why both pyramid and Ponzi schemes are illegal is the fact that they would invariably always collapse at the end.

There is no continuity to these schemes and the expectation that they would continue to generate returns over a longer time can also be completely ruled out.

The cardinal truth about these schemes that they are going to fall apart, makes them bad or illegitimate in the FTC’s point of view.

In their words, no scheme can continue to generate new recruits forever.

While the returns earned by those at the top are huge, the losses or the hit taken by those at the bottom is also severe.

In general, it is noticed that a lot more suffer severe losses compared to a handful who earn the profit.

Why Do Pyramid Schemes Collapse After a While?

Can’t the members keep on recruiting new members forever or at least for a reasonably long time?

When the program is new, nobody knows what it is exactly.

So people join and start promoting the program and recruiting the new members eagerly.

Early birds who succeed to recruit a reasonable number of members.

They make a lot of money and talk about their income everywhere.

They encourage the others to join and have the same income.

However, not everybody is able to advertise, promote the program and recruit new members.

Indeed, recruiting the others to a program is not that easy.

So, most of those who join, make no money, and they just pay the membership fee.

After a while, the number of the members who have no income goes up, and many of them start complaining about the program everywhere.

Therefore, the number of those who sign up for the program goes down every day.

As a result, the senior members’ income goes down too.

Members stop promoting and recruiting gradually, and so, the scheme dies after a while.

Therefore, governments prefer people not to join such programs from the first day.

To do that, they make the pyramid schemes illegal; don’t allow them to work in the country; and stop any of them that gets find out.

Illegal Pyramid Schemes and Legitimate Multi-Level Marketing Programs

It is quite common to see investors getting confused between pyramid scheme that is considered illegal and a multi-level marketing program that is legitimate.

The FTC spells out the basic difference between them quite simply.

MLMs or multi-level marketing programs almost always sell a real product.

The products constitute the core business and source of revenue generation.

In comparison, the pyramid schemes never have any real product that they can sell to the public and the consumers.

They make money through the membership fee that the members have to pay.

MLMs might have some small commission plan for long time distributors, but they would decidedly not have any payment plans for fresh recruits.

MLM promotes wider awareness while the pyramid scheme is about letting select members garner extraordinary profits at the expense of a large victim base.

The sad truth is the number of victims in case of a pyramid scheme is high.

What Is Legitimate Marketing of Pyramid Scheme? Is That Possible?

Illegal Pyramid Schemes vs Legal Pyramid Schemes

Now you could ask the question that if the pyramid schemes are illegal, can you construct the pyramid in a legitimate fashion?

Or rather is there a format which does not make a pyramid scheme illegal?

Well, according to the Federal Trade Commission:

“Pyramid schemes now come in so many forms that they may be difficult to recognize immediately.”

But one basic feature that separates the fraudulent ones is no doubt the ones that promise high returns on the basis of recruiting others into a specific program.

In most cases, involving this type of scheme, you mostly have a namesake product to disguise the actual pyramid scheme.

But there are two ways to identify a fake product front and identify telltale signs of a fake scheme.

These are

  1. Inventory loading of the product that is being marketed.
  2. The quantum of retail sales for the product. The lack of sales or insufficient amount will reveal the inherent fraud in the scheme.

These are useful signs to identify.

The reason is that you must remember that inventory loading happens only when a specific company’s incentive scheme mandates the recruits to buy an unrealistic amount of products at a relatively inflated rate.

When this kind of buying happens across the product distribution system, the people at the top undoubtedly reap significantly larger benefits and make a huge profit compared to those who are stuck with the products and have no exit.

Unfortunately, for those at the bottom, they are forced to make those high payments and reap no benefit from the process.

Lack of Retail Sales

The lack of retail sales is another big example of a potentially problematic situation.

Many pyramid schemes might claim that they have very high sales.

But closer examination would reveal that this is not to the general public.

It is rather to only the recruits who are forced to buy these products to become part of the structure.

The only point you could see a legitimate version is where there are real sales in a similar structure.

These are essentially known as multilevel marketing programs or MLM.

Unlike pyramid schemes, there is actually a real product to sell in legitimate MLMs.

Additionally, MLM’s pay a commission to long term distributors more as an incentive.

And, any new recruit would not have to pay any money or would not be forced to buy any products.

Therefore, a simple answer to why are pyramid schemes illegal would be the fact that:

These schemes target towards addressing individual interest or the interest of a small group.

To that effect, they do not mind jeopardizing the many unsuspecting victims.

Whether it is in the form of penny stocks IPO or a gifting scheme or even product distribution line, it is in effect taking advantage of the ignorance of the broader masses and working towards the gain of a selected few who are privy to some sensitive information.

The fact that the ultimate aim is to profit at the expense of someone’s ignorance makes it a fraudulent and illegal scheme.

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