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Pyramid Schemes

What is Third Party Fraud?

This is a fraud committed by people outside an employee employer relationship. They can be committed against individuals, businesses, companies, the government or any other entity. Third party frauds are not as common as occupational frauds, but on average each fraud is for a larger amount.

Some third party frauds are not meant to remain hidden forever. Some only remain hidden long enough for the fraudster to make their get-away. The fraudster may not care if the fraud is eventually discovered as they do not have a continuing relationship with the victim and they cannot be found.

What is a Pyramid Scheme?

These are investment schemes where people pay a participant of the scheme to enter the scheme. This is done on the prospect of receiving payments for introducing other people into the scheme. A pyramid scheme rewards victims for finding new victims for the scheme.

Pyramid schemes, by what ever name they are known, are frauds and all states in Australia and the Commonwealth have made them illegal.

The schemes are also known as "bigger idiot" schemes as, to make money from them you have to find a number of people that are bigger idiots than you - in that they are willing to give you money for the chance that they may be able to find other people to give them money.

Pyramid schemes have been around for centuries and appear from time to time. They usually appear long enough after the last scheme for people to have forgotten that people lost money the last time. These schemes will also change their appearance so they don't look the same as the old scheme when they are reintroduced.

Description of Pyramid Schemes

Pyramid schemes are frauds. Promoters advertise large possible returns for small investments and rely on potential victim's greed to make then want to join. These victims then have to find more victims for the scheme to grow and for the promoters to make their money.

Promoters of these types of investment frauds generally start by targeting unsophisticated or inexperienced people who are not used to reviewing investment potentials and who will be influenced by someone waving money in front of them. They will also target less well-off individuals who hope that they may make some money easily. Once people start entering the scheme and talking up the potential to make money, other people - who generally would not get involved in these types of 'investments' - may join as they do not want to miss out on 'easy money'.

These schemes are illegal

Promoters of these schemes will deny that the scheme is a pyramid scheme and illegal. They generally attempt to dress up and present the scheme as something legal. But under whatever facade the promoters put on the scheme, it will either fall under the definition of a pyramid or not, and be illegal or not.

Pyramid schemes are illegal in all states of Australia. The Fair Trading Acts of each state (see the end of the paper) specifically deal with pyramid schemes, as does section 61 of the Commonwealth Trade Practices Act. A person commits an offence if:

(a) the person is a promoter of, or participant in, a trading scheme (the "payee"); and
(b) someone else who is, or has applied or been invited to become, a participant in the scheme (the "payer") makes a payment to or for the benefit of the payee; and
(c) the payment is made under an inducement of a prospect held out to the payer of receiving benefits for the introduction, by the payer or someone else, of other persons who become participants in the scheme.

Pyramid schemes have one common factor - they are based on the proposition that people pay to enter the scheme, and they get payments for introducing other people to the scheme.

How to recognize a pyramid scheme

The scheme will vary and promoters will try to put a legitimate face on the scheme. They sometimes describe their schemes as shopping clubs or assistance clubs where low cost items are passed in consideration of the payments made into the scheme. In most cases these attempts at legality fail. Unfortunately, by the time that most schemes mature sufficiently for them to be noticed, it has generally caught a number of victims.

Pyramid schemes are called trading schemes in the Commonwealth Trade Practices Act. A trading scheme is one where:

(i) goods, services or both goods and services are to be provided by a promoter of the scheme;
(ii) the goods or services are to be supplied to or for other persons under transactions arranged or effected by participants in the scheme, whether or not they are all promoters of the scheme.

A trading scheme may be a illegal (a pyramid scheme) if it falls under the conditions in section 61. Whatever the face of the scheme, it will have some common principles.

1. It is being based upon a hierarchal structure (a pyramid) with money flowing towards the top of the pyramid to the promoter.
2. Participants obtain payment or other benefit from the scheme by introducing more people.
3. New participants make a payment into the scheme for the benefit of other participants.

The main factor to these schemes is payment for the introduction of new participants. People should be aware if they have to pay to join any scheme and expect to get paid by introducing other people into the scheme. The scheme is illegal where:

(i) someone else, who is or has applied or been invited to become a participant in the scheme, makes a payment to or for the benefit of the payee; and
(ii) the payment is made under an inducement of a prospect held out to the payer of receiving benefits for the introduction, by the payer or someone else, of other persons who become participants in the scheme.

How these Schemes grow

These schemes grow because the participants are actively recruiting new people. Participants move up levels in the pyramid by the introduction of the required amount of new people into the scheme. That is, each new participant must find more participants to be able to advance up the pyramid.

In theory the promoters will be able to sit back and let their victims do all of the work, as participants know that this is how they will eventually make money from the scheme. Some promoters of schemes will pay higher level participants some money from time to time to give them the incentive to promote the scheme even harder. The promoters will be happy for these higher level participants to make some money because every dollar that their victims receives, the promoters receives many more.

Pyramid schemes are only meant to enrich the people at the very top of the pyramid. People need to look past the gloss and hype of the scheme and treat all 'get rich quick' schemes with a good deal of skepticism and study their true substance. At best you may lose some money by entering the scheme. At worst, you are involved in an illegal activity and there could be criminal consequences.

Be careful when:

(i) Entering the scheme entails the payment of money to some person for no real reason. Be especially careful where your role and the basis of the return on your investment is introducing more people to the scheme.

(ii) Any form of urgency is suggested by the promoter. Urgency and greed are the two main weapons of fraudsters. Take the time to think about and research an investment scheme.

(iii) Documents are not left for your perusal or the promoters do not want you to get independent legal advice on the investment. If that is the case, the promoters are probably nervous about the advice that you will get.

(iv) The salesman/consultant will not come to a meeting with your accountant, solicitor or other advisor, or says that these people just do not understand the investment. Understanding these investments is generally easy.

(v) The promoters state that the scheme is legal because you are receiving some small item in consideration for your money. The legislation recognizes this attempt at legality.

The size of the structure

There is no set size for these schemes. But with only six levels in a pyramid with six people on each level, a new participant will need to introduce 55,986 people to get to the top level. The sixth level alone needs 46,656 people to fill it. Very few people ever make it to the top the pyramid and this is why the schemes always fall over. There are simply insufficient people ('bigger idiots') to fill the pyramid.

Take the position further. Based on a 10 person-per-level scheme, the seventh level alone will require 1 million people, with the eighth requiring another 10 million. In total, to get to eight completed levels you will need more than 11 million victims. That is about one-half of the population of Australia. The scheme will not last that long and never get to the ninth level, needing over 100 million people.

To have sufficient participants to fill 11 levels, you will need to increase the world's population to 10 billion people. But even if the scheme collapses well before level 6, the promoter will have done well financially.

For Example

Let's say that it is 10 people per level and the amount of money to be contributed is $1,000.

1. The promoter finds 10 investors that each give him $1,000 to enter the pyramid at the lowest level. The promoter has made $10,000. He is the top level. The 10 new investors create the second level. There are now 11 people in the scheme.

2. Each of the 10 second level investors have to find 10 new investors (100 in all) who each pay $1,000 to the person that introduced them. This is split with the promoter; the promoter getting $900 and the second level person getting $100 from each of the new 100 investors. The total number of people in the scheme is now 111. The 100 new investors are the third level of the pyramid. The promoter has received $100,000 ($10,000 from the second level and $90,000 from the third level). The people in the second level have received their initial $1,000 investment back (10 x $100).

3. Each of the new 100 third level investors have to find another 10 investors (1,000 in all) who each pay $1000 to be split ($800, $100, $100) between the three higher levels. The promoter receives $800 from each of the new 1,000 people. There are now 1,111 people in the scheme and the promoter has received $900,000. This is now the fourth level of the pyramid. The third level have received their money back and the second level have made a tidy profit of $10,000 each.

4. Each of the new 1000 investors finds 10 more people, and 10,000 new people join the scheme for $1,000 each with a $700, $100, $100, $100 split. There are now 11,111 in the scheme and the promoter has received a further $7,000,000 (10,000 x $700). This is the fifth level.

5. The chances of the scheme lasting this long are very remote, but the sixth level is formed with 100,000 new people entering the scheme. The promoter will receive a further $60 million.

The theory now is that the promoter drops out of the scheme (and goes to Bermuda on an extended holiday) and the second level people each become a first level person in their own pyramid. This is the incentive for the lower level people to keep feeding new participants into the system.

In reality the pyramid will collapse and the lower levels of people in the scheme when it does collapse will loose all, or most of, the money invested.

Legislation prohibiting Pyramid Schemes

Sections of Fair Trading Acts

Victoria - Section 22
Tasmania - Section 26B
Western Australia - Section 24
Queensland - Division 2A
South Australia - Section 70
New South Wales - Part 5D
Commonwealth Trade Practices Act - Part 1AAA

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Acknowledgment
The material in this Fact Sheet was sourced from various publications including those listed in the Reading List on the Fraud Awareness page on this website.

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Last Updated: 7.7.2010