Why ponzi scheme is illegal

However, little or no effort is made to actually market the product. Instead, money is made in typical pyramid fashion Pyramid companies make virtually all their profits from signing up new recruits and often attempt to disguise entry fees as the price charged for mandatory purchases of training, computer services, or product inventory.

Pyramid schemes are not only illegal; they are a waste of money and time. Because pyramid schemes rely on recruitment of new members to bring in money, the schemes often collapse when the pool of potential recruits dries up market saturation. When the plan collapses, most people, except the few at the top of the pyramid, lose their money.

Although pyramid promoters claim that the possibility to earn is endless, this possibility cannot materialize due to market saturation. For example, if a program begins with one person who recruits two people, each one of whom recruits two more people, and so on, in only 28 levels practically the entire population of the United States - every man, woman, and child - would be involved, as is illustrated below.

When investigating a multi-level marketing opportunity, you should ask about market saturation and determine the saturation levels in your area of distribution. Legitimate companies do not have too many distributors in one area. Pyramid promoters are masters of group psychology. Recruitment meetings create a frenzied, enthusiastic atmosphere where group pressure and promises of a large sum of money play upon people's greed and fear of missing a good deal.

Promoters also openly discourage thoughtful consideration and questioning of the scheme. Victims often find themselves tricked into participating.

At a recruitment meeting, you might hear phrases like "this is a ground floor opportunity which will change your life", "opportunities don't go away, they go to other people", and "if you act now and work hard for three to five years, you can retire and live off of the residual income.

Claims by a company that their plan has been "approved" by the Michigan Attorney General should be bright red flags and you should report such a claim immediately to our office. A company that misrepresents one fact will likely misrepresent others. While our office is able to tell you if we have taken any legal action, we will not comment on any specific investigation of multi-level marketing companies.

Additionally, we do not provide any advance form of approval for any company and if you want legal advice on whether a multi-level marketing opportunity is actually an illegal pyramid, you need to seek private legal counsel. Many chain letters claim to be legitimate because they offer a product. Upon close examination, the product is just a pretense. Often the newsletter simply describes additional "get rich quick" schemes and may be the only item that new members "purchase.

In either case, the scheme is just a pyramid if it pays distributors to recruit new members rather than sell a real product to the wider public. In recent years, pyramid schemes have become more sophisticated, and many have surfaced on the internet. The pyramid scheme disguised as a multi-level marketing opportunity is not always easy to spot, but is just as much of a scam as the chain letter. Ponzi claimed that he could pay such a high rate of return because he could earn percent by trading and redeeming postal reply coupons.

These coupons had been established under the Universal Postal Convention to enable a person in one country to pre-pay the return postage on a package or letter sent back from another country. For a short time after World War I, fluctuations in currency exchange rates did create a disparity between the cost and redemption value of postal reply coupons among various countries.

However, Mr. Ponzi discovered that he could only make a few cents per coupon and that handling large volumes of coupons cost more than they were worth. He stopped redeeming any coupons but continued to collect investors' money. When he actually paid a 50 percent return to some early investors, his reputation soared and more money flowed in from around the country. Ponzi bought a stylish house in the best part of town and purchased a large minority interest in his local bank, the Hanover Trust Company.

Eventually his scheme began to unravel, bringing ruin to the bank and thousands of investors. When Mr. The bank refused and even issued back-dated certificates of deposit to cover Mr. Ponzi's overdrafts. Ponzi was arrested for mail fraud. He was convicted of fraud in both state and federal court and served ten years in prison. The legacy of Mr. Ponzi lives on as pyramid and Ponzi schemes continue to plague us and challenge the law enforcement community.

Fortunately, in the U. The Securities and Exchange Commission also pursues these schemes, obtaining injunctions against so-called "financial distribution networks" which in fact sell unregistered "securities.

Postal Inspection Service, prosecutes pyramid schemes criminally for mail fraud, securities fraud, tax fraud, and money laundering. State officials independently file cases in state court, often under specific state laws that prohibit pyramids.

California defines pyramids as "endless chains" and prohibits them under its laws against illegal lotteries. At the Commission, we bring cases against pyramid schemes under the FTC Act, which broadly prohibits "unfair or deceptive acts or practices in or affecting commerce. The Commission took its first concerted action against pyramid schemes in the 's during a boom in home-based business and MLM or direct selling.

Unfortunately, the rise in legitimate multilevel marketing was accompanied by a surge in pyramid schemes. Those schemes played off the popularity of MLM or network sales but paid more attention to networking than to selling actual goods.

Pyramid schemes became so notorious that then-Senator Walter Mondale sponsored a federal anti-pyramiding bill. It passed the United States Senate twice in the 's, but never became law. The company's incentive structure really did not encourage retail sales. First is "the right to sell a product", second is "the right to receive, in return for recruiting other participants into the program, rewards which are unrelated to sale of the product to ultimate users.

The short-term result may be high recruiting profits for the company and select distributors, but the ultimate outcome will be neglect of market development, earnings misrepresentations, and insufficient sales for the insupportably large number of distributors whose recruitment the system encourages. In In re Amway Corp. At the time, Amway manufactured and sold cleaning supplies and other household products.

Under the Amway Plan, each distributor purchased household products at wholesale from the person who recruited or "sponsored" her. The top distributors purchased from Amway itself. A distributor earned money from retail sales by pocketing the difference between the wholesale price at which she purchased the product, and the retail price at which she sold it. She also received a monthly bonus based on the total amount of Amway products that she purchased for resale to both consumers and to her sponsored distributors.

Since distributors were compensated both for selling products to consumers and to newly-recruited distributors, there was some question as to whether this was a legitimate multilevel marketing program or an illegal pyramid scheme. The Commission held that, although Amway had made false and misleading earnings claims when recruiting new distributors, 21 the company's sales plan was not an illegal pyramid scheme.

Amway differed in several ways from pyramid schemes that the Commission had challenged. It did not charge an up-front "head hunting" or large investment fee from new recruits, nor did it promote "inventory loading" by requiring distributors to buy large volumes of nonreturnable inventory.

Instead, Amway only required distributors to buy a relatively inexpensive sales kit. Moreover, Amway had three different policies to encourage distributors to actually sell the company's soaps, cleaners, and household products to real end users. First, Amway required distributors to buy back any unused and marketable products from their recruits upon request.

Finally, Amway required each sponsoring distributor to make at least one retail sale to each of 10 different customers each month, known as the 10 customer rule. The Commission found that these three policies prevented distributors from buying or forcing others to buy unneeded inventory just to earn bonuses. Thus, Amway did not fit the Koscot definition: Amway participants were not purchasing the right to earn profits unrelated to the sale of products to consumers "by recruiting other participants, who themselves are interested in recruitment fees rather than the sale of products.

The 's first brought an important refinement in the law. However, an appellate court decision called Webster v. Omnitrition Int'l, Inc. While new cases were refining the law in the 's, radical changes were underway in the marketplace. Pyramid schemes came back with a vengeance. Like most economic activity, fraud occurs in cycles, and new pyramid schemes exploited a new generation of consumers and entrepreneurs that had not witnessed the pyramid problems of the 's.

Also, the globalization of the economy provided a new outlet for pyramiding. Pyramids schemes found fertile ground in newly emerging market economies where this type of fraud had previously been scarce or unknown. In the U. The introduction of electronic commerce has allowed con artists to quickly and cost-effectively target victims around the globe.

Pyramid operators can target specific audiences by posting messages in specialized news groups e. In addition, through unsolicited e-mail messages -- known on the Internet as "spam" -- pyramid operators can engage in cheap one-on-one marketing. Whereas it might cost hundreds or thousands of dollars to rent a mailing list and send cent post cards to potential recruits, it costs only a fraction of that to send out similar e-mail solicitations.

The Federal Trade Commission's current law enforcement efforts reflect this new wave in pyramiding. The Commission has brought eight cases against pyramid schemes in the last two years, 30 and six of those have involved Internet marketing. FutureNet, Inc.

The FTC filed suit, charging that FutureNet's earnings claims were false because the company really operated an illegal pyramid scheme. Near the time of filing, FTC investigators discovered that FutureNet had begun to sell electricity investments as well, riding a wave of speculation in advance of the deregulation of California's electricity market. The Commission continues to litigate its case against three non-settling individual defendants.

Pyramid schemes not only injure consumers. In many cases, they affect the daily operations of banks and taint the banking industry's overall reputation for safety and soundness. Many pyramid promoters disparage the bank industry and promote their own program as a superior alternative to traditional banking and investment. Melvin Ford, a defendant in the SEC's recent case against International Loan Network, stated that his company's bonus program was "the most powerful financial system since banking.

In FTC v. Cano, 35 the Commission observed first-hand the impact of pyramid schemes on the banking system and individual banks. CDI representatives claimed that they could offer such attractive terms because they had a special marketing relationship with a large overseas bank, the Banque Nationale de Paris BNP. According to the transcript of a taped sales meeting, CDI hinted that a broad conspiracy prevented U. A CDI representative claimed, "normal banks do not want people to know that they could have a 6.

Our evidence also showed that the defendants likely misled the one bank with which they did have a relationship. When investors paid by credit card to join CDI, the defendants apparently processed these payments, not through CDI but through a different "front" company with a VISA merchant account. Consequently, the defendants put their own merchant bank at risk for any charge backs that VISA might credit to angry investors. In the end, CDI members never received their credit cards, and according to a Commission economist, at least 89 percent of them would never have made enough money to recoup their initial investment.

Last autumn, the Commission obtained a temporary restraining order and a preliminary injunction against the CDI defendants, as well as a freeze over their assets. The Commission estimates that over the five-month life of CDI, more than 30, consumers from the U. The matter is still in litigation; the Commission is now seeking to amend its complaint and name additional defendants.

In the largest pyramid case brought by the Commission in the 's, we witnessed how pyramid operators often try to use the international banking system to hide their assets. Companies that engage in a Ponzi scheme focus all of their energy into attracting new clients to make investments. This new income is used to pay original investors their returns, marked as a profit from a legitimate transaction.

Ponzi schemes rely on a constant flow of new investments to continue to provide returns to older investors. When this flow runs out, the scheme falls apart. The term "Ponzi Scheme" was coined after a swindler named Charles Ponzi in However, the first recorded instances of this sort of investment scam can be traced back to the mid-to-late s, and were orchestrated by Adele Spitzeder in Germany and Sarah Howe in the United States.

In fact, the methods of what came to be known as the Ponzi Scheme were described in two separate novels written by Charles Dickens, Martin Chuzzlewit , published in and Little Dorrit in The postal service, at that time, had developed international reply coupons that allowed a sender to pre-purchase postage and include it in their correspondence. The receiver would take the coupon to a local post office and exchange it for the priority airmail postage stamps needed to send a reply.

This type of exchange is known as an arbitrage , which is not an illegal practice. But Ponzi became greedy and expanded his efforts. Due to his success in the postage stamp scheme, investors were immediately attracted.

Instead of actually investing the money, Ponzi just redistributed it and told the investors they made a profit. As a result of the newspaper's investigation, Ponzi was arrested by federal authorities on August 12, , and charged with several counts of mail fraud. The concept of the Ponzi scheme did not end in As technology changed, so did the Ponzi scheme.

In , Bernard Madoff was convicted of running a Ponzi scheme that falsified trading reports to show a client was earning a profit on investments that didn't exist. Madoff died in prison on April 14, Regardless of the technology used in the Ponzi scheme, most share similar characteristics:. Securities and Exchange Commission. Wealth Management. Investing Essentials.

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