SEC Guidance on Ponzi, Pyramid Schemes

Related to this SEC guidance on ICOs:

I thought it would be useful to have this here as well:


What is a Ponzi scheme?

A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors to create the false appearance that investors are profiting from a legitimate business.

Why do Ponzi schemes collapse?

With little or no legitimate earnings, Ponzi schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out.

How did Ponzi schemes get their name?

The schemes are named after Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. At a time when the annual interest rate for bank accounts was five percent, Ponzi promised investors that he could provide a 50% return in just 90 days. Ponzi initially bought a small number of international mail coupons in support of his scheme, but quickly switched to using incoming funds from new investors to pay purported returns to earlier investors.

What are some Ponzi scheme “red flags”?

Many Ponzi schemes share common characteristics. Look for these warning signs:

  • High investment returns with little or no risk. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk. Be highly suspicious of any “guaranteed” investment opportunity.
  • Overly consistent returns. Investment values tend to go up and down over time, especially those offering potentially high returns. Be suspect of an investment that continues to generate regular, positive returns regardless of overall market conditions.
  • Unregistered investments. Ponzi schemes typically involve investments that have not been registered with the SEC or with state regulators. Registration is important because it provides investors with access to key information about the company’s management, products, services, and finances.
  • Unlicensed sellers. Federal and state securities laws require investment professionals and their firms to be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
  • Secretive and/or complex strategies. Avoiding investments you do not understand, or for which you cannot get complete information, is a good rule of thumb.
  • Issues with paperwork. Do not accept excuses regarding why you cannot review information about an investment in writing. Also, account statement errors and inconsistencies may be signs that funds are not being invested as promised.
  • Difficulty receiving payments. Be suspicious if you do not receive a payment or have difficulty cashing out your investment. Keep in mind that Ponzi scheme promoters routinely encourage participants to “roll over” investments and sometimes promise returns offering even higher returns on the amount rolled over.

If you are aware of an investment opportunity that might be a Ponzi scheme, contact the SEC by phone at (800) 732-0330 or submit a tip online at sec.gov/complaint/tipscomplaint.shtml.

What steps can I take to avoid Ponzi schemes and other investment frauds?

Whether you are a first-time investor or have been investing for many years, there are some basic questions you should always ask before you commit your hard-earned money to an investment.

The SEC sees too many investors who might have avoided trouble and losses if they had asked questions from the start and verified the answers with information from independent sources.

When you consider your next investment opportunity, start with these five questions:

  • Is the seller licensed?
  • Is the investment registered?
  • How do the risks compare with the potential rewards?
  • Do I understand the investment?
  • Where can I turn for help?

For more information, check out these resources: SEC Enforcement Actions Against Ponzi Schemes; Ponzi Schemes Using Virtual Currencies; Ask Questions; Avoiding Fraud; Affinity Fraud; Social Media and Investing – Avoiding Fraud.

What are some of the similarities and differences between Ponzi and pyramid schemes?

Ponzi and pyramid schemes are closely related because they both involve paying longer-standing members with money from new participants, instead of actual profits from investing or selling products to the public. Here are some common differences:

or more information regarding pyramid schemes, please read Beware of Pyramid Schemes Posing as Multi-Level Marketing Programs.


Beware of Pyramid Schemes Posing as Multi-Level Marketing Programs

Oct. 1, 2013

The SEC’s Office of Investor Education and Advocacy is issuing this Investor Alert to warn individual investors about pyramid schemes, a type of investment scam that fraudsters often pitch as a legitimate business opportunity in the form of multi-level marketing programs.

Have you ever been tempted by an advertisement or offer to make “easy money” or “online income” out of your own home? Multi-level marketing (“MLM”) programs are promoted through Internet advertising, company websites, social media, presentations, group meetings, conference calls, and brochures. In an MLM program, you typically get paid for products or services that you and the distributors in your “downline” (i.e., participants you recruit and their recruits) sell to others. However, some MLM programs are actually pyramid schemes – a type of fraud in which participants profit almost exclusively through recruiting other people to participate in the program.

Pyramid schemes masquerading as MLM programs often violate the federal securities laws, such as laws prohibiting fraud and requiring the registration of securities offerings and broker-dealers. In a pyramid scheme, money from new participants is used to pay recruiting commissions (that may take any form, including the form of securities) to earlier participants just like how, in classic Ponzi schemes, money from new investors is used to pay fake “profits” to earlier investors. Recently, the SEC has sued the alleged operators of large-scale pyramid schemes for violating the federal securities laws through the guise of MLM programs.

When considering joining an MLM program, beware of these hallmarks of a pyramid scheme:

  • No genuine product or service. MLM programs involve selling a genuine product or service to people who are not in the program. Exercise caution if there is no underlying product or service being sold to others, or if what is being sold is speculative or appears inappropriately priced.
  • Promises of high returns in a short time period. Be leery of pitches for exponential returns and “get rich quick” claims. High returns and fast cash in an MLM program may suggest that commissions are being paid out of money from new recruits rather than revenue generated by product sales.
  • Easy money or passive income. Be wary if you are offered compensation in exchange for little work such as making payments, recruiting others, and placing advertisements.
  • No demonstrated revenue from retail sales. Ask to see documents, such as financial statements audited by a certified public accountant (CPA), showing that the MLM company generates revenue from selling its products or services to people outside the program.
  • Buy-in required. The goal of an MLM program is to sell products. Be careful if you are required to pay a buy-in to participate in the program, even if the buy-in is a nominal one-time or recurring fee (e.g., $10 or $10/month).
  • Complex commission structure. Be concerned unless commissions are based on products or services that you or your recruits sell to people outside the program. If you do not understand how you will be compensated, be cautious.
  • Emphasis on recruiting. If a program primarily focuses on recruiting others to join the program for a fee, it is likely a pyramid scheme. Be skeptical if you will receive more compensation for recruiting others than for product sales.

The SEC has taken emergency enforcement action to stop alleged pyramid schemes that violate the federal securities laws, including schemes disguised as MLM programs.

For example, in a recently filed litigation, SEC v. CKB168, the SEC filed charges to stop an alleged pyramid scheme perpetrated under the façade of an MLM program for online children’s courses. The promoters of the scheme allegedly solicited investors worldwide, including targeting members of Asian-American communities in New York and California. The SEC alleges that these promoters misrepresented CKB as a legitimate and profitable MLM company that sells web-based children’s educational courses when, in fact, CKB has little or no retail consumer sales and no apparent source of revenue other than money received from new investors.

In an adjudicated settled action, SEC v. Rex Venture Group, the SEC shut down a $600 million fraud that duped approximately one million Internet customers through a complex investment scam involving a Ponzi scheme promoted as a daily profit-share pool and a pyramid scheme pitched as an MLM program for Zeekrewards.com, the self-described affiliate advertising division for zeekler.com, a penny auction website. The SEC alleged that, for the pyramid scheme component of the scam, the defendants promised bonuses and commissions to customers for enrolling in a monthly subscription plan and recruiting others to join the plan. However, according to the SEC’s complaint, new customers’ funds were pooled and used to pay recruiting bonuses to existing customers because there was no substantial legitimate revenue from product sales.

Pyramid schemes cannot be sustained and always collapse eventually. Protect yourself and your money by steering clear of any “opportunity” bearing warning signs of a pyramid scheme.

To receive the latest Investor Alerts and Bulletins from the SEC’s Office of Investor Education and Advocacy, sign up for our RSS feed at sec.gov/rss/investor/alertsandbulletins.xml or for email at sec.gov/news/press/subscribe_updates.htm. You can also follow us on Twitter @SEC_Investor_Ed, or visit Investor.gov, the SEC’s website dedicated to individual investors.

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