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Ask the expert: Stacie Bosley

Hamline associate professor of economics explains the logistics of pyramid schemes and how to recognize the warning signs

Interview by Julie Carroll

What is a pyramid scheme? Can you give an example?  
During the 2016 holiday season, you might have seen someone on Facebook asking friends to participate in a wine gift exchange. If participants bought one bottle of wine or other gift valued at $15 or more, sent it to another participant, and then recruited more people to do the same, they were told they would receive from six to 36 bottles of wine in return. The problem? This pay-and-recruit structure, or pyramid scheme, guarantees losses for the majority of participants—not because they failed to “do it right,” but because the structure is constructed to enrich a few at the expense of the many. Whether it’s wine, books, presents, or cash, there’s no magic multiplication process that occurs. These items are simply transferred from the “losers” to the “winners.” The promise of a return is inherently deceptive and, therefore, illegal.

Are there different kinds of pyramid schemes?​ 
There are pure pyramid schemes (chain letters or gifting circles—like the wine exchange mentioned above) and schemes disguised as multilevel marketing organizations. In the latter case, a participant pays to join and is, in turn, paid to sell a product or service and recruit additional sellers. It’s actually a pyramid scheme in disguise if the multilevel marketing organization is fueled primarily by recruitment rather than retail sales.​ I recently served as an expert witness for the Federal Trade Commission (FTC) in a case against multilevel marketer Vemma/Verve. The FTC charged that the company was focused almost entirely on recruiting new sellers, often on college campuses, rather than selling the company’s line of energy and supplement drinks to retail buyers. This can make for a difficult landscape for consumers, including college students who are looking for supplemental income. We have initiated workshops for Hamline students to help them identify fraud, especially when it is disguised as empowerment or entrepreneurship.

Are there “good” pyramid schemes that deliver what they promise?​ 
No. They may deliver for a select few, but those gains are achieved only because of losses to the vast majority of participants. If a structure is based on the premise of “pay, recruit, duplicate” (meaning getting other people to also pay and recruit), it’s built as an illegal structure and should be avoided and reported to authorities. It’s different from gambling in that it brings in new recruits through systematic false promises, suggesting that any and all can benefit if they only follow the instructions.

Why don’t most pyramid schemes work?​ 
Since there’s limited to no value creation or retail sales, the scheme simply moves money from many to a few. Recruits will find it increasingly difficult to find new participants as the scheme grows exponentially and exhausts the population of potential recruits. The vast majority fail to earn more than they invest.

In your research, you compare pyramid schemes to the Ku Klux Klan’s approach to recruiting members. What are some of the similarities?​ 
According to a 2012 study by Roland Fryer of Harvard and Steven Levitt of the University of Chicago, the Klan was driven, in part, by financial incentives that were similar to those in modern multilevel marketing organizations. New recruits paid to join the organization (e.g., for robes, renewal fees) and were​ paid for recruiting additional Klan members. Fryer and Levitt contend that many joined to have an opportunity to earn potential financial benefits of membership. In the same way, pyramid scheme participants pay to join and are incentivized to recruit additional participants.

How have pyramid scheme tactics evolved for the digital age?​ 
The internet and social media certainly have made it easier to make contact with friends, family, and potential recruits. On the other hand, many multilevel marketing organizations find that, while digital environments might be good at energizing and communicating within a community of existing members, initial contact and recruitment is still most effective face to face. ​Pyramid schemes also often start with face-to-face recruitment. Once a scheme is established, the digital realm can help support wildfire-like growth.

Who is most at risk?​ 
While fraud statistics are difficult to capture accurately, FTC surveys indicate that the 18- to 24-year-old age group is most at risk, and the risk to the just-retired group, 65 to 74, is increasing. Schemes also target affinity groups—communities with high degrees of trust based on similarities in religion, race or ethnicity, profession, or other social bonds. My prior research also indicates higher levels of risk in locations with larger economic contractions (e.g. bigger increases in the unemployment rate).

Are pyramid schemes growing or shrinking in popularity?​ 
Both the Securities and Exchange Commission (SEC) and the FTC have noted the increase in fraud, especially affinity-based frauds. As pyramid schemes are one form of affinity fraud, there is concern that they are growing, both domestically and globally. ​

What are some tips for recognizing a pyramid scheme and protecting yourself from becoming a victim?​ 
First, look behind the rhetoric and promises. If the opportunity at its essence has a pay, recruit, duplicate structure, reject and report.​ Additional warning signs include:

• High-pressure sales tactics and a sense of urgency.
• Promises of making money fast.
• Suggestions of “passive” or “residual” income (i.e., money that flows in without effort after you have built a team).
• Compensation structures that are hard to understand.
• Push for up-front investments and/or monthly payments.
• Focus on recruiting friends and family.
• Limited focus on selling to customers outside the organization.