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Investors should watch out for pyramid schemes
Toronto - The Ontario Securities Commission is warning investors to watch out for the signs of pyramid schemes. Pyramid schemes work by rewarding participants for recruiting others. The schemes are most often promoted by scheduled meetings and word of mouth. Participants initially pay a fee to join a club, or invest money in a company or product – the schemes are often disguised as chain letters, investment organizations, and buying clubs. The concept behind the scheme is that the initial participants get paid from the fees collected from new recruits. Unfortunately, the pyramid ultimately collapses.
While some pyramids are based on cash, some schemes use product sales to boost credibility. Product-driven pyramid schemes can be confused with legitimate multi-level marketing plans (MLMs) but there is a key difference - pyramid schemes profit from the recruitment of new participants, while MLMs profit from product sales.
In a product-driven pyramid scheme, the product is sold only to the scheme's participants and not to the general public. The participants believe that they are distributors who must purchase their own inventory. They may be told that their profits will be based on both sales and recruitment of new distributors - but recruitment usually pays more than product sales. What the participants don't know is that there is no market for the product. Even if there were, the company would not be able to sell at a competitive price due to the markup required to pay all distributors involved in the scheme.
Pyramid schemes must have a continuous inflow of new recruits in order for the scam to survive. Basic math, however, proves that pyramids eventually collapse. If one person recruited six distributors, who each recruited six others, at nine levels the pyramid would require more than ten million recruits.
Participants in the lower levels of the pyramid are at high risk of losing their money because they have few, if any, recruiting opportunities. Participants in the higher levels of the pyramid are likely to be convinced to reinvest their profits, and are also at high risk. Since most participants recruit their friends first, it is not just money that the participants lose when the pyramid collapses.
Use these tips to avoid getting involved in a pyramid scheme:
- Con artists may claim they have a "miracle product" to justify the product's high price and force participants to recoup via recruiting instead of sales. Be sceptical about outlandish claims, and testimonials from "elite members."
- A slick organizer may invite you to an "opportunity meeting" where, in the frenzied atmosphere, you learn that you can make huge profits by doing little or no work. Research the company to make sure that their focus is on service or product sales, and not recruitment, and don't fall prey to high-pressure sales tactics.
- Make sure that the opportunity is legitimate. Call the OSC Contact Centre toll-free at 1-877-785-1555 to inquire about investment scams. Call your local Better Business Bureau to investigate the background of the company.
- Check the credibility of company information. The documents that public companies file with securities regulators are available on www.sedar.com. Verify any information you receive with a credible source before investing your money.
If you suspect a scam, or have information pertaining to this or a similar scam, contact the Ontario Securities Commission at 1-877-785-1555. You can learn more about investment fraud and other investment topics on-line at www.investorED.ca.
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