Sorry, you need to enable JavaScript to visit this website.

Why pyramid scams are on the rise

Why pyramid scams are on the rise

They promise big financial returns, deliver guaranteed losses, and social media is making them more common

They promise big financial returns, deliver guaranteed losses, and social media is making them more common

Richard Davies | November 15th 2016

On the face of it these seem like tough times for financial scammers. The crash of 2008 burned investors, exposed fraudsters and has forced regulators to toughen up. Yet dodgy “pyramid” investment schemes that promise huge returns before inevitably collapsing are going strong, especially those targeting women. In late 2015 British regulators jailed the leaders of a plot that had duped over 10,000 women. In June 2016 authorities in Belize warned of a scam sweeping the country. America, India, Mexico and Indonesia have seen similar stories. 

The structure is always the same. First, new members pledge a joining fee: $5,000 in the case of Canada’s “Women’s Wisdom Circle”, £3,000 for Britain’s “Give and Take” scam. Then they are asked to recruit two new members, who must also pay and commit to finding two investors. After a couple more rounds of this, one member sits at the top of a pyramid with eight newbies at its base. At this stage a party is held at which the person at the top is crowned the “birthday girl” or “bride” and given the cash from the joiners at the base of the pyramid. The promised return – $40,000 in the Canadian scheme, £24,000 in the British one – is 700%. The actual return tends to be zero.

The roots of these scams lie in an idea hatched by Carlo (“Charles”) Ponzi in 1919. He hoped to exploit an imperfection in foreign-exchange markets by buying postal coupons cheaply in countries with weak currencies and transporting them back to America to exchange them for dollars. The return, he calculated, would be 400%. The problem was that the costs involved in transporting and exchanging the coupons meant he actually lost money. Ponzi’s plan was useless. But as he described his scheme to friends, he noticed that many were attracted by the idea of exploiting a secret loophole. So he started promising them interest rates of 100%, to be paid in just 90 days. But rather than trading currencies he simply used the money from new investors to pay off old ones. Within ten months he collected $10m from 20,000 people in Boston and New York. Ponzi was quickly exposed as a fraud. 

All modern schemes follow Ponzi in making payouts from new members’ savings. But while they never say they are pyramid schemes, they do little to hide that fact: they do not pretend that the money is invested, but sell themselves as games or clubs. The rise of social-networking sites like Facebook seems to be one reason they are doing so well, and why women are so often the victims. 

In a famous 1992 study, Robin Dunbar, an anthropologist at Oxford University, predicted that humans had the brain power to sustain around 150 friendships. More recent research backs this up. This puts a cap on Ponzi plans: even if your pals are credulous, it is hard to find eight new joiners if your friends are all signed up already. But Dunbar has also shown that while the majority of people have a similar number of friends on Facebook as they do offline, around 15% of people are much more active, collecting more than 500 Facebook friends. That helps schemes spread easily. 

There are also important differences between the sexes. Women have more Facebook friends, are more likely to recommend goods and services online, and are more likely to use social media to help others. All this explains the branding that pyramid scams use to tap into these wider and more trusting networks. “Women’s Integrity Group”, “Women Helping Women” and “Women Empowering Women” sound helpful and supportive, the “Women’s Wisdom Circle” sounds clever, the “Gifting Circle” and the “Dinner Club” sound exclusive.

The simple mathematics that makes them so tempting also explains why these schemes are guaranteed to fail. If an investment club makes sure that each new round of members is twice as big as the last one then every existing member can be paid off. A Mexican scam called Flor de la Abundancia uses diagrams of flowers to explain the logic. In one image, eight petals on the outside support four on the inside, which in turn support two. The message is that there will always be enough new cash coming in to make the plan work. 

But the numbers rise fast: repeated doubling means that to fund its 20th payout a scheme will need to find over 8m new members. Once recruitment starts to fail the pyramid gets top-heavy, and falls down. In Albania in the mid-1990s, a collection of pyramid scams masquerading as banks duped the public. When they collapsed in 1997 over 51% of the population had invested and the losses ran to 64% of GDP. It led to rioting, a change in government and over 2,000 deaths. Thankfully schemes on this scale are rare. 

One way to avoid losing your money and alienating people is to examine the promised returns on any new investment. Even with a 10% interest rate – miraculous these days – it takes eight years to double your money. So anything promising a faster rise needs a lot of explaining. And anyone invited to an exclusive party where people talk about petals or pyramids should run a mile.

Readers' comments

Sign in or Create your account to join the discussion.