How to spot a Ponzi or pyramid scheme

Do you know how to spot a Ponzi or pyramid scheme? Many other people thought they were sure that the scheme they were investing in was not one of these illegal ways of fleecing consumers of their hard-earned money, just to end up destitute, with not a cent to their name.

Just think of BHI Trust and Mirror Trading International and how it destroyed people’s lives when the schemes folded. Consumers have to be very careful when they invest their money to ensure that their funds are safe.

Roshan Jelal, head of fraud risk management at FNB Commercial, says the key to helping investors protect themselves better from falling victim to investment fraud is to stay alert and be aware of the key characteristics and red flags associated with Ponzi and pyramid schemes.

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What is a Ponzi scheme?

“Ponzi schemes have existed for over 100 years and range in shape, complexity and size. Investors are often promised extraordinarily high returns within a short period of time, with little or no risk.

“However, the money ‘invested’ from new investors is either used to pay returns promised to earlier investors or returns are paid from the initial investment, creating an illusion of a very lucrative business.”

Jelal says in the absence of any legitimate underlying business, this unsustainable scheme eventually collapses as it becomes impossible to attract new investors that enables the scheme operators to pay as it promised, particularly to earlier investors. These schemes rely solely on the steady stream of new investor (victim) funds.

“While these scams often rely on word-of-mouth for marketing, social media gives it further momentum.”

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Red flags for a Ponzi scheme

If you are wondering whether an investment opportunity may be a Ponzi scheme in disguise, consider these red flags and tips to protect yourself:

• Be cautious of opportunities promising high rates of return with little or no risk attached. Remember that all investments carry some risk, particularly short-term investments with high rates of return.
• Look out for investment schemes that are not registered and licensed with the relevant regulatory authority. All financial services providers (FSPs) must be registered with the Financial Sector Conduct Authority (FSCA) to operate in the financial services industry. Therefore, it is of utmost importance to do your due diligence and check if the FSP is indeed registered before investing.
• Only licensed professional are allowed to sell any investments and you can also check their registration with the FSCA. If the person trying to sell you an investment is not registered, you could be dealing with a con.
• Beware of investment opportunities that lack transparency, a clear business model, or are exceedingly difficult to understand. You must always be able to understand how and where your hard-earned money is invested.
• Never rush into investment opportunities. It is wise to take as much time as required to authenticate the entity and related parties and check with the FSCA if they are legitimate.

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What is a pyramid scheme?

Jelal warns that pyramid schemes are just as unsafe as Ponzi schemes. Pyramid schemes require that participants recruit new people to join the scheme. If you ever knew someone who wanted to come and see you to tell you about a wonderful new scheme with an opportunity that is too good to miss, that person was likely to have been trying to get you to join a pyramid scheme, especially if they were extremely insistent.

“The initial participant often pays an upfront fee to sell the products or services. After joining, the participant is enticed to recruit new participants and at each new tier or level, he/she receives recruitment-based commissions which are usually paid from the fees received from each new recruit.”

Jelal says pyramid schemes inevitably collapse when participants are unable to recruit more people. “These schemes often mimic multi-level marketing concepts as both offer recruitment-based commissions. The difference is that with pyramid schemes, the earlier participants take money from lower-tiered recruits while with multi-level marketing the commission and revenue are generated through product sales.”

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Red flags for a pyramid scheme

Watch out for these red flags to identity a pyramid scheme:

• Pyramid schemes focus on the large sums of commissions you can earn through recruiting others.
• There is often no actual product or service that is sold. If products and services are sold, these may be vague and benefits are unclear.
• Beware of fast, easy money and passive income that requires little or no effort.

“Consumers must take time to understand the red flags and validate and verify investment opportunities, as this time and effort could save you a lifetime of pain and financial loss.”