The Meaning of Pyramid Schemes

by Robert L. FitzPatrick
July 2003

On a recent appearance on the NBC Today show and then on a local call-in radio show at KOMA in Oklahoma City three days later, the same question was raised, yet again, about the "meaning" of pyramid schemes that are sweeping America and Canada. The pyramid schemes include community-based scams that pose as private clubs or semi-religious movements and the product-based pyramid schemes that pose as "direct selling" or "multi-level marketing" companies.

The community-based schemes have recently broken out in more than 30 states. Hundreds of thousands of women have joined the latest version of the old-fashioned pyramid scheme, this time called "Women Helping Women." Authorities in several states have attracted national publicity as they arrested leaders and sought to break up the schemes. The product-based schemes are multiplying and operating ever more brazenly. They cause billions in losses to millions of people, but they are seldom investigated or prosecuted by state and federal regulators. Increasingly, these schemes are being accepted as legitimate "businesses."

This puzzling question of what the proliferation of these schemes says about us as a people and our country goes beyond the other more specific inquiries I typically get from the media and consumers regarding the legality or the details of operation of these frauds.

Lax enforcement of pyramid laws and political protection gained with campaign contributions offer some explanation for the pyramids' spread. Hard times, rising consumer debt, downsizing and general job insecurity undoubtedly account for some of the motives of participants. And clever disguises of the pyramids as "direct selling" businesses, gifting clubs and voluntary investment groups are also valid factors for their continuation.

But these answers are still unsatisfying. Millions of Americans could not all be so naïve. Government regulators are not all so corrupted or inept. And the tens of thousands in each city who join the scams are not so economically distressed that they must forsake conventional ethics and values just to survive.

Something more is at work in America that contributes to this massive breakdown in ethics, values, personal responsibility and common sense.

Enron for the Common Man

Why would so many gleefully join programs that fleece 90% to 99% of all participants ­ many of them friends, relatives and neighbors? And then, when the police or the state Attorney General informs them that the scheme is illegal and harmful to so many other people, why would they deny its harm and defy the government, as so many do? Some involved in the schemes have actually sued the police for enforcing the laws against pyramid fraud. In Texas, a large group of women hired lobbyists and tried to pass a state law that would make the most blatant of all pyramid schemes, the so-called gifting clubs, legal. A national business association is seeking to get state and federal laws changed to make legal what the FTC, most state laws and several federal court rulings now treat as illegal pyramid sales schemes.

Pyramid participants will never be accurately researched. Understanding this phenomenon or venturing a useful explanation requires intuition and analysis backed up with direct experience with pyramids. Having personally participated in a pyramid scheme, researched and written a book on the subject, appeared on many news shows, testified in court and corresponded or talked personally with several thousand people directly involved in these schemes, I have formed a view that is disturbing and challenging and tends to shift the focus from understanding "them" to looking at ourselves.

I see pyramid schemes as part of much wider trends and changes that are occurring in our culture and in the hearts and minds of most people in America. The pyramid scheme is the purest and starkest example of a larger shift in social and business values.

I also see the pyramids and the values they represent driving and influencing mainstream business practices. If the executives at Enron represent a set of corrupt values and practices that are more prevalent than we realized at the top end of our economy, the participants in the pyramid schemes can be seen as representing those very same values and practices at the bottom end where most of us live.

I came to this view after seeing that the basic elements and characteristics of the pyramid scheme are showing up in mainstream business, government and community life.

Anatomy of the Pyramid Scheme

There are at least three essential elements of the pyramid model:

1. Positioning: Profiting from being in the right place at the right time in contrast to gaining an equitable return for having delivered value or performed a useful service. The pyramid's ROI is akin to that of the speculator's and the gambler's.

2. Recruiting/enrolling/promoting: Seeking other people's investments as the source of your income, rather than from a profit based on creating or delivering value. Profit in the pyramid is not the by-product of labor, service or added value. It is gained at what is normally viewed as the start of a transaction, when investments are first made toward funding an enterprise. The pyramid diverts funds from real enterprise in the manner of embezzlement.

3. Leveraging: Multiplying your profits based on growth and expansion of new investors. The pyramid scheme model requires continuous leveraging through continuously expanding enrollments of investors. This is, of course, mathematically impossible. It therefore cannot deliver on its promises to any but a few, usually those who join at the launching of the scheme. For this reason, above all others, a pyramid scheme is an inherent fraud.
The pyramid scheme differs from the Ponzi scheme in that it requires each investor to enroll others. Each victim is induced to also become a perpetrator. The pyramid scheme multiplies its impact exponentially in the population. In addition to causing largescale financial harm the scheme spreads corruption, debases personal and social relationships and destroys informal networks that were based on trust.

Character of the Pyramid Scheme

To the components of positioning, recruiting and leveraging, we can add a few related characteristics in order to get a clearer picture.

1) Pyramid schemes are about, quick, short-term profit. They are the quintessential get-rich-quick scam. Leveraging a continuously growing base of new investors can produce enormous revenue to the perpetrators at the top. No need to wait for profits from offering a real service or product to real consumers, the pyramid just siphons off investment funds and transfers them to those "positioned" at or near the top. A long-term customer base is also not required since a steady flow of new buyers can be churned annually by attaching the promises of fast wealth to the product.

2) Pyramid schemes require an unconscionable lack of responsibility toward others. Profit is gained from someone else's loss. Value is not exchanged. Even when products are involved, the scheme is not a real business. "Profit" requires enrolling an endless chain of new salespersons and falsely promising them the same opportunity. In such a program, the vast majority must always be at the bottom where they can't earn a profit because they have no 'downline.' Pyramid sales schemes often couch this predatory behavior as "American individualism" and "personal responsibility", as if being responsible for yourself exempts you from responsibility to others and excuses deception. The values of the pyramid are those of the scavenger.

3) Pyramids are inherently deceptive. Deception in the pyramid involves lying to others and lying to oneself. In the pyramid sales schemes, for example, the real business is not vitamins or water filters, but recruiting other investor/salespeople. Almost no one actually makes money in a program hyped as the "opportunity of a lifetime." The speakers on the stage are not making the incomes they claim they are. This is not a program of "winners" at all. Indeed, 50-70% will quit the program in the first year and 99.9% actually lose money!

In the "gifting" schemes, for example, no one is really giving "gifts." They are buying positions in a scam that promises an 800% return. The women in the "women helping women" gifting schemes do not tell their friends that 90% will lose in the scheme, even if they realize this. If they don't realize this, it is because, to some extent, they willfully chose not to look at the facts. The scheme is not about "helping" others but about helping oneself at the direct expense of others. Like an onion, as each layer is peeled away, yet another level of deception and manipulation is revealed.

4) Ultimately, pyramid schemes steal. They are a form of organized thievery carried out within a system of money transfers in which everyone, to some extent, is seeking to steal from someone else. A kind of looters' mentality takes hold to justify this behavior. If everyone is doing it, why can't I? And, it is okay to steal from those who are trying to do the same thing?

5) And, finally, no one who studies pyramid schemes can fail to notice that pyramid schemes are characterized by a kind of lapse in common sense and normal intelligence. Denial and delusion, perhaps associated with desperation that is now being let loose with visions of quick riches, are in full swing. Well educated women will insist that a pyramid - in which each person gets the money paid in by eight others, and those eight will do the same with the process continuing indefinitely - is completely sustainable forever. They adamantly deny its inevitable collapse. They refuse to do the math. Nor, will they admit that 90% must, always, and by design, lose.

Multi-level marketing zealots, who have lost thousands already, will insist the program is valid and that "success" is just around the corner. They will reject any analysis or disclosure of actual financial results of all distributors as just "negativity". They will assert that all those who lose ­ even if it's 99.9% - cause the losses themselves due to laziness, lack of character or refusal to learn the "secrets" of success.

Extraordinary Popular Delusions in Everyday Life

With the three components and the five related characteristics listed above as guidelines, where else can we see this syndrome in operation in society that would put the pyramid in a larger context and help us understand its "meaning"?

Here is a short list that reveals that the pyramid scheme is part of a much larger system of values and practices that are gathering momentum and prominence in our society. Far from an aberration, the pyramid scheme is very much part of the "mainstream" or, more accurately, the mainstream increasingly resembles the pyramid scheme.

To understand the "meaning" of classic pyramid schemes and their unfortunate participants we must recognize that they share values, beliefs and practices with the nation's top securities firm, Fortune 500 companies, high flying technology firms, famous and revered CEOs, state and federal budget planners, with typical consumers, homeowners and IRA investors, lottery players, and millions of MLMers trying to enroll their family and friends into their "downlines." In short, all of us, to some extent, extol and support the pyramid mentality and its delusional behavior.

That pyramid scheme participants are part of mainstream America does not in any way lessen the personal and social harm, the financial losses or the corrupting influence. The damage grows proportionately. The losses accumulate exponentially. Moreover, in an era when millions are losing jobs to globalization and new technology, the legalization of business practices or programs designed to fleece unwitting and sometimes desperate consumers of their savings will have long term negative effects.

From the Enron scandal we have learned that specious and predatory business practices can hide behind a public façade of financial integrity, religious piety and business innovation. Pyramid schemes are camouflaged in the language of patriotism, entrepreneurship, community, personal fulfillment, marketing "trends", religion, personal freedom, or fun and games.

Beyond deception, delusion and desperation, the most important "meaning" of pyramid schemes may be their corruption of the core values and loftiest aspirations of the American people.