The Securities and Exchange Commission (“SEC”) has set out the warning signs or red flags that should alert investors that an investment might be a Ponzi Scheme.

Many Ponzi schemes share common characteristics. Look for these warning signs:

  • High investment returns with little or no risk. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk. Be highly suspicious of any “guaranteed” investment opportunity.
  • Overly consistent returns. Investment values tend to go up and down over time, especially those offering potentially high returns. Be suspect of an investment that continues to generate regular, positive returns regardless of overall market conditions.
  • Unregistered investments. Ponzi schemes typically involve investments that have not been registered with the SEC or with state regulators. Registration is important because it provides investors with access to key information about the company’s management, products, services, and finances.
  • Unlicensed sellers. Federal and state securities laws require investment professionals and their firms to be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
  • Secretive and/or complex strategies. Avoiding investments you do not understand, or for which you cannot get complete information, is a good rule of thumb.
  • Issues with paperwork. Do not accept excuses regarding why you cannot review information about an investment in writing. Also, account statement errors and inconsistencies may be signs that funds are not being invested as promised.
  • Difficulty receiving payments. Be suspicious if you do not receive a payment or have difficulty cashing out your investment. Keep in mind that Ponzi scheme promoters routinely encourage participants to “roll over” investments and sometimes promise returns offering even higher returns on the amount rolled over.

For more details, please visit the SEC website. 

These are the SEC’s suggested steps to avoid Ponzi schemes and other investment frauds.

Below are some basic questions you should always ask before you commit your hard-earned money to an investment.

  • Is the seller licensed?
  • Is the investment registered?
  • How do the risks compare with the potential rewards?
  • Do I understand the investment?
  • Where do I turn for help?

If you do not understand an investment, its features, risks and/or the seller or investment is not registered, these are reasons to not buy the investment.

Sometimes, a multi-level marketing scheme is in actuality a Ponzi scheme.

As explained by the SEC, Pyramid schemes masquerading as multi-level marketing (“MLM”) programs often violate the federal securities laws, such as laws prohibiting fraud and requiring the registration of securities offerings and broker-dealers. In a pyramid scheme, money from new participants is used to pay recruiting commissions (that may take any form, including the form of securities) to earlier participants just like how, in classic Ponzi schemes, money from new investors is used to pay fake “profits” to earlier investors. Recently, the SEC has sued the alleged operators of large-scale pyramid schemes for violating the federal securities laws through the guise of MLM programs.

When considering joining an MLM program, the SEC has warned investors to beware of these hallmarks of a pyramid scheme:

  • No genuine product or service. MLM programs involve selling a genuine product or service to people who are not in the program. Exercise caution if there is no underlying product or service being sold to others, or if what is being sold is speculative or appears inappropriately priced.
  • Promises of high returns in a short time period. Be leery of pitches for exponential returns and “get rich quick” claims. High returns and fast cash in an MLM program may suggest that commissions are being paid out of money from new recruits rather than revenue generated by product sales.
  • Easy money or passive income. Be wary if you are offered compensation in exchange for little work such as making payments, recruiting others, and placing advertisements.
  • No demonstrated revenue from retail sales. Ask to see documents, such as financial statements audited by a certified public accountant (CPA), showing that the MLM company generates revenue from selling its products or services to people outside the program.
  • Buy-in required. The goal of an MLM program is to sell products. Be careful if you are required to pay a buy-in to participate in the program, even if the buy-in is a nominal one-time or recurring fee (g., $10 or $10/month).
  • Complex commission structure. Be concerned unless commissions are based on products or services that you or your recruits sell to people outside the program. If you do not understand how you will be compensated, be cautious.
  • Emphasis on recruiting. If a program primarily focuses on recruiting others to join the program for a fee, it is likely a pyramid scheme. Be skeptical if you will receive more compensation for recruiting others than for product sales.

According to the SEC, Ponzi and pyramid schemes are closely related because they both involve paying longer-standing members with money from new participants, instead of actual profits from investing or selling products to the public. Here are some common differences:

Pyramid Scheme

Ponzi Scheme

Typical “hook” Earn high profits by making one payment and finding others to become distributors of a product. The scheme typically does not involve a genuine product. The purported product may not exist or it may be “sold” only to other people who also become distributors. Earn high investment returns with little or no risk by simply handing over your money; often the investment does not exist or only a small percentage of incoming funds are actually invested.
Payments Must pay a one-time or recurring participation fee and recruit new distributors to receive payments. No recruiting necessary to receive payments.
Interaction with original promoter Sometimes none. New participants may enter the pyramid scheme at different levels. Promoter generally interacts directly with all participants.
How the scheme works Funds from new participants are used to pay recruiting commissions to earlier participants. Funds from new investors are used to pay purported returns to earlier investors.
Collapse Fast. An exponential increase in the number of participants is required at each level. May be relatively slow if existing participants reinvest money.

If you believe that you are the victim or a Ponzi scheme or other investment scam, call us today for a free consultation.Former Wall Street Attorney Melanie S. Cherdack represents investors in the United States and the Caribbean in claims against brokers and brokerage firms for wrongdoing. If and have experienced investment losses, please call us at 888-768-2499  or complete our contact form for a free consultation.