What is a Pyramid Scheme? - Definition & Examples

Instructor: Brianna Whiting

Brianna has a masters of education in educational leadership, a DBA business management, and a BS in animal science.

When a person invests money, they want to know that their investment is safe and there is money to be made. Unfortunately, some companies do not always play by the rules. Let's learn about one illegal practice known as a pyramid scheme.

Looking at a Pyramid Scheme

Meet Sally! Sally had been looking for a little extra income when her friend suggested she consider working for ABC Skin Company. Knowing very little about the company, Sally decided to do some research. She found that ABC Skin Company was hugely popular and many people had decided to invest in it. She found that all she had to do was make a small investment and get others to invest a little money too. You see, Sally would need to find enough people to invest so that she and other recruiters above her could make a little money back. Even though the business was supposed to be about selling skin products, the real objective seemed to be about recruiting people so that her profit would grow. While it seemed easy enough, Sally had a bad feeling about this company. She decided to wait before investing any of her money which ended up being a good idea because shortly after, ABC Skin Company was accused of being a pyramid scheme. Come along as we learn what a pyramid scheme is and why they all eventually fail for most investors.

Pyramid Scheme Defined

So what exactly is a pyramid scheme? Well, a pyramid scheme is an illegal investment practice in which individuals recruit others to invest their money which is then paid to the earlier investors. As each new investor is recruited, the earlier investors make more money because all new recruits are recruited under them. When the scheme is laid out, it forms a pyramid because all of the investors are under the original investor. Although these businesses are presented as a multi-level marketing opportunity to sell products or services, the only real way to make money is to recruit new people. The new people have to continue to recruit to get their money back, and so forth. Eventually it becomes harder to get new recruits and the scheme fails for those at the bottom. Pyramid schemes pretend that their recruits will sell products and make money, but the real way to make money is recruitment of new members.

Why it Fails

While ABC Skin Company looked like a great opportunity, all pyramid schemes ultimately fail for most participants. This is because the scheme cannot keep going on and on due to the lack of recruits. Even if Sally were able to recruit everyone she knows, eventually she would run out of new recruits to invest. Those at the bottom of the pyramid are the most vulnerable because they have the task of finding people who have not already been recruited. When they cannot find recruits they are not able to get enough investments to cover the costs. This leads to a loss of money with approximately 90% of all people who invest in a pyramid scheme losing their money.

Popular Examples

Let's take a look at some companies that have been accused of being a pyramid scheme and those that have actually been charged.

Accused

1. Herbalife - Herbalife is a supplement and skin care company that was ruled a pyramid scheme in Belgium. It currently is facing several class action lawsuits from previous investors and is being investigated by the FTC.

2. USANA Health Sciences - Another supplement company, USANA Health Sciences was investigated as well. The FBI was unable to find concrete information to shut it down, but many accusations keep the company in the news. A government statistician in New Zealand has even made claims that USANA could be considered a pyramid scheme.

3. NU Skin Enterprises - Nu Skin is a supplement and skin care company that has been investigated in several U.S. states as well as by a Chinese government agency. The company settled many cases and ended up paying millions of dollars.

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