Fraudulent investment schemes have been in the news over the past few years as unscrupulous individuals stole millions of dollars from people enticed by the opportunity to earn extraordinarily high returns on their investments. The most common form of investment fraud is the pyramid scheme.

How a Pyramid Scheme Functions

In a typical pyramid scheme, the person committing the fraud recruits investors with the promise of returns on their investments that far exceed the returns on other investment vehicles. The originator of the scheme recruits someone to invest a fixed sum of money by giving it to the originator. The investor must recruit other people willing to pay the investor.

The scheme continues with additional people being recruited in order to pay those investors who preceded them. The fraudulent aspect of a pyramid scheme is found in the geometric shape from which it derives its name. The originator of the scheme is at the top of the pyramid with an abundance of potential investors. As more investors join the scheme, fewer potential investors exist for newcomers to recruit.

Ultimately, the vast majority of the people involved in a pyramid scheme will lose the money they invest in it. For this reason, Texas and most other states have enacted laws making pyramid schemes illegal.

Attempts to Disguise Pyramid Schemes

People have devised variations on the traditional pyramid scheme in an attempt to circumvent criminal laws making it illegal. Multi-level marketing where a distributor recruits people to sell a product and profits from their sales volume is not a pyramid scheme as long as the product or service offered for sale has an intrinsic value.

A fraudulent multi-level marketing scheme occurs when the only value of the product or service is the cost charged to new people recruited to sell it. Essentially, the only way a person can make money from the product is to recruit other salespeople who pay the recruiter for the product.

Charles Ponzi and Fraudulent Investments

Charles Ponzi operated one of the first fraudulent investment schemes in 1920 when he recruited investors with the promise of a 100 percent return on investment within three months. Ponzi did not invest the money taken from investors. Instead, early investors were repaid with money collected from new people recruited into the investment scheme.

Eventually, Ponzi ran out of new investors. One year after he began to recruit investors, Ponzi was arrested and charged with taking more than $20 million from his victims for his ponzi scheme.

If you would like to learn more about pyramid schemes, then call Rand Mintzer, Attorney at Law for a free legal consultation session at 713-862-8880.