What’s the Difference Between Ponzi Schemes and Pyramid Schemes?

It’s not uncommon to see news reports about Ponzi schemes and pyramid schemes. Some might even use the two terms interchangeably. While these two white-collar crimes are similar, they have key differences.

If you’re facing charges involving a white-collar crime, the LLF Law Firm Criminal Defense Team can help. We work with individuals charged with federal and Pennsylvania state crimes. Call us at 888-535-3686 or fill out our online form.

What Is a Ponzi Scheme?

A Ponzi scheme pays early investors with money taken from later investors. They often claim to be legitimate investments with minimal risk, but the money is never invested.

Perhaps the best-known and largest Ponzi scheme in history was run by Bernie Madoff. This scheme went on for decades and is estimated to have involved up to $65 billion.

By paying off early investors, a Ponzi scheme can appear legitimate. These early returns can also assist a Ponzi scheme by generating positive word-of-mouth, making it easier to recruit later investors.

The person or people who operate a Ponzi scheme generally skim a percentage from the received assets. These schemes collapse when the operators can no longer recruit enough new investors.

What Is a Pyramid Scheme?

A pyramid scheme involves early participants earning money by recruiting new members. It’s not a sustainable business model because it only works as long as participants can recruit an ever-expanding group of members.

Pyramid schemes collapse when they are no longer able to recruit a sufficient number of new members. Most participants end up losing money.

Pyramid schemes are different than multilevel marketing operations (MLMs). MLMs are selling a legitimate product or service. Some pyramid schemes will pretend to be MLMs, although the focus is on collecting fees instead of revenue or sales.

How are Pyramid Schemes and Ponzi Schemes Different?

Both schemes involve luring people in with promises of big returns. Both require a constant supply of new money to continue operating and fall apart when that cash dries up.

Ponzi schemes operate on the idea that they are legitimate investments. Individuals turn assets over to a portfolio manager or other finance professional. They believe their money is legitimately invested.

In contrast, pyramid schemes focus on recruitment. Those at the top of the pyramid, the early investors, tend to benefit the most from the scheme. They recruit new members, who in turn recruit new members. In some cases, members may receive a fee or cash incentive for recruiting new people. When the scheme collapses, those at the bottom are most likely to lose out.

In contrast, even long-time investors may take a financial hit when a Ponzi scheme collapses. While they may have received interest, they may have lost all or part of the initial principal.

Similarly, while Ponzi schemes can benefit from word of mouth, individuals generally don’t receive any incentives or fees for recommending an investor’s services to new clients. Similar to a positive Yelp review, happy investors are merely telling other people they’re happy with someone’s services.

Defend Your Future

Ponzi scheme or pyramid scheme, anyone charged with either is facing potentially serious criminal charges.

If you’ve been charged or believe you may be charged for alleged actions related to a Ponzi, pyramid scheme or other white collar crime, contact the LLF Law Firm Criminal Defense Team. Call us at 888-535-3686 or fill out our online form.