What is the difference between a Ponzi and a pyramid scheme?

By Arthur Pinkasovitch AAA
A:

Pyramid schemes and Ponzi schemes share many similar characteristics in which unsuspecting individuals are fooled by unscrupulous investors who promise extraordinary returns. However, in contrast to a regular investment, these types of schemes can offer consistent "profits" only as long as the number of investors continues to increase. Ponzi and pyramid schemes are self sustaining as long as cash outflows can be matched by monetary inflows. The basic difference arises in the type of products that schemers offer their clients and the structure of the two ploys.
Ponzi schemes are based on fraudulent investment management services – basically investors contribute money to the "portfolio manager" who promises them a high return, and then when those investors want their money back they are paid out with the incoming funds contributed by later investors. The person organizing this type of fraud is in charge of controlling the entire operation; they merely transfer funds from one client to another and forgo any real investment activities.

On the other hand, a pyramid scheme is structured so that the initial schemer must recruit other investors who will continue to recruit other investors and those investors will then continue to recruit additional investors and so on. Sometimes there will be an incentive that is presented as an investment opportunity, such as the right to sell a particular product. Each investor pays the person who recruited them for the chance to sell this item. The recipient must share the proceeds with those at the higher levels of the pyramid structure.

There are two additional important factors to consider: the only guilty party in the Ponzi and pyramid scheme is the originator of the corrupt business practice, not the participants (as long as they are unaware of the illegal business practices). Secondly, a pyramid scheme differs from a multi-level marketing campaign which offers legitimate products.

For related reading, take a look at What Is A Pyramid Scheme? and The Ghouls And Monsters On Wall Street.

This question was answered by Arthur Pinkasovitch.

RELATED FAQS

  1. What's the difference between legal defalcation and illegal defalcation?

    Discover what is meant by the term ''defalcation'' and how it can be used in multiple contexts to describe illegal or legal ...
  2. What was the Mahonia company and why did it become the subject of a lawsuit?

    In 1992, J.P.Morgan went into the energy trading business by creating a venture company called Mahonia Limited. At least, ...
  3. Which day is known as China's "Black Tuesday" and why?

    On February 27, 2007, the Chinese stock market suffered a correction, causing choppy markets all over the world. The Shanghai ...
  4. What is an echo bubble?

    To understand the term "echo bubble", you have to understand what a bubble is. A financial or economic bubble occurs when ...
RELATED TERMS
  1. Asset Liquidation Agreement (ALA)

    A contract between the Federal Deposit Insurance Corporation ...
  2. Capital Loss Coverage Ratio

    The difference between an asset’s book value and the amount received ...
  3. Gross Cash Recovery (GCR)

    The gross cash colloctions expected over the remaining life of ...
  4. Initial Targeted Cash Value

    The gross amount of collections expected to be obtained through ...
  5. Liquidation Differential

    The loss in value of an asset after it has been placed in receivership ...
  6. Financial Action Task Force (FATF)

    An intergovernmental organization that designs and promotes policies ...

You May Also Like

Related Articles
  1. Economics

    The New Global Banking Regulations To ...

  2. Venezuela has more oil than anyone, and Brazil and Argentina have lots going for them, too, so why can't they get out of their own way economically?
    Economics

    Where NOT To Invest in Latin America

  3. Financial advisors must lead the charge against cybersecurity risks, for their clients and for their own practices.
    Investing News

    Educating Your Clients About Cybersecurity

  4. The USA Patriot Act gave the government more muscle to fight financial crime after the Sept. 11 terrorist attacks. Here's an overview.
    Investing News

    How The Patriot Act Works & Why Is It ...

  5. Savings

    10 Mistakes To Avoid When Trying To ...

Trading Center