How to spot a pyramid scheme

There are a variety of scams out there, many of them perpetrated by illegitimate entities, and all of them designed to swindle you out of money.

We look at one of the most common types of financial scam: the pyramid scheme. We explain exactly what a pyramid scheme is and the questions you should ask to avoid being taken in.

READ MORE: How to identify an investment scam

What is a pyramid scheme?

According to Ayanda Ndimande, strategic business development manager of retail credit at Sanlam, “A pyramid scheme is a fraudulent, so-called investment scheme, that lures investors by offering unusually high payouts. Investors get payouts from newer investors instead of profit earned, and encourage others to invest, or invest more themselves.”

Craig Pedersen, forensic investigator, notes that a pyramid scheme usually has a “product” attached to it. He states, “The focus is always on recruiting new members for reward. Without recruiting new members, there’s little benefit and very little return on investment, if any.”

To illustrate this concept, Pedersen cites the example of a company called World Ventures.

“In this case,” Pedersen says, “the ‘product’ was a club membership which included ‘benefits’ that were later found to be of nominal value, and not saleable.

“A percentage of the membership price was given to those who recruited new members. If those new members recruited someone else, then those who recruited them would also receive a percentage of the membership commission.

“Ultimately, pyramid schemes are impossible to sustain," Pedersen continues. "After a few recruiting levels, the population of the planet is saturated. They implode quite spectacularly because there is no way to make money, except by recruiting.”

READ MORE: Be careful of credit scams – protect yourself!

How to identify a pyramid scheme

Ruvan Grobler, wealth manager and business development specialist at BOVEST Wealth Management, recommends that you ask the following questions in order to identify a pyramid scheme.

• What are you investing in?

Don’t let the scheme’s promise on returns impair your judgement. Make sure the proposed assets actually exist and that proof can be provided. The proposal and the actual nature of the assets should line up.

• What is it promising?

Normally, these types of scams promise a massive return on investment, but the risks involved will probably not be explained. For example, a recent crypto scheme offered returns of close to 20% every six months, along with annual payouts. These types of returns and structures are highly unlikely, as favourable as they may seem.

• Is the company registered with the Financial Sector Conduct Authority (FSCA)?

All institutions that give advice on investments must be registered as a financial service provider (FSP) at the FSCA, and all representatives must be licensed to give advice. This means that the company must have an FSP number and a license certificate clearly visible at their business premises. FSP numbers and representatives can also be verified on the FSCA website.

• Does the company require compliance documentation?

All registered FSPs must comply with the Financial Intelligence Centre Act (FICA). They need to know who their clients are and must comply with international anti-money laundering standards.

This means that they will ask for FICA documentation before a transaction is done. This documentation includes ID, proof of bank account, and proof of address.

They will also need to know the source of the funds to be invested. This ensures that business is done with a legitimate person, and that the investment is not simply made to evade taxes or hide the origin of funds.

“Reputable entities will always have business premises, and a website where you can learn more about them and their services,” Grobler says.

“Always google the entity and read comments and reviews from other individuals and investors. You would usually read about investors not being able to make withdrawals. It will never hurt to ask your wealth manager for an informed opinion.”

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