From MLM to Ponzi and Pyramid Schemes: Recognizing the Red Flags

September 3, 20237 min read
From MLM to Ponzi and Pyramid Schemes: Recognizing the Red Flags
Share on facebookShare on TwitterShare on Linkedin

Key Takeaways

  • A pyramid scheme is a kind of fraudulent system of generating income based on the recruitment of an ever-rising number of “investors.”
  • Perhaps the most well-known Ponzi scheme was run by investment manager Bernie Madoff, whose scheme cost investors as much as $65 billion and wiped out the life savings of many unwitting participants.
  • A Ponzi scheme, meanwhile, is a fraudulent system in which investors are paid with funds from new investors. Organizers of such schemes commonly pledge to invest one’s capital and produce high returns with minimal risk, if any. 

As it is, many investors must regularly comb through unsolicited “invitations” to take advantage of some opportunity or another. Beyond being a nuisance, though, some of these offers could pose a real danger in the form of a Ponzi, pyramid, or multilevel marketing scheme. Thus, diligence is always required.

Here is an exploration of common financial schemes and how to recognize the red flags to avoid being taken.   

What is a Pyramid Scheme?

A pyramid scheme is a kind of fraudulent system of generating income based on the recruitment of an ever-rising number of “investors.”

Such schemes generally involve the initial promoters recruiting investors who subsequently lure more investors, and on and on. While some techniques are generally conservative, rendering them only minimally risky, others can be aggressive and involve more risk.

The scheme is dubbed a “pyramid” since the number of investors increases at every level. In addition to causing financial loss, pyramids also have participants scam recruits, thereby themselves committing fraud.

How Pyramid Schemes Operate

Say, for example, a scheme requires a $2,000 “buy in” from each participant. The first participant gets paid from new recruits’ receipts. The new recruits bring in others. With each payment made by a new recruit, the people above them get a cut. As the enterprise grows, as promises of big payouts also grow.

Early scheme participants do make money, while those who come in later get increasingly less. Why? Because it becomes more challenging to find individuals amenable to paying $2,000.    

Legality of Pyramid Schemes

Such schemes are illegal under federal law and in most states. In Connecticut, for example, the law says that if the program’s method of making money is based on membership recruitment, and not on a product or service, it is a pyramid, which is a felony.

While no federal statute exists for the express prosecution of pyramids, the nation’s Federal Trade Commission’s Division of Enforcement has gone after them for fraud or deceptive trade practices.

Pyramid Scheme Case Studies

There have been some prominent case studies i volving pyramids. A couple of them are:

  • Energy drink pyramid scheme. In 2015, federal regulators halted operations of the energy drink company Venma that used college students to sell the beverage called Verve. Venma was found to be running a pyramid scheme that recruited the students with the potential of gaining wealth. Instead, most left with no profits. At length, business bank accounts and assets were frozen. Venma, which posted $200 million in sales in 2013 and 2014, had marketed its “business opportunity” to students as a college alternative.  
  • Insurance pyramid scheme. Business Review at Berkeley columnists in 2019 were asked to attend a World Financial Group branch where they were told how to become wealthy by selling life insurance. This occurred as the attendees’ recruiter attempted to also sell each of them an insurance policy and hit them with pricey license fees. While WFG used a direct selling strategy, such products were only occasionally used to conceal its pyramid structure, according to the Federal Trade Commission.   

Ponzi vs Pyramid Schemes

A Ponzi scheme, meanwhile, is a fraudulent system in which investors are paid with funds from new investors in what appears to be a legitimate security or some other investment product.  Organizers of such schemes commonly pledge to invest one’s capital and produce high returns with minimal risk, if any. 

Perhaps the most well-known Ponzi scheme was run by investment manager Bernie Madoff. He perpetuated a scheme that cost investors as much as $65 billion and wiped out the life savings of many unwitting participants.

The main difference between Ponzi and pyramid schemes is that with the former, victims simply invest. With pyramid schemes, though, investors are expected to help recruit new participants.

MLM vs Pyramid Schemes

Direct sales companies, seeking to promote their goods or services while keeping sales costs minimal, often employ what is called multilevel marketing to generate sales.

The strategy calls for a network of distributors to sell directly to consumers – in person or online — and recruit other salespeople on whose sales they make commissions. Such sales people can work as direct sales representatives, contractors, participants, or independent business owners. Whatever the title, a share of the profits they generate goes to the frontline distributor, who now has two income streams. 

Most such programs are legitimate – though there are always exceptions — with top MLM companies including Amway, Avon, and Herbalife. What makes MLM controversial is primarily the use of a commission-based or non-salaried workforce. 

While the MLM general structure is often likened to pyramids, the difference between the two is that, with a pyramid scheme, there is no actual product for sale.  

Red Flags for Investors

There are common signs or red flags that should make full- or part-time investors cautious about potential scams. Those include:

  • Offers that require money up front with guarantees of large profits in a short period, with no product but a dependency on recruitment, should be viewed as a possibly pyramid scheme.
  • Extravagant promises about potential earnings.
  • High-pressure sales tactics or an attempt to play on emotions.
  • Promises of compensation in exchange for little work.
  • No demonstrated revenues from retail sales.
  • A complicated and murky commission structure.

Investing with Trusted Partners

In this day and age, particularly given technological advances that enable scams, it can be challenging and burdensome to stay ahead of financial schemes.

However, accredited as well as retail investors must continue to be diligent to avoid making costly investment decisions. A chief way to do that is by only investing with those who are reputable, credible, and experienced.

Take Yieldstreet, for example. For nearly a decade, the platform on which almost $4 billion has been invested has offered opportunities in “alternative” assets such as art, real estate, private debt, and more. In fact, Yieldstreet has grown to offer more asset classes than any other platform. 

What is also notable is that Yieldstreet’s offerings are highly vetted and that while every investment carries risk, they are backed by assets, which can help shield against default.

In addition to a proven track record, Yieldstreet offers opportunities in a burgeoning private market that serves a crucial purpose: portfolio diversification. Intermingling holdings with assets with low correlation to public markets can mitigate overall portfolio risk, reduce volatility, and potentially offer better returns.

Start Investing Today

Diversify your portfolio with private market investment offerings.

Portfolio Diversification and Alternative Investments

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

When it comes to investing, it is a fact of life that scams abound. Ultimately, investors must be diligent about their investment choices. The good news is that there are red flags that, if heeded, can keep investors from making potentially very damaging investment decisions.

We believe our 10 alternative asset classes, track record across 470+ investments, third party reviews, and history of innovation makes Yieldstreet “The leading platform for private market investing,” as compared to other private market investment platforms.

1 Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in significant losses.

3 "Annual interest," "Annualized Return" or "Target Returns" represents a projected annual target rate of interest or annualized target return, and not returns or interest actually obtained by fund investors. “Term" represents the estimated term of the investment; the term of the fund is generally at the discretion of the fund’s manager, and may exceed the estimated term by a significant amount of time. Unless otherwise specified on the fund's offering page, target interest or returns are based on an analysis performed by Yieldstreet of the potential inflows and outflows related to the transactions in which the strategy or fund has engaged and/or is anticipated to engage in over the estimated term of the fund. There is no guarantee that targeted interest or returns will be realized or achieved or that an investment will be successful. Actual performance may deviate from these expectations materially, including due to market or economic factors, portfolio management decisions, modelling error, or other reasons.

4 Reflects the annualized distribution rate that is calculated by taking the most recent quarterly distribution approved by the Fund's Board of Directors and dividing it by prior quarter-end NAV and annualizing it. The Fund’s distribution may exceed its earnings. Therefore, a portion of the Fund’s distribution may be a return of the money you originally invested and represent a return of capital to you for tax purposes.

5 Represents the sum of the interest accrued in the statement period plus the interest paid in the statement period.

6 The internal rate of return ("IRR") represents an average net realized IRR with respect to all matured investments, excluding our Short Term Notes program, weighted by the investment size of each individual investment, made by private investment vehicles managed by YieldStreet Management, LLC from July 1, 2015 through and including July 18th, 2022, after deduction of management fees and all other expenses charged to investments.

7 Investors should carefully consider the investment objectives, risks, charges and expenses of the Yieldstreet Alternative Income Fund before investing. The prospectus for the Yieldstreet Alternative Income Fund contains this and other information about the Fund and can be obtained by emailing [email protected] or by referring to www.yieldstreetalternativeincomefund.com. The prospectus should be read carefully before investing in the Fund. Investments in the Fund are not bank deposits (and thus not insured by the FDIC or by any other federal governmental agency) and are not guaranteed by Yieldstreet or any other party.

8 This tool is for informational purposes only. You should not construe any information provided here as investment advice or a recommendation, endorsement or solicitation to buy any securities offered on Yieldstreet. Yieldstreet is not a fiduciary by virtue of any person's use of or access to this tool. The information provided here is of a general nature and does not address the circumstances of any particular individual or entity. You alone assume the sole responsibility of evaluating the merits and risks associated with the use of this information before making any decisions based on such information.

9 Statistics as of the most recent month end.

300 Park Avenue 15th Floor, New York, NY 10022

844-943-5378

No communication by YieldStreet Inc. or any of its affiliates (collectively, “Yieldstreet™”), through this website or any other medium, should be construed or is intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice, except for specific investment advice that may be provided by YieldStreet Management, LLC pursuant to a written advisory agreement between such entity and the recipient. Nothing on this website is intended as an offer to extend credit, an offer to purchase or sell securities or a solicitation of any securities transaction.

Any financial projections or returns shown on the website are estimated predictions of performance only, are hypothetical, are not based on actual investment results and are not guarantees of future results. Estimated projections do not represent or guarantee the actual results of any transaction, and no representation is made that any transaction will, or is likely to, achieve results or profits similar to those shown. In addition, other financial metrics and calculations shown on the website (including amounts of principal and interest repaid) have not been independently verified or audited and may differ from the actual financial metrics and calculations for any investment, which are contained in the investors’ portfolios. Any investment information contained herein has been secured from sources that Yieldstreet believes are reliable, but we make no representations or warranties as to the accuracy of such information and accept no liability therefore.

Private placement investments are NOT bank deposits (and thus NOT insured by the FDIC or by any other federal governmental agency), are NOT guaranteed by Yieldstreet or any other party, and MAY lose value. Neither the Securities and Exchange Commission nor any federal or state securities commission or regulatory authority has recommended or approved any investment or the accuracy or completeness of any of the information or materials provided by or through the website. Investors must be able to afford the loss of their entire investment.

Investments in private placements are speculative and involve a high degree of risk and those investors who cannot afford to lose their entire investment should not invest. Additionally, investors may receive illiquid and/or restricted securities that may be subject to holding period requirements and/or liquidity concerns. Investments in private placements are highly illiquid and those investors who cannot hold an investment for the long term (at least 5-7 years) should not invest.

Alternative investments should only be part of your overall investment portfolio. Further, the alternative investment portion of your portfolio should include a balanced portfolio of different alternative investments.

Articles or information from third-party media outside of this domain may discuss Yieldstreet or relate to information contained herein, but Yieldstreet does not approve and is not responsible for such content. Hyperlinks to third-party sites, or reproduction of third-party articles, do not constitute an approval or endorsement by Yieldstreet of the linked or reproduced content.

Investing in securities (the "Securities") listed on Yieldstreet™ pose risks, including but not limited to credit risk, interest rate risk, and the risk of losing some or all of the money you invest. Before investing you should: (1) conduct your own investigation and analysis; (2) carefully consider the investment and all related charges, expenses, uncertainties and risks, including all uncertainties and risks described in offering materials; and (3) consult with your own investment, tax, financial and legal advisors. Such Securities are only suitable for accredited investors who understand and are willing and able to accept the high risks associated with private investments.

Investing in private placements requires long-term commitments, the ability to afford to lose the entire investment, and low liquidity needs. This website provides preliminary and general information about the Securities and is intended for initial reference purposes only. It does not summarize or compile all the applicable information. This website does not constitute an offer to sell or buy any securities. No offer or sale of any Securities will occur without the delivery of confidential offering materials and related documents. This information contained herein is qualified by and subject to more detailed information in the applicable offering materials. Yieldstreet™ is not registered as a broker-dealer. Yieldstreet™ does not make any representation or warranty to any prospective investor regarding the legality of an investment in any Yieldstreet Securities.

YieldStreet Inc. is the direct owner of Yieldstreet Management, LLC, which is an SEC-registered investment adviser that manages the Yieldstreet funds and provides investment advice to the Yieldstreet funds, and in certain cases, to retail investors. RealCadre LLC is also indirectly owned by Yieldstreet Inc. RealCadre LLC is a broker-dealer registered with the Securities and Exchange Commission (“SEC”) and a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation (“SIPC”). Information on all FINRA registered broker-dealers can be found on FINRA’s BrokerCheck. Despite its affiliation with Yieldstreet Management, LLC, RealCadre LLC has no role in the investment advisory services received by YieldStreet clients or the management or distribution of the Yieldstreet funds or other securities offered on our through Yieldstreet and its personnel. RealCadre LLC does not solicit, sell, recommend, or place interests in the Yieldstreet funds.

Yieldstreet is not a bank. Certain services are offered through Plaid, Orum.io and Footprint and none of such entities is affiliated with Yieldstreet. By using the services offered by any of these entities you acknowledge and accept their respective disclosures and agreements, as applicable.

Investment advisory services are only provided to clients of YieldStreet Management, LLC, an investment advisor registered with the Securities and Exchange Commission, pursuant to a written advisory agreement.

Our site uses a third party service to match browser cookies to your mailing address. We then use another company to send special offers through the mail on our behalf. Our company never receives or stores any of this information and our third parties do not provide or sell this information to any other company or service.

Read full disclosure