The best way to protect yourself is to understand how pyramid schemes operate, as this example shows:
Example: Frank L. was phoned by a friend and offered an opportunity to "get in on the ground floor" of a business involving selling products to the public. He was told he would get a 50 percent return on his money within a month and how his friend had made thousands of dollars on a $1,000 investment. Frank L. quickly accepted the offer and gave his friend $1,000 to buy a "distributorship" in this business.
What Frank didn't know was that his friend had fallen victim to a pyramid scheme. Such schemes work as follows: A promoter offers investors "distributorships" at $1,000 each. The distributorships give the investor the right to sell other distributorships to friends and neighbors for $1,000 each, and also a right to sell some sort of product. Whenever an investor sells a $1,000 distributorship, he or she must give a percentage, usually half, to the promoter, and can keep the rest.
The tricky thing about pyramid schemes is that, for the first ten or twenty investors, they work. But, the pyramid scheme could continue to provide returns only in a world where there are infinite numbers of investors willing to invest $1,000, and willing (and able) to sell distributorships to others. Returns depend totally on new investors making an investment rather than on any business venture.
Result: Because Frank had no sales ability, he was unable to unload even one distributorship, and thus the $1,000 was lost. He is currently trying to get his money back and has reported the investment to the SEC.
