How to spot a pyramid scheme

Published on 7th September, 2021 at 02:41 pm

Pyramid schemes aren’t new, but advances in technology and social media mean scammers are getting more creative with their tactics.

What is a pyramid scheme?

A pyramid scheme is an illegal investment or business model that generates returns for earlier investors (at the top of the pyramid) through joining fees or initial investments paid by later investors (at the base of the pyramid) instead of through the sale of goods and services. There is no underpinning financial investment that generates growth, says Nischal Mewalall, CEO of the South African Banking Risk Information Centre (SABRIC).

Why should I be worried?

The key danger of this type of scheme is that it’s unsustainable; when it reaches a point where there are more existing members than there are new members, it collapses, which means all money is lost. “People who invested believing they were going to make a good return on their investment not only get nothing, but also stand to lose most (if not all) of the money they initially invested,” says Mewalall. Besides the financial implications, pyramid schemes put long-standing relationships on the line. “People borrow from friends, family and financial institutions, and when it fails, one is left with debt and broken relationships,” says Thezi Mabuza, acting commissioner of the National Consumer Commission (NCC).

If you have a goal in mind and don’t know which savings vehicle will get you there, read this.

How to spot a pyramid scheme

A friend or family member solicits investment
An invitation to invest can often come from a trusted family member, friend or even a respected member of your community, to establish trust in the scheme. “The initial strength of a pyramid scheme is word of mouth,” says Lyndwill Clarke, Head of Consumer Education at the Financial Sector Conduct Authority (FSCA).

While they may mean well, friends and family often dish out financial advice without being qualified to do so, leading to dire circumstances. These are the pieces of bad financial advice to steer clear of, and what to do instead.

Secrecy & anonymity
“The secrecy associated with word-of-mouth advertising can be enticing, as you are getting into something not many people know about,” says Clarke. “Closed online user groups are popular too, with an increasing trend towards messaging on WhatsApp, presumably owing to the belief that it offers end-to-end encryption, and therefore anonymity,” adds Mewalall.

The hook
Scheme members lure prospective investors with promises of high returns over a short period. “Short investment periods are common, sometimes as little as 10 days, promising high rates of return with strong encouragement to reinvest automatically,” says Mewalall. Mabuza adds that a red flag would be guaranteed returns of 20% more than the repo rate.

Get recruiting
From the outset, members are encouraged and incentivised – often by means of the promise of increased returns – to recruit new members. This is what builds the pyramid.

Virtual currency
Modern pyramid schemes can depend on cryptocurrencies like Bitcoin and Ethereum to sidestep the formal banking sector, where they could be detected, says Mewalall. “Other investment offers include commodity trading or forex trading,” he says.

Tiered investment structure
“Another sign is if you advance in the hierarchy levels through the recruitment of others,” says Mabuza. The appeal of a premium membership is also used to incentivise larger investments into schemes. This can leave unsuspecting investors high and dry if they invest their retirement savings, for example.

The stokvel disguise
“Traditional stokvels are a trusted savings mechanism in South Africa,” says Clarke. “A WhatsApp stokvel is nothing more than a pyramid scheme in a new guise.” Never pursue an invitation where you need to pay a joining fee to be a part of a WhatsApp group. Find out more about the dangers of WhatsApp stokvels here.

I’ve been scammed. Now what?

Stop participating
“If you think you are actively participating in a pyramid scheme, break off contact with the fraudsters immediately and do not invest any more money,” suggests Clarke. “Keep any written communication you have received from the pyramid scheme. This may help as evidence for the relevant authorities.”

Report it
You can contact the below authorities to report a suspected pyramid scheme:

South African Reserve Bank
0861 12 7272

National Consumer Commission
012 428 7000

Speak to a qualified financial planner to put your money into trusted investments and savings vehicles suited to your personal needs. Make an appointment today.