What exactly is a pyramid scheme?
29 July 2016
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On mobile, on digital, on demand, this is Old Mutual Live, the Money Coach edition. Hello and welcome, my name is Chris Gibbons. With me in the Old Mutual Live studio is John Manyike, Head of Financial Education at Old Mutual. John welcome, good to have you with us.
John Manyike: Thank you Chris.
CG: Today we’re talking about pyramid schemes. They’ve been in the news an awful lot. what exactly is a pyramid scheme?
JM: In terms of Section 43 of the Consumer Protection Act, an arrangement or an agreement or a scheme were participants receive their income primarily from recruiting new members as opposed to selling or buying a product, is a pyramid scheme. Quite often these are disguised as multi-level marketing programmes. They will pretend they’re selling products when actually they’re not. Sometimes they will say these are stokvel’s, which they’re not.
The classic pyramid scheme
CG: Let me get this right, this could be a family member, it could be a close friend who comes to you and says: Look, I invested R500, I made R10 000. All you have to do is give me R500 and you go off and find another 10-20 members and you’ll get rich.
JM: Classic pyramid scheme right there, but what is interesting is that promoters of the investment use money from new recruits to pay off any stage investors. The reason it becomes problematic is that at times these schemes get too big that promoters cannot raise enough money to pay their early investors. That’s where schemes generally collapse and a lot of people lose their hard-earned earnings.
CG: There’s no product, they’re selling hot air.
JM: Yes, there’s no underlying asset, there’s no product, that money is not invested in any asset class of any form. It’s purely money received from new recruits in order to pay early investors.
CG: One word of caution, it could be that there is a product, but the product is a rubbish product. I’m thinking back to a pyramid scheme in the late 1980’s where the product was dried milk powder. It was completely nonsense, complete rubbish. The founder went to jail.
When it sounds too good to be true…
JM: Yes, that’s the thing, a lot of promoters, because they know it’s illegal, they always find a smart way to disguise this as something legal. These days they’ll say no, there’s no money exchanging hands, you’re buying something, virtual money –
CG: That was the three MMM thing, Bitcoin –
JM: I won’t even mention the name, but you find those things, but it just sounds too good to be true. The kind of returns that are promised, they’re astronomically very high.
CG: That’s a critical point you make because it’s worth remembering. This kind of scam is also called a Ponzi scheme, after an American crit called Charles Ponzi. Who guaranteed investors fantastic returns in a matter of months. Of course the biggest Ponzi scheme of all, Bernie Madoff who scammed $65 billion – with a B – dollars. He’s currently serving 150 years in jail. As the point you made, if it looks too good to be true, it always it.
JM: What I find interesting is that a lot of these schemes, when they collapse, the chief promoter disappears and they cannot be found. People are stuck and they’re worried about their hard earned money and the promoter is nowhere to be found.
Too many pyramid schemes in South Africa
CG: Is it happening in a big way here?
JM: Hugely, there’s been lots of pyramid schemes, different names, new ones mushroom and so and people keep losing money. I did a radio show with one of the SABC African language stations and people were calling in. The kind of money people have lost and that were calling in, it was amazing. Very sad stories I heard on that day, people complaining about how they’ve lost money.
CG: One of the things, I’ve been working as a financial journalist for nearly 40 odd years, South African’s fall for it. South African’s, all classes, all backgrounds, all ethnicities, fall for it again and again and again. We want to get rich quick.
JM: Absolutely. I think there are two things that, in my view, drive a lot of South African’s into these Ponzi or pyramid schemes. One is perhaps the need or the urge to escape poverty. Everybody wants to escape poverty, we want to be financially secure. But we want this thing to happen overnight. Of course then the urge to want to get rich quickly and which is unrealistic. You have to grow your wealth organically, over time, with patience, through a legitimate product or savings instrument.
How to spot a pyramid scheme
CG: Let’s do some basics here, how do I spot a pyramid scheme?
JM: There are a couple of ways you could spot a pyramid scheme because we need to be very cautious of opportunities here. Firstly, if they’re promising you abnormal returns, you should actually be concerned. You should be asking a lot of questions. You also need to check whether, are they registered with the Financial Services Board.
Do they have a registration number, what are their qualifications, are they qualified to be involved in that kind of business? You need to be asking those questions. But more importantly, is how do you get your money. Is your income dependent on you recruiting new members or are you selling a specific or legitimate product? If those things, you’re not getting clear answers, you should actually think twice about getting involved.
CG: You made an interesting point, a lot of these things are disguised as stokvel’s. What’s the difference between a pyramid scheme and a stokvel?
JM: I think in a stokvel, let’s take the example of a rotation stokvel. You have ten people all put R1 000 a month and the money rotates amongst them. You know there’s money that’s simply exchanging hands between members of that particular stokvel. In most cases you find that well, they might not put the money in the bank. In some instances they do put money in the bank and collect the money there.
But the rotational stokvel, you know where the money is coming from. You know, but you can’t say you’re going to be making donations to people you’ve never met. That just sounds strange in the first place. How do you donate to people you don’t know and how do other people who don’t know you, donate money to you?
CG: The basics on the stokvel, you’ve outlined, R1 000, ten people, every ten months you’re going to be getting R10 000, that’s completely understandable. The same person comes to you and says, listen, we’re going to take R1 000 and give you R100 000, you know there’s a scam going on.
JM: It sounds abnormal. The question is, where does that money come from because for money to grow, it has to be invested somewhere. If somebody is promising such an abnormal return, where does that money come from?
The Tax issue
CG: You might be making money out of this, whether you should be or not is a different issue, but there is a question about SARS, I bet there’s a tax issue here?
JM: Absolutely. I read somewhere that there was a case at High Court where a judge had to make pronouncement around people who have derived money from such illegal scams or schemes. That any income derived, it’s liable for tax.
A lot of people who actually making money through these pyramid schemes are not aware that they’ve actually made income and they are liable for that tax. If the Receiver of Revenue picks up that you’ve made money, you didn’t declare that income and at some point you could be up with another issue with regards to tax evasion.
CG: There is something that’s illegal, Pyramid schemes are illegal, but something legal called multi-level selling. I’m thinking about Tupperware, I’m thinking about Avon, where you do sell a genuine product, you are encouraged to recruit other agents. You go on to earn a small percentage of whatever they sell. How do I tell the difference between legal, multi-level selling and illegal pyramid schemes?
JM: You see there, they’re selling a product, it’s a tangible product. You can see the product and so on. The profits and the mark up and everything is transparent there. Whereas with these, everything just looks so abnormal and the manner in which it’s designed, everything about it is very secretive. I would be worried, being involved with such things.
CG: John, if I think that I’ve become a victim of a pyramid scheme, what should I do?
What to do if you’ve fallen into the trap
JM: If you suspect that you are a victim of a pyramid scheme, you need to report that to Action Fraud, or you could go to your nearest police station or you could even escalate this to the South African Reserve Bank for the matter to be investigated. A couple of things you could do there to make sure, there’s also a National Consumer Commission which one could contact. So they can help with advice and investigation there.
CG: All right, you’re listening to Old Mutual Live, the Money Coach edition, on demand, visit dogreatthings.co.za. John, let’s just recap, what do I need to remember about pyramid schemes? What are the key questions I need to ask before investing?
JM: Number one is the money invested somewhere? If you’re investing money, is the money going to be invested somewhere. Are they registered with the financial services –
CG: That’s a key one because if they duck that question, you know there’s something dodgy going on.
JM: They’re not authorised to operate.
CG: This has been another edition of Old Mutual Live, the Money Coach edition, my name is Chris Gibbons. With me in the Money Coach studio has been John Manyike, Head of Financial Education at Old Mutual. John, if the listeners want more information, where would they go?
JM: They’re welcome to join our digital community on Facebook which is On the Money Financial Education Programme. They can learn a lot of ways of managing money and understand all the different concepts, or they can follow us on Twitter, @OM_OnTheMoney.
CG: Get in touch any time if you have any questions for either John or myself, topics you’d like us to cover, issues you want us to discuss on Old Mutual Live Money. Please feel free, drop me an email, send it directly to me at email@example.com. John and I would be delighted to hear from you. Old Mutual Live, on mobile, on digital, on demand.