Last week, former pyramid scheme Herbalife Ltd had to change the way the company operates and pay a US$ 200 million fine in order to avoid being explicitly labelled a pyramid scheme by the FTC in the United States. Herbalife in future will now have to pay its distributors based on sales, and not on how many new distributors they recruit. "Herbalife is going to have to start operating legitimately, making only truthful claims about how much money its members are likely to make, and it will have to compensate consumers for the losses they have suffered," FTC Chairwoman Edith Ramirez said.
Pyramid schemes are a form of investment fraud that preys on our human propensity not to properly envisage large numbers. The most well-known pyramid scheme is the age old chain letter. We’ve perhaps all see one in our lives, one promising that by sending a minimal amount to the 6 or 10 people on this list, then adding your name to the list, removing the top name and mailing it to the next group of people, you’d make millions in a short time. After all, it sounds so simple.
N$ 100 is first sent to you by 6 people (N$ 600), then 36 people send you N$ 100 in the second round (N$ 3600), 216 people in the third round (N$ 21 600), 1296 people in the fourth round (N$ 129 6000), 7776 people in the fifth round (N$ 777 600) and finally 46 656 people in the sixth round, netting you a cool N$ 4 665 600. Unfortunately, this explanation misses out on a crucial point. You are most likely not on round 1 of this pyramid scheme.
If you’re starting on round 6, you’re one of the 46 656 people who are now sending out letters. Your group will need to recruit almost 2 billion people by stage 12 to get your money – a third of the world’s population! In fact, by stage 8, almost all of Namibia would have to be recruited! It becomes clear why this is untenable. Pyramid schemes, thus, make a few people at the top of the pyramid rich, at the expense of everyone below them.
This fact is now widely recognized, and its why multi-level marketing companies, such as Amway and Herbalife, as so cautious to not be labelled pyramid schemes, and why they have to actually sell products and pay commission instead of just receiving money. Of course, their commissions schemes are set up like pyramids just like the example above, which means most of the commission still accrues to those at the top of the pyramid, a fact they are loathe to admit in their recruitment.
But pyramid schemes are simply the second most popular form of an investment scam that preys on our greed, and our wish to get rich quick. At the start of the 19th century, a man named Charles Ponzi started a company and offered investors either a 50% return on their investment in 45 days, or 100% return in 90 days. He claimed that he could achieve this due to postal reply coupons, which would be redeemed in a country at a set value, but purchased in other countries at a discount.
While this was true, countries had restriction on the volume that could be imported, and Charles Ponzi in fact did NOT use this to generate returns. Each new investor’s money was put in a pool, and if someone wanted to withdraw the money, that was taken from the pool as well. As long as he had enough new investors, he could pay out the old ones, and he built up his credibility using that. Investors eventually simply reinvested immediately, meaning money could just stay in the pool.
This, of course, was doomed to failure to moment that new investors could not cover those who wanted to withdraw. Such schemes are insolvent from the get go, and those running the pool usually dip into this money to fund lavish lifestyles to keep up the impression that the investments are doing quite well. Charles Ponzi took in US$ 15 million in a year, and when investors wanted to cash out, his pool had only N$ 5 million left.
In Africa, we’ve also had our share of Ponzi Schemes. Adriaan Nieuwoudt and his Kubusse is probably the most well-known of these, but in recent times these schemes are usually packaged as ‘secret investment vehicles’ with a ‘magic formula’ that guarantees returns. The Masterbond Group investment Ponzi scheme had a Namibian pensioner shoot himself while on the phone with the liquidators in South Africa when that broke. And more recently, Riaan Potgieter’s suicide when Prowealth’s Ponzi scheme collapsed also comes to mind.
And yet people still fall for these schemes. After South Africa’s Abante Group’s Relative Value Arbitrage Fund Poniz Scheme failed, Herman Pretorius shot his partner Julian Williams before turning the gun on himself. Currently Kobus Kellerman and David Cosgrove’s South African Belvedere Ponzi scheme is also in the midst of collapsing. And this happened even after the high profile implosion of the biggest Ponzi Scheme ever – that of Bernie Madoff. It’s a mighty fall after you’ve swindled investors out of US$ 65 billion.
Why do so many people get taken in by scams such as these? Because we tend to look at people instead of the facts on the ground. These scammers either are or appear to be experts in their field, and appear trustworthy – they’re in good standing at the church, and they look successful. But neither of those are any indication that an investment that is pitched is sound.
They then go one further – they claim they’re formula or strategy is a secret, and only a select few will be brought into the club. We have a natural need for exclusivity, a need to feel special, and they exploit that. People also tend to get drawn into it because a friend can get them into ‘the opportunity of a lifetime,’ and we tend to trust our friends and peers. After all, if people like me are doing it, someone would have checked it out and seen if there was anything untoward, right? And that’s how Bernie Madoff took US$ 65 billion from his friends and members of his synagogue.
So how can you prevent yourself from falling for scams like these? Don’t invest emotionally – be dispassionate. Don’t get involved in investments after dramatic changes in your life. Be careful about who you trust with your money – just because someone is well-known at church, or a good friend or coworker, does not mean they have your best interests at heart. See if this person and institution is registered and has information available on public websites and at the regulator. Watch out for these tactics: They tell you that you have a limited time to invest, or that the investment has a 10% or more return without any risk. They say the investment is too complex to explain, or top secret. And their returns year after year is too consistent, regardless of what happens in the market. If it sounds too good to be true, you’re probably being scammed.
It took Warren Buffet 15 years to earn his first million. It took him another 25 years to reach a billion. Bill Gates took 6 years to make his first million, and another 8 to make his first billion. Even our own Quinton van Rooyen built up his wealth over the past 25 years. What they’d all tell you is that becoming rich is not a quick process – in fact, it takes years filled with blood, sweat and tears to get there.