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.
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