Differences between Ponzi and pyramid schemes

On Behalf of | Mar 1, 2019 | Firm News, Fraud

When discussing fraudulent schemes to illegally obtain money from unsuspecting citizens, people in New York may mistakenly use the terms “Ponzi scheme” and “pyramid scheme” interchangeably. The confusion is understandable because both types of schemes function in a basically similar way. Each requires many investors to opt into it, each involves moving ill-gotten money around from person to person, and each inevitably collapses when it becomes too large to sustain itself, leaving only the original instigator with a profit. However, there are some fundamental differences that distinguish the two. 

According to the FBI, a Ponzi scheme involves one “recruiter” who solicits funds from unwitting victims. The initial investors pay into the scheme, and the recruiter keeps the money instead of investing it as he or she promised. Then the recruiter targets a subsequent group of investors, keeping some of the funds solicited for himself or herself while distributing the rest among the initial group of investors, deceiving them into believing that their investments are paying dividends. There are two ways that a Ponzi scheme can come to an end, and neither is good for the investors. Either the recruiter is unable to keep paying dividends to existing investors due to an inability to solicit new ones, or he or she flees with the money before it comes to that point. 

A Ponzi scheme involves one recruiter who moves funds around among investors, who have only a passive role to play in the process. According to FindLaw, a pyramid scheme is different in that once the investors buy into it, they become recruiters themselves. In order to profit from the scheme, the victims have to take an active role in recruiting new investors, and then it falls to them to take a share of the profits for themselves and pass the rest along to the instigator of the scheme. However, pyramid schemes have the same fatal flaw as Ponzi schemes, in that eventually, there are not enough new recruits available to maintain their profitability. 

It is typically the states that prosecute fraudulent schemes of either type, although the Federal Trade Commission may sometimes bring charges of deceptive trade practices. Consequences for promoting such a scheme can include prison time and hefty fines.