The Ponzi-type scheme again reared its ugly head with the recent FrancSwiss scam. A Ponzi scheme is a type of fraudulent transaction named after Charles Ponzi, who, as noted by the US SEC, "duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. Ponzi thought he could take advantage of differences between U.S. and foreign currencies used to buy and sell international mail coupons. Ponzi told investors that he could provide a 40% return in just 90 days compared with 5% for bank savings accounts. Ponzi was deluged with funds from investors, taking in $1 million during one three-hour period and this was 1921! Though a few early investors were paid off to make the scheme look legitimate, an investigation found that Ponzi had only purchased about $30 worth of the international mail coupons."

 

The pyramid scam, on the other hand, is characterized by the US Securities and Exchange Commission (SEC) in this manner:

In the classic "pyramid" scheme, participants attempt to make money solely by recruiting new participants into the program. The hallmark of these schemes is the promise of sky-high returns in a short period of time for doing nothing other than handing over your money and getting others to do the same.

The fraudsters behind a pyramid scheme may go to great lengths to make the program look like a legitimate multi-level marketing program. But despite their claims to have legitimate products or services to sell, these fraudsters simply use money coming in from new recruits to pay off early stage investors. But eventually the pyramid will collapse. At some point the schemes get too big, the promoter cannot raise enough money from new investors to pay earlier investors, and many people lose their money. The chart below shows how pyramid schemes can become impossible to sustain. 

Investors almost always have a nagging doubt whenever a high-yielding investment is offered to them, but the decision is often clouded by the very same reason - high returns - and the fact that the one bringing them into the pyramid is usually a relative or a friend. Others who have an inkling that the investment scheme closely resembles a pyramid or Ponzi scheme often think that they are at the top of the pyramid, and would receive profits before the pyramid comes tumbling down. This is very risky because the investor doesn't know his place in the scheme of things, as shown by the following figure:

 

(This illustration is courtesy of the US SEC. This is the first of a 2-part article; read Part 2 here)