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As in Ponzi schemes, the money collected from newer victims of the fraud is paid
to earlier victims to provide a veneer of legitimacy. In pyramid schemes,
however, the victims themselves are induced to recruit further victims through
the payment of recruitment commissions.
More specifically, pyramid schemes—also referred to as franchise fraud or chain
referral schemes—are marketing and investment frauds in which an individual is
offered a distributorship or franchise to market a particular product. The real
profit is earned, not by the sale of the product, but by the sale of new
distributorships. Emphasis on selling franchises rather than the product
eventually leads to a point where the supply of potential investors is exhausted
and the pyramid collapses. At the heart of each pyramid scheme is typically a
representation that new participants can recoup their original investments by
inducing two or more prospects to make the same investment. Promoters fail to
tell prospective participants that this is mathematically impossible for
everyone to do, since some participants drop out, while others recoup their
original investments and then drop out.
Tips for Avoiding Pyramid Schemes:
- Be wary of "opportunities" to invest your money in franchises or investments
that require you to bring in subsequent investors to increase your profit or
recoup your initial investment.
- Independently verify the legitimacy of any franchise or investment before you
invest.
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