In 2008, residents of Louisiana and the other 49 American states learned of the arrest of Bernard Madoff. A high powered Wall Street stock broker, Madoff was accused of utilizing a pyramid or Ponzi scheme to defraud his clients out of billions of dollars. In 2009, Madoff pleaded guilty to nearly a dozen federal financial crimes and was sentenced to more than 100 years in prison.
Despite the notoriety of this famous story and a host of other infamous similar schemes making the national news, many people may not know what a pyramid or Ponzi scheme is. A Ponzi scheme occurs when a person sets up a fraudulent business or investment. That individual may hire on others to his business, and those new hires must pay a fee to join. The new recruits then hire on more new workers and collect fees from them. The scheme continues to grow and grow as new workers join it and make investments into the scheme.
The problem with a Ponzi scheme is that, eventually, the business will run out of individuals to join and make investments. At that time, individuals who have paid into the scheme may lose the money that they provided in their own fees. A Ponzi scheme is considered a white collar crime and can be prosecuted under federal law.
Though Ponzi schemes are illegal, many legitimate businesses are accused of operating as Ponzi schemes each year. Businesses that utilize multi-level marketing (MLM) are not Ponzi schemes. An MLM business derives its profits from the sale of products, not the hiring of new business members, though for some the distinction is difficult to recognize.
A Ponzi or pyramid scheme is a financial crime. However, not every business that grows through the recruitment of new hires or sales people is a Ponzi scheme. Legitimate businesses that use MLM structures can be wrongly accused of illegal activity even if their operations conform to legal business practices.