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Ponzi vs Pyramid Scams: What's the Difference?

The SEC is warning the public against investment scams during Investor Protection Week.
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On November 9 to 13, the country will observe the first-ever Investor Protection Week (IPW). Spearheded by the Securities and Exchange Commission (SEC), IPW is meant to promote investor education amid the rising number of unauthorized investment-taking activities, especially during the COVID-19 pandemic. 

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According to the SEC, it has issued advisories against more than 100 groups and individuals soliciting investments without the necessary license, almost double the total number for the whole of 2019. The SEC has charged 32 individuals in seven cases for violations of Republic Act No. 8799, or The Securities Regulation Code, and in two cases for violations of Republic Act No. 10175, or the Cybercrime Prevention Act of 2012.

In addition, the SEC announced that it has issued cease and desist orders and revocation orders against entities engaging in fraudulent investment schemes, including Boss Network, Forsage and Fast Track Worldwide, Inc.

The Commission has also identified two of the most common investent scams in the country: Ponzi and pyramid schemes.

But what’s the difference? 

Ponzi schemes

According to the Gibbs Law group, Ponzi and pyramid schemes are similar in that both involve existing investors getting paid by the contributions of new investors. However, there are some clear distinctions between each time of securities fraud. 

Let’s start with Ponzi schemes. The scam is named after Charles Ponzi, who was able to attract large numbers of investors by promising them a 50 percent or better return on their investments in postal coupons. But instead of actually making investments, Ponzi pocketed the investors’ money for himself and used money from newer investors to pay earlier investors.

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And that’s what a Ponzi scheme is: a scam that guarantees ridiculously high returns to attract more investors. They pay the promised profits to earlier investors using the money placed by newer members.

One of the most famous examples of a Ponzi scheme is the one perpetrated by Bernie Madoff for over 30 years.

Pyramid schemes

Pyramid schemes, meanwhile, require members to recruit people into the group in exchange for fees. Also called multi-level marketing, pyramid schemes gets its name from the structure of the business—larger numbers of investors below, all paying money that is divided up among smaller numbers of investors above them, according to the Corporate Finance Institute.

Many pyramid schemes attempt to gain a semblance of legitimacy by offering products—such as health supplements—for sale. But you hardly earn money from this aspect of the supposed business. The “real” earnings come from recruiting other people who pay the membership fee and who, in turn, recruit other people to do the same, and so on. As you can imagine, those who are at the top of the pyramid make all the money, while the new recruits are then left with all the work of trying to attractnew investors. 

There have been many examples of these pyramid or MLMs over the years here in the Philippines. 

The most striking difference between Ponzi and pyramid schemes is the level of involvement of the investor. In Ponzi schemes, participants of a Ponzi scheme are unaware that they are involved in a Ponzi scheme, while participants in pyramid schemes are aware how they will earn money and are actively involved by recruiting newer members.

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Raising awareness

Educating the public to be wary of these types of scams is the main goal of the IPW. Based on Section 8 of the Securities Regulation Code, securities shall not be sold or offered for sale or distributed within the Philippines, without a registration statement duly filed with and approved by the SEC.
    
“Our fight against investment scams is anchored on the public’s awareness and empowerment to spot, avoid and expose investment scams,” SEC Chairperson Emilio B. Aquino said. “While we remain relentless in unmasking and busting investment scams, we also encourage the public to always check with SEC before entertaining any investment opportunity, especially when they are too good to be true.”

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The SEC is said it has invited organizations from the public and private sectors alike to form the SEC Campaign Network, which will be formally launched on November 9, to expand the reach of its investor education programs. The Commission will also launch The SEC Academy, an online learning resource center developed in collaboration with the Commission on Higher Education and the Department of Education. The SEC Academy will offer courses and learning modules for students and educators, as well as aspiring entrepreneurs and those looking to invest in securities, among others.

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Paul John Caña
Associate Editor, Esquire Philippines
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