A pyramid scheme is a type of securities fraud where a company will recruit “investors” who buy into the company for a certain amount of money. These investors then recruit other investors who pay them for the investment. A portion of this investment is then paid back to the company founders. This process then continues to third and fourth and eventually fifth level investors until, ultimately, there is no more money to be made. The founders typically make the most money and first generation investors make the second largest amount from the investment. Eventually, lower level investors do not even break even, and below that, investors lose significant amounts of money. A pyramid scheme is never an acceptable investment.
Often times, pyramid schemes are sold as multi-level marketing businesses. While multi-level marketing business are not usually suitable investments, they are not illegal. In a multi-level marketing business, the company actually has a product that it sells to the public. The “investor” collects a commission on the products that he or she sells, and that commission may be shared with a long line of previous “investors” to the point where the return on effort is miniscule, but the “investor” is not asked to pay to join the company, and the return involved is the return on the sale of a product, not a return on investment.
There is no legitimate reason for an investment advisor to recommend an investment in a pyramid scheme. Recommending involvement in a pyramid scheme would likely involve a number of other types of misconduct, which may include fraud, misrepresentation and unsuitability. Prompt legal action must be taken to minimize the damage and to obtain a recovery.