A pyramid scheme is a non-sustainable business model where investment returns are typically from membership or sign-up fees associated with newly recruited members and are not related to returns from any underlying investment. Pyramid schemes can be divided by whether the scheme involves the sale of a product. While there are legitimate businesses which may offer a tiered compensation system whereby a participant who recruits a new seller will get a cut of that new seller's sales commissions, this type of business can be distinguished from a pyramid scheme by evaluating whether returns are from new membership fees or from real product sales. Other pyramid schemes forgo the use of products and may be marketed as a full-proof way to turn a small amount of money into big returns. In order for members to receive a return on their sign-up fees, they must recruit a certain number of new members. As new recruits become unable to recruit further members, the whole scheme will collapse leaving some with substantial losses.
For more information, see:
- The Securities and Exchange Commission (SEC): http://www.sec.gov/answers/pyramid.htm.