HOW TO AVOID PONZI AND PYRAMID SCHEMES
 

PONZI AND PYRAMID SCHEMES

Investors generally set two objectives in evaluating an investment:
(a) As high a return as possible ("yield" in the form of interest,
dividends and/or long term appreciation), and (2) Safety. Ponzi
and pyramid schemes normally attract unsuspecting investors by the
promise of an unusually high rate of return.

Experience has demonstrated, however, that as a general rule, the
higher the return on an investment, the riskier it is likely to be.
In other words, the higher return is usually paid to justify the
higher risk. The prudent investor will compare the return promised
or proposed with that generally being realized on other types of
investments.

It is impossible to describe thoroughly the various forms Ponzi and
pyramid schemes might take, but these operations do have certain
hallmarks. You should be particularly cautious when an investment
opportunity emphasizes:

     -very high yield;
     -quick return;
     -"a once in a lifetime" opportunity; and
     -the chance to "get in on the ground floor."

PONZI SCHEME

Named for Charles A. Ponzi, who defrauded hundreds of investors in
the 1920s, a Ponzi scheme pays off old "investors" with money
coming in from new "investors." It works this way:

     Example: Investor A gives Promotor ("P") $1000 on P's promise
     to repay $1000 plus $100 "interest" in 90 days. During the
     90 days, P makes similar promises to Investors B and C,
     receiving $1000 each from them. At the end of the first 90
     day period, P may offer to pay A the $100 "interest" and to
     return the original $1000. More likely, he will invite A to
     "re-invest" the $1000 plus the $100 "interest" for a similar,
     or higher, return at the end of another 90 days. Thereafter,
     A, believing he or she can receive a good return on the
     investment, is likely to bring other investors to P.

In this manner P collects a pool of money that he can use to pay
out to those few wishing return of their money. P may operate his
scheme for some time before "pulling the plug" - that is, either
disappearing with all the "investments" or revealing the bad news
that the investments went "sour."

A major factor in the eventual collapse of a Ponzi scheme is that
there is no significant source of "income" other than from new
investors.

A PONZI SCHEME IN OPERATION

Joe Smith claims that he operates a factoring business, buying
accounts receivables from small companies at a discount and then
making a large profit when he collects the receivable. In order
to conduct his business, he says that he needs, on a short term
basis, large amounts of money. Because his factoring business is
so profitable, he is prepared to offer promissory notes paying
20-50% within 6-9 months.

In this case, there was no factoring business. The promoter used
the borrowed money for his own personal uses. The operation kept
going because many "investors," instead of cashing their promissory
notes upon maturity, agreed to new ones that they thought would
allow their capital and profit to accumulate. Those "investors"
who did not want to continue were paid off with funds from new and
present "investors."

PYRAMID SCHEMES

The "pyramid" scheme is essentially a business variation of the
familiar "chain letter." It works this way:

     Example: Promotor ("P") offers A and B the chance to "invest"
     by purchasing "distributorships" at $1000 each. The
     "distributorships" give A and B the "exclusive" right to sell
     "distributorships" to others for $1000 each and to sell
     certain products to the public. However, each $1000 that A
     and B receive from their sales of "distributorships" must be
     divided with P, say 50-50. Thus, theoretically, A and B can
     realize $500 on each "distributorship" they sell and can
     completely recover their initial $1000 "investment" by selling
     only two "distributorships." P, however, has received not
     only A's and B's $1000 each, but also $500 for each
     "distributorship" that A and B sell. Initially, it appears
     that this can go on forever, with no one being hurt and
     everyone making money. But, the chart below shows that the
     number of investors needed to keep the pyramid scheme working
     quickly exceeds the population of the United States. (The
     chart assumes P initially sells "distributorships" to six
     persons, each of whom brings in an additional six "purchasers"
     per month.)

           Month Participants
           1 6
           2 36
           3 216
           4 1,296
           5 7,776
           6 46,656
           7 279,936
           8 1,679,616
           9 10,077,696
           10 60,466,176
           11 362,797,056 (Exceeding US Population)
           12 2,176,782,336
           13 13,060,694,016 (Exceeding World Population)

The chart also shows why such a scheme is called a "pyramid" - the
promoters are at the top of a pyramid-shaped flow of money. Money
coming from later investors flows upward to the top. Being at the
top may result in your receiving a lot of money quickly, but it is
virtually impossible to determine, at the beginning, where in the
pyramid you stand.

OTHER CHARACTERISTICS OF PONZI AND PYRAMID SCHEMES

In brief, Ponzi and pyramid schemes may also be characterized by:

     - Reliance on funds from new investors to pay returns,
          commissions or bonuses to old investors;

     - Need for an inexhaustible supply of new investors; and

     - Absences of a profitable product or efforts to make
          profits through productive work.

WHAT CAN I DO ABOUT THESE SCHEMES?

You can help by notifying the SEC promptly if you are approached
to participate in a questionable investment scheme or if you think
you have invested in such a scheme. Information should be sent to
any regional or district office of the Commission (see list at the
end of this document) or to:

     Securities and Exchange Commission
     Office of Consumer Affairs
     450 Fifth Street, NW
     Washington, DC 20549
     PHONE: (202) 942-7040

LIST OF THE SEC'S REGIONAL AND DISTRICT OFFICES

     Northeast Regional Office
     7 World Trade Center, Suite 300
     New York, New York 10048
     (212) 748-8000

     Philadelphia District Office
     The Curtis Center, Suite 1005 E.
     601 Walnut Street
     Philadelphia, Pennsylvania 19016-3322
     (215) 597-3100
          
     Boston District Office
     75 Tremont Street, Suite 600
     Boston, Massachusetts 02108-3912
     (617) 424-5900
     
     Southeast Regional Office
     1401 Brickell Avenue, Suite 200
     Miami, Florida 33131
     (305) 536-5765

     Atlanta District Office
     3475 Lenox Road, N.E., Suite 1000
     Atlanta, Georgia 30326-1232
     (404) 842-7600

     Midwest Regional Office
     Citicorp Center
     500 West Madison Street, Suite 1400
     Chicago, Illinois 60661-2511
     (312) 353-7390

     Central Regional Office
     1801 California Street, Suite 4800
     Denver, Colorado 80202-2648
     (303) 391-6800

     Fort Worth District Office
     801 Cherry Street, 19th Floor
     Fort Worth, Texas 76102
     (817) 334-3821

     Salt Lake City District Office
     500 Key Bank Tower
     50 S. Main Street, Suite 500 Box 79
     Salt Lake City, Utah 84144-0402
     (801) 524-5796

     Pacific Regional Office
     5670 Wilshire Boulevard, 11th Floor
     Los Angeles, California 90036-3648
     (213) 965-3998

     San Francisco District Office
     44 Montgomery Street, Suite 1100
     San Francisco, California 94104
     (415) 705-2500
 

Last modified on Monday, January 12, 1998