7 Alleged Pyramid Schemes and Scams - Mentalfloss
There have been a number of notorious companies that were accused (and sometimes convicted of) engaging in scams over the ages. Maybe you've heard them called "Ponzi schemes" or "pyramid schemes." But while some people use the terms interchangeably, they actually refer to different variations of investment fraud. Both scenarios rely on new money coming in to fund unrealistic promises, but the inner mechanisms are different.
A Ponzi scheme requires an investment from participants, with the promise that their investment will passively multiply. And for the people at the top, it does—the money comes in from new recruits at the bottom. But the people at the bottom are the ones paying the price; the money they paid to get into the investment is typically paid out as phony returns to those who put money in earlier, ostensibly the payoff for some kind of sage investment. Though he wasn't the first to run a scheme of this nature, the Ponzi scheme takes its name from Charles Ponzi, who ran a stamp-selling scam and swindled $20 million from investors before being busted in 1920.
A pyramid scheme is often more retail-oriented, relying on the recruitment of people to sell a product—and the recruitment, not the product itself, is how the scheme generates the most of its money. The new recruits have to buy inventory and sometimes pay hefty fees in order to sell the items. People on the bottom prop the whole thing up and can usually only generate sizable revenue for themselves by finding new sellers to take their place on the bottom.
Let's not forget about multi-level marketing, or MLMs. Multi-level marketing is, in fact, legal. It can look like a pyramid scheme, but the difference is that an MLM does actually pay sellers based on the sales they make. While they also have the opportunity to make income by recruiting more sellers, it's not the main—or only—way to make money.
Now that you know how to tell a pyramid scheme from a Ponzi scheme, let's take a look at some infamous alleged scams from history, adapted from an episode of The List Show on YouTube.
Holiday Magic started when a man named William Penn Patrick bought into a small makeup brand. He dubbed his new line Holiday Magic and began recruiting people to sell lipstick, blush, powders and creams supposedly made from organic ingredients.
For an extra fee, his distributors could enroll in his "Leadership Dynamics" course where, among other things, Patrick made participants crawl into coffins, get strapped onto a cross, and endure physical abuse. Patrick claimed it was all part of a big-picture strategy to help seminar attendees appreciate what they had in life and prove that they were psychologically sound enough to move on.
The schemes made Patrick filthy rich, and he wasn't exactly shy about sharing his success: One company ad featured a photo of a yacht accompanied by the copy, "Doesn't every cosmetics company have a Navy? Probably not. But then every cosmetics company isn't Holiday Magic."
Then, in the early '70s, the lawsuits hit, with the government alleging that Patrick had stolen more than $250 million from the staggering 80,000 people he had recruited for the scheme. But before he could be brought to trial, Patrick was killed when his personal plane crashed. The company was eventually found guilty of deceptive trade practices, but even so, it carried on for several more years before fizzling out.
As a "general" with Holiday Magic, Glenn Turner claimed to have earned more than $30,000 per month. He smelled an opportunity and eventually founded Koscot, which stood for "Kosmetics for the Communities of Tomorrow." And don't forget the "Interplanetary," an ambitious tag for a door-to-door cosmetic sales company.
Just like its predecessor Holiday Magic, Koscot was a bona fide pyramid scheme. Newbie distributors paid a sign up fee of $5000, which earned them the right to recruit their own sellers at a $2000 buy-in—$700 of which went into their own pocket as a commission. When the lawsuits started rolling in, the Pennsylvania attorney general noted that each distributor was asked to bring 12 more people on. And then those 12 people were asked to bring 12 people each. If you follow this through just 12 tiers, the result is 8,916,100,448,256 people—more than 2000 times the number of people on Earth at the time.
Obviously, that wasn't sustainable. Maybe that's why Turner also founded Dare to be Great, a motivational course that took another page out of the Holiday Magic playbook. With Dare to Be Great, participants bought "adventures," a.k.a. sales courses, at levels from $100 to $5000. Turner's "inspirational" techniques included yelling "Money! Money!" at attendees.
The FTC and the SEC came after Turner for Koscot and Dare to Be Great and forced them to cease operations. Turner then started a third company called Challenge, Inc.—another motivational course that promised people huge incomes if they invested $5000 to sell its courses—and it ultimately landed him in prison. He served five years, then returned immediately to motivational speaking.
The multi-level marketing company LuLaRoe—which sells leggings and other clothing items—became notorious for what some people felt was its cult-like membership, and for leaving thousands of distributors with unsold inventory, even bankrupting some. In 2019, Washington state's attorney general Bob Ferguson accused the company of running an illegal pyramid scheme: "LuLaRoe tricked consumers into buying into its pyramid scheme with deceptive claims of high profits and refunds for unsold merchandise," he said at the time. In 2021, LulaRoe settled for $4.75 million out of court in Washington state to avoid going to trial and had to adjust its sales practices there. That same year, LuLaRich, a four-part documentary series about the company, hit Amazon.
While LuLaRoe is still in business and denies that it's a pyramid scheme, their distributor numbers have dropped from 80,000 to less than 20,000, and the company is still in the middle of some lawsuits.
The early to mid-2000s was the forefront of the digital music industry. In 2005, a company called BurnLounge began recruiting people to open digital music stores, providing them with a prebuilt webpage to do so. How well the store supposedly did depended largely on the package that was purchased as part of the deal. The lowest level was just $29.95 a year, while VIP access would set you back $429.95 annually. Selling music gave shop owners points, not money—unless they paid an additional $6.95 per month to be part of the Mogul program.
While shop owners earned a paltry 50 cents per album sold, they earned up to $50 for recruiting fellow shop owners and selling them packages. Company leaders told BurnLounge's 62,250 recruits that they had the potential to make hundreds of thousands of dollars; CEO Juan Arnold told one audience that the business model was a "license to print money."
But the truth was, it was nearly impossible for most "store owners" to make any money at all. From 2005 to 2007, the company paid $17.4 million in commissions. Of that, 66 percent went to the top 1 percent of sellers, and 85 percent went to the top 6 percent. That left a meager 15 percent for the tens of thousands of people at the bottom.
The FTC declared BurnLounge a pyramid scheme and filed a complaint in 2007; by 2008, BurnLounge was effectively kaput. In 2015, the FTC announced that tens of thousands of people who had paid to be Moguls would be receiving a share of $1.9 million from BurnLounge.
Starting in 2012, a company called TelexFree conned a shocking 1.8 million victims out of a total of $3 billion. The scam? Free internet phone calls to Brazil and other countries in Latin America. Participants weren't actually required to sell the product itself; instead, they had to spend their own money to join and then buy ad space online. Of course, they were also required to recruit others to do the same. It was later estimated that 2 percent of TelexFree's revenue came from selling the actual VOIP product, while 98 percent was from new participant buy-in.
When authorities in both the U.S. and Brazil began investigating the company, TelexFree abruptly shut down, declared bankruptcy, and froze all members' accounts. Participants were out everything they had invested. Unfortunately, there isn't a happy ending here, but there is, at least, a little bit of justice: In 2017, the president of TelexFree was sentenced to six years in prison for fraud. And in 2020, a judge ruled that more than $150 million would be paid out to 100,000 of TelexFree's victims.
The Kentucky Attorney General once called Fortune Hi-Tech Marketing "one of the most prolific pyramid schemes operating in North America." Founded in 2001, the company claimed they had more than 160,000 representatives selling consumers a staggering variety of products—everything from DISH Network subscriptions to vitamins. These representatives had to pay about $1500 annually in membership fees and products, but 90 percent of them netted less than $15 a year. Meanwhile, Fortune's top tier, otherwise known as "Presidential Ambassadors," were each making more than $1.2 million annually. The company was shut down by the FTC in 2013; the executives denied wrongdoing.
As of July 2022, the FTC was still sending out checks from the Fortune settlement; a total of $4.6 million has been returned to victims so far. That works out to be $41.23 per person, which doesn't come close to covering their losses.
Another group of people often in need of cash? College kids. And that's exactly who energy drink company Vemma targeted. Founded in 2004, Vemma's products of choice were beverages with names like Bod-E and Verve, purported to boost energy and weight loss. They called themselves "the Young People Revolution" and recruited young adults just out of high school. In order to sell the drinks, Vemma required their "affiliates" to buy starter packs that cost up to $600. But while the company itself raked in more than $200 million a year in 2013 and 2014, 40 percent of its sellers were making less than $1000 per year.
In 2015, the FTC set its sights on Vemma; the company denied any wrongdoing. By 2016, the FTC shut down the recruitment part of their business model, and in 2019, more than $2.2 million was given back to 28,224 former Vemma sellers—an average of about $79 per person. According to a press release from Vemma, the company agreed to the settlement because it allowed them to stay in business and "contains no admission of fault or any finding that Vemma operated unlawfully or as a 'pyramid scheme.'"
This story was adapted from an episode of The List Show on YouTube. Subscribe to Mental Floss for new videos every week.
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