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By Solomon Severa
INVESTMENT fraud refer to investment scams or fraudulent business models used to dupe participants of their hard earned money by promising them high and quick return for presumably little to no risk. Investment frauds are usually prevalent when there is unfamiliarity with financial markets by the general public, lax regulatory framework and oversight, a largely informalized economy and a deficient formal financial system which encourage the public to seek alternative informal financial services.
The widespread of investment frauds in an economy can be avoided by promoting financial education, financial inclusion, building public confidence in the formal financial markets, having an accommodative financial system catering diverse financial services and having a regulatory framework that covers informal as well as formal markets and general governance problems.
Most common and prevalent investment frauds in Zimbabwe are the Ponzi and Pyramid schemes. The difference between Ponzi and Pyramid schemes is so obscure. People ignorantly use the words interchangeably in everyday interactions. However, understanding the schemes and their differences helps avoid falling prey to these shenanigans or leave it too late before getting out that is if you happen to have already been tricked into one of the schemes.
To fool both unsuspecting and sceptic victims, they take complicated and evolving forms but their core aspect remains the same. In a Ponzi scheme what lures participants are high returns for their money, while in a Pyramid scheme it’s the opportunity to make money by recruiting more people they become part of the group.
A Ponzi scheme is basically ‘robbing Paul to pay Peter’ kind of scam. It was named after Charles Ponzi, an Italian American who become infamous for running such an operation in United States of America around 1920s, however the schemes preceded him. Cases of similar schemes were documented in centuries before. He did it at a grand scale as a result the name stuck.
The mastermind promises a lucrative return for every money invested. The difference with a normal and legitimate investment fund is returns are paid directly from someone else’s investment in the fund not from investment returns made by the portfolio/ fund hence the phrase, ‘robbing Paul to pay Peter scheme’. Basically, the money pooled by the mastermind has no realistically way (whether specified or not) of making returns that are to be transferred to the investors as is normally the case with a legitimate fund.
In a typical Ponzi scheme, victims are enticed by phrases like ‘Invest and reap big’ or ‘Let your money work for you while you focus on important aspects of your life.’ People are mostly fooled because at some stage the scammer may pay out the promised high returns. The pay outs are used as a point of reference or proof to all sceptics and the scammer makes it a point they gain much publicity.
However, he/she encourages participants to reinvestment both principal and returns, claiming participants should not lose the opportunity to maximise their overall returns. When the scheme gains some credibility with the public or the mastermind is beginning to get overwhelmed by the rate of withdrawals, he/she may introduce a time frame when your investment would be locked in or time period before you can not draw on both your principal and returns.
The mastermind profits either by charging fees to investors or running away with participants’ invested funds later. As long as more people are willing to put in their funds than those who are withdrawing, the scheme keeps going. Trouble comes when withdrawals can no longer be covered by money inflows or the mastermind decides to take the funds and run. Both ways, individuals who still have their money locked in, lose out big.
Ponzi schemes usually come structured and packaged in a way likely to fool many into thinking it is a legitimate investment fund. There was a Ponzi scheme that surfaced this recently. The scheme gave participants an opportunity to invest around US$1000 in one batch 100 chickens and receive US$250 per month for 22 months. Another opportunity was to invest US$2000 in one dairy cow and receive US$450 per month for 48 months. An initial membership fee of around $40 was required on both. On surface it looked like a legitimate opportunity, however on a close look one would see how unrealistic the returns are. Furthermore, although the scheme was specified as invested in poultry and dairy; the fund was not invested in any chicken or dairy cow farming. It was also unregistered with local authorities.
On the other hand, a Pyramid scheme exists when would be participants are asked to pay an upfront payment to be part of a business model which guarantees them a chance to share some form of financial benefits by primarily recruiting more participants in future. The upfront payment may be referred to as a registering fee or membership fee or payment for training to run a business operation. Sometimes in a bid to look like a legitimate business, they ask participants to buy a certain amount of merchandise for say resell or personal use.
The merchandise or product on offer would have no demonstrated product sales and passing it through the normal product chain would usually prove difficult. However, participants are assured not to worry because that is not where they need to put much of their effort on. They are advised, they can easily compensate that by improving their benefits through recruiting/registering more participants hence the phrase, ‘the business of recruiting people’.
Emphasis is repeatedly given, participants’ focus should be on recruit as many as possible in order to maximise returns. The benefits of recruiting more participants are high and enhances rewards quicker than from the specified normal business activity.
The contributions of new participants’ flow up through the pyramid up to the pyramid architects as shared returns. Earlier participant’s returns or benefits are paid from inflow funds from new participants not from the profits of the said normal business activity.
As long as the participants are recruiting new participants, the pyramid scheme grows until such a time when it becomes impossible/difficulty to bring in new participants, then the Pyramid crumbles. On many occasions, Pyramid scheme architects have a tendency of disappearing as soon as the scam starts showing signs of collapsing orwhen the scam gains too much attention from the authorities.
Either way, new participants at the base of the Pyramid are left in line yet to receive their returns which would have come with future recruits and holding merchandise and/or training of no real value to them. Therefore, participants on the base of the pyramid (late entrants) lose out while those at the upper levels, mostly architects of the scheme, are eventual big time winners.
Pyramid schemes are sometimes sold as legitimate multilevel marketing businesses. However, Pyramid schemes would have no genuine or profit making product to sustain the business. Whilst in multi level marketing the distributors are usually non salaried, commission based salesperson whose benefits are linked directly to the revenue they generate and those generated by their referrals from selling products.
In a typical Pyramid scheme benefits are not linked to the products participants or their referrals would be selling but mainly to the number of recruits they bring in. Furthermore, there is also a transfer of business risk once the participant receives the goods unlike in a multi level marketing. ‘Be your own boss in no time’, ‘Here is an chance to monetise your personal network’ and ‘ The best way to quit your eight to five job,’ are usual statements thrown around with exuberance to entice potential victims.
A typical Pyramid scheme rocked Harare’s western high suburbs during the second half of 2020 and the first half of 2021, targeting mainly informal enterprising women (madzimai emusika). Participants where asked to seed an initial amount of US$20. They were further asked to recruit people into the scheme for a bonus of US$5 per person recruited. An incentive was also offered, they would be able to redeem their initial contribution of US$20 if they managed to recruit 6 individuals. Easy money you might be tempted to think, but the scheme ended with many enterprising women crying, others at each others throat. Friends turned into foes. Understandably, when people lose money, they tend to forget a friend invited them to join the schemes with good intention.
In recent years, the schemes are mushrooming at an alarming rate in Zimbabwe, coming one after another. The prospect of making quick money in these trying times is quite difficult to resist however, the risk is not worthy taking.
Please note, the schemes are illegal making a recourse for victims very difficult if not non-existent. If an investment promises little to no risk but high and quick rewards, chances are high its an investment fraud. It is okay to be sceptical when you feel something is too good to be true. Nine times out of ten, it is truly too good to be true because in investmenet, there is no free lunch.
Solomon Severa is an Independent Macro Analyst. He writes in his personal capacity. You can follow him on LinkedIn : https://www.linkedin.com/in/solomonsevera
