Exposing the Famous Financial Pyramid Schemes


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This report sheds light on Ponzi and other financial pyramid schemes. The definition and origin of these schemes is overviewed in the introductory section of this report. Afterwards, focus is placed on MMM as one of the many Ponzi schemes that have existed. Using this case study, the unsustainability, dubious and fickle nature of Ponzi schemes in general is brought to the fore. This report concludes by outlining the lessons that can be drawn from what happened to MMM and advices how one can spot a similar scheme and not fall prey to it.


From the dawn of human history, business transactions with a view to making gain have always been a constant part of living. Overtime, however, the type and nature of these commercial activities have evolved and given birth to many other variants. Gone are the days when people used to trade by barter. The use of monetary systems came on the scene. It first began with the use of cowries, then later coins and much later paper money. In this jet generation money has been digitalized giving birth to several digital currencies called crypto-currencies. But along the side of this evolution are systems and schemes through which people carry on their businesses. One model is called Multi-level marketing, MLM wherein a company pushes its product around by recruiting a few persons who in turn will bring in more people that will bring in yet more and so on. This sort of business model is legally established in many countries. There is another kind called the pyramid scheme and Ponzi scheme both also known as the get-rich-quick schemes. They too have been around for a while, but unfortunately are dubious and even illegal in some places. The sections to follow take a closer look at these schemes highlighting why they are unsustainable and bound to fail.

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Overview of Ponzi Scheme

Definition of Ponzi Schemes

A Ponzi scheme as defined by a UK Organization, Action Fraud in 2016 is a scheme that is built on the premise of paying returns to old investors by the cash inflow from new investors. A report by the FBI in 2016 also explains it as an investment where there are very high returns over a very short time frame in comparison to the low risk involved. Many Ponzi Schemes focus on false incentives by enticing old investors to introduce new ones in order that they keep getting their promised returns on a regular without fail.

History of Ponzi Schemes

A report in 2008 by Alex Altman for Times magazine stated that Charles Ponzi’s name became synonymous with Ponzi Schemes because he helped bring these ‘robbing Peter to pay Paul’ schemes to more light as his own defrauded thousands of people. He set up a company called the Securities and Exchange Company. His scheme was based on the sales of International coupons, promising a return of 100 percent over 90 days. This was an incredulous amount as compared to the 5% per annum rate offered by banks back in the day.

Initially, it was a big hit for him. A lot of investors got their money doubled, and some even tripled over a very short time span. This success, in addition to the rave reviews he got from the newspapers attracted much more investors. He lived a very lavish life of cars and houses from the proceeds of his business. It was also recorded that by this same report by Altman (2008) that over 40,000 people were defrauded to the tune of over 15 million dollars between 1919 and 1920. His high rate of returns however raised suspicious eyebrows and his cover was actually blown that he was merely giving profit to old investors by using the cash inflow from the new ones. He was subsequently arrested and jailed by the Federal government for 5 years. After serving his time in the federal prison, he was further sentenced to 9 years by Massachusetts State. He however absconded to Brazil where he spent his last years in ill health and abject penury.

Ponzi Schemes Today and the Biggest Scandals in Ponzi Schemes; Past and Present

Besides Charles Ponzi and his scheme that was discussed earlier, here are some of the biggest Ponzi scandals reported in history. The last one by Sergey Marvrodi discussed in this section will be the focal point of our case study in this project.

According to Alex Santaso (2008), in 2005, a Pakistani science teacher Syed Sibtul also known as the “Double Shah” Hassan Shah (because he gave a hundred percent returns) after a trip to Dubai came back to his hometown of Wazirabad, Pakistan and convinced his neighbors to contribute their savings to invest in a new stock business he had learnt during his time away in Dubai. He gave them hundred percent returns over a week’s period. More people got to know about the him and a lot of people began investing with him. Over a period of 18 months, he raked in over Rs. 70 billion (about US$880 million) from 3,000 people. He was even considered to be the next political leader from his area.

Nick Carbone of Time Magazine reported in 2012 that Bernard ‘Bernie’ Madoff was found guilty of running a Ponzi Scheme using his investors capital. Bernard Madoff was a former chairman of NASDAQ and the founder of the company, Bernard L. Madoff Investment Securities LLC. Some notable facts about his operation are that it was the largest Ponzi Scheme uncovered in history (worth billions of dollars) and the longest running scheme uncovered in history for it had been running for many decades, undetected. Again, it was handled by one of the top shots of the Wall Street, Bernie Sanders. Again, his victims were not just nobodies, but some of the wealthiest and financially savvy people in the world who were not new to the investment environment. It was purported that one needed at least 20 million dollars to invest in Madoff’s company. (Satone, 2008). Madoff was later convicted and sent to jail for a hundred and fifty years. Statone stated that “People were actually confident enough to invest with him because he was highly regarded and well known in the financially business and he was believed to have an interest in maintaining high standard of corporate ethics”.

Principle of Ponzi scheme Operations: Pyramid Scheme of Operations

Jory and Perry (2018), elaborately described how a Ponzi scheme operates using a pyramidal structure. In a pyramidal scheme, more money is to be fed in to sustain the structure and keep paying returns to older ‘investors’ as new recruits keep coming. Figure 1 as seen in the appendix makes reference to a theoretical pyramidal structure running over a period of say, four years. The perpetrator takes $100,000 initially from the first investors and promises a return of 20 percent interest after a year’s interval. He may not be able to raise that capital sum from an individual, so he has to recruit say, two people into his scheme. He now owes them a total of 120,000 dollars, due at the end of the 1st year. At the end of the first year, he will need to go searching for new people to pay up this amount. He recruits in three people that each contribute 40,000 dollars each to pay up the previous set. He owes these fresh set of recruits 144,000 due at the end of the second year. At the end of the second year, he has to go hunting for people that will contribute up to that amount that will be used to offset the debt. Soon again, he owes these new people 172,800 dollars at the end of the third year, and he has to search for more people to pay up. This cycle continues on and on, until there are no new people to get funds from, and the scheme crashes like a house of cards.

The analysis shown by Figure 1 is based on the assumption that none of the investors default in making their contributions or that the perpetrator keeps finding new people to keep contributing to the scheme. Thus, the major reasons why Ponzi schemes don’t last past the first year because the inflow of cash is much lesser than the outflow paid to ‘investors’. The originator and the initial investors however, enjoy the most returns from a Ponzi scheme network.

The Issue with Ponzi Schemes

History of MMM

Popularly called Mavrodi Mundial Moneybox, MMM was founded in 1989 by three Russians: Sergei Mavrodi, his brother, Vyacheslav Mavrodi, and Olga Melnikova. The company reportedly started out as a network of computer importing cooperatives. (Womack, 1994) However, it crumbled in January 1992 after a tax evasion charge levied against it by the tax police. Sergei Mavrodi found a way out by launching the MMM Ponzi scheme in February 1994 which promised a monthly return of up to 250 % and annual return of up to 3000 %. Not finding anything else to use against the company the government discovered a huge tax evasion against MMM and capitalized on that. By December 1997, MMM was bankrupt leading Mavrodi to go into hiding until 2003 when he was arrested and sentenced to a four and a half years prison terms. In January 2011. Mavrodi launched another pyramid scheme called MMM-2011 which later found root other countries like China, India, the Philippines, South Africa, Zimbabwe, Nigeria to name but a few.

How MMM works

The principle of operation of MMM is based on a pyramid model as well as a social financial cooperative where members give and receive financial help. New entrants are required to contribute a certain amount of money (minimum of $10) into the system. This is called giving help. This money is paid to other existing members. After 30days the contributed money grows accruing an interest of 30% which the person can cash out by requesting help. This time the system will match other members who want to give help with him and he will be paid the amount corresponding to 130%of what he initially invested. So, it is like moving money around the system since every member is expected to give help at least once a month. Everybody gets to have a share of the cake from the 30% interest after 30 days. Additionally, members who bring in new members into the system are rewarded with a referral bonus which is equivalent to 10% of what the new member first contributes for the first generation. Guiders are able to earn up to the third generation- 5% for the second generation and 2.5% for the third generation in the pyramid.

Why it Crashed

The system was bound to fail because of its unsustainability. Money was merely pushed around between members monthly. And since the organization was not actually investing the money, all the interest and rewards given to members were derived from the contribution of newer members. An inevitable point will always be reached where there is saturation within the system. That is the rate of people coming into the system declines causing the money that comes in to reduce exponentially compared with the money that is required by existing members. In other words, at the point when help given is less than the help requested the system fails. The water in the bucket model can give us a better understanding of how this works.

Let’s imagine a bucket that is filled by a hose connected to a tap (see figure 2 in the appendix). At the same time, water leaves the bucket from three holes in the body. There are three scenarios to the water problem.

  1. If the volume of water that comes in equals the volume that leaves, the level of water in the bucket will remain the same.
  2. If the volume of water that enters the bucket is more than the volume that exits the water level will gradually rise until the bucket is filled.
  3. If the volume of water that comes in is less than the volume that leaves, the level of water in the bucket will gradually go down till the bucket is empty.

Scenario 3 perfectly describes what happened with MMM. At the point the money coming into system from fresh recruits was less than what was required to pay existing members the system crashed. It crashed in several countries where it was established. For example, in Nigeria when the system reached the point of saturation, accounts of members were frozen in December 2016 causing members to lose lots of money.

Was it a Scam?

“МММ was a Russian company that perpetrated one of the world’s largest Ponzi schemes of all time, in the 1990s”, says Brigg (2012). She continues, “By different estimates from 5 to 10 million people lost their savings. According to contemporary Western press reports, “most investors were aware of the fraudulent nature of the scheme, but still hoped to profit from it by withdrawing money before it collapsed”. The character of the founder of MMM was questionable, he was found guilty of tax evasion, convicted of fraud, and given a sentence of four-and-a-half years. He co-founded the old MMM which was a Ponzi scheme. It came as no surprise when the MMM-global crashed because it was never a real investment. According to Kudaonline, MMM does not have a central account. There is also no central administration which translates to mean that there is no accountability in the system and no one can be called to account or held responsible if something went amiss.

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