California Financial Fraud Laws: Ponzi Scheme, Pyramid Schemes and Penalties

California Financial Fraud Laws: Ponzi Scheme, Pyramic Schemes and Penalties
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Financial fraud is rampant in California and often involves schemes designed to rob people of their investments. California pyramid scheme laws and Ponzi scheme laws protect consumers and provide whistleblowers with protection and rewards.

Even though the words Ponzi and pyramid are sometimes used interchangeably, the two types of schemes are quite different. Ponzi schemes usually involve only one con artist, while a pyramid scheme involves a band of people. Ponzi schemes center on supposed investments, while a pyramid scheme often relies on tangible goods.

Pyramid Schemes Explained

Like in an actual pyramid shape, there is one investor at the top of a pyramid scheme who benefits from multiple levels of investments below. The promise is that there is enough opportunity for every investor to eventually be in the top position. Organizers use that promise to encourage participants to recruit more pyramid scheme victims.

The system is designed so there will always be someone left at the bottom who doesn’t benefit at all unless more investors are brought in. This is why pyramid schemes are often known as endless chains and are prohibited by California pyramid scheme law.

Pyramid schemes offer the promise of high returns with minimal effort or investment. The most popular schemes ask for participants to contribute as little as $1 to reap thousands or tens of thousands of dollars later.

The earliest pyramid schemes were simple ones, such as the eight-ball model or the mail chain. Today, pyramid schemes are based on various complex models, often posing as a company selling a product or a service that appears legitimate. This helps convince pyramid scheme victims that any return is solely dependent on their own efforts.

In 2019, for instance, a multilevel marketing (MLM) skincare company was fined $150 million for pyramid scheme structuring that rewarded recruits more for recruiting than for selling the company's products. That isn’t to say that all MLM, or direct sales, companies are scams, but investors should be cautious.

Ponzi Schemes Explained

Coined after the Italian fraudster, Charles Ponzi, the Ponzi scheme is another illegal way of making money through false investments. The Ponzi scheme, like the pyramid scheme, seeks investors. But unlike pyramid scheme victims, there is no recruitment. The only requirement participants have is to invest a specific amount. In Ponzi schemes, the investors are promised an unrealistic return on their investment within a certain timeframe.

The hope of getting a large payout in a small amount of time is alluring to hopeful investors. Plus, having a timeframe provides a false sense of security. It gives the impression that people are guaranteed to get their money back when nothing could be further from the truth. Like in a pyramid scheme, a Ponzi scheme ensures that some investors will never see a dime.

Ponzi schemes rely on the concept of robbing Peter to pay Paul. One investor benefits based solely on the fact that another loses out. Usually in this type of scheme, the investors are not aware of the risks because there’s no recruitment element to tip them off.

Ponzi Schemes Use Investment Scenarios

Unlike pyramid schemes, where the program often has a commodity like supplements or essential oils to sell upfront, Ponzi schemes rely only on promising to make investments and reap huge returns.

Famous Ponzi scheme cases include:

  • Madoff Investment Securities: $65 billion in losses.
  • Bitconnect: $1.5 billion in losses.
  • Florida-based Mutual Benefits Company: $1.1 billion in losses.
  • European Kings mail club: $1.2 billion in losses.

Laws Regarding Ponzi and Pyramid Schemes

The prosecution on charges for Ponzi or pyramid schemes falls under California Penal Code Section 319, which prohibits lottery schemes and California pyramid scheme law Penal Code Section 327, that prohibits endless chain schemes. Under these laws, a person involved in such schemes may be charged and prosecuted for:

  • Wire fraud.
  • Mail fraud.
  • Tax fraud.
  • Money laundering.
  • Business records fraud.
  • Theft.
  • Securities fraud.

Violations can be punished by imprisonment in county jail up to a maximum of one year or imprisonment in a state prison between 16 months to three years, depending on the severity of the crime. However, when federal agencies get involved, offenders can face serious fines and federal charges. Federal agencies that prosecute Ponzi and pyramid schemes include:

  • U.S. Attorney General.
  • Federal Trade Commission.
  • Security Exchange Commission.

How to Report Financial Fraud

When financial fraud involves federal agencies, whistleblowers can become eligible for financial rewards while retaining their anonymity. The SEC has paid out as much as $30 million to people who turned in evidence leading to the discovery of a major Ponzi scheme. It is imperative that someone seeking whistleblower protection and other benefits work with an experienced lawyer when submitting claims.

If it’s unlikely that a federal agency will take notice of a possible unlawful scheme, it’s best to inform the local police or state attorney general’s office.

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