Dissecting the Pyramid & Ponzi Schemes Quandary

Dissecting the Pyramid & Ponzi Schemes Quandary

Dissecting the Pyramid & Ponzi Schemes Quandary

By Winnie Chepkemoi & Sitati Wasilwa

Image: Courtesy

Touted as one of the destructive effects of capitalism, the emergence, re-emergence and existence of the pyramid schemes as well as the Ponzi schemes is believed to be engendered by a myriad of factors some of which this article seeks to unravel. Albeit very close similarities between a Ponzi scheme and a pyramid scheme, it is vitally important to distinguish the supposed meaning of the two. To begin with, a pyramid scheme is an investment model that is based on the concept and aspect of increased recruitment of members and future payments. Typically, a pyramid scheme operates on the maxim that any additional member recruited by an existing member increases the amount of money that the latter is to paid. The payments, pegged on the future, are solely based on promises which turn out to be vague and empty.

A Ponzi scheme, on the other hand refers to an investment model in which an entity/organization promises the investors high rates of return on investments in addition to very low risk for the investment made. The origin of the Ponzi schemes can be traced to an Italian swindler and con artist by the name of Charles Ponzi, who later migrated to the United States of America and Canada. One overarching feature of the pyramid schemes and the Ponzi schemes is that they pay the initial/earlier investors using capital or finances made available by the new investors and not from the profits generated by the entity. All in all, the pyramid and Ponzi schemes alike are fraudulent schemes whose initiators (the con artists & cunning investors) have the main aim of swindling money from the members of the public.

The Underlying Economics

Various doctrines under the discipline of Economics can be used to explain why these fraudulent schemes exist in the society. It is in view of the discipline of Economics that any transaction or any form of economic activity be guided by two fundamental principles; the motive and the incentive. With respect to these two, the originator of a pyramid/Ponzi scheme has the motive of swindling relatively huge amounts of money from the unsuspecting members of the public. The incentive for the initiators of these fraudulent schemes is the urge to attain quick riches. Similarly, the incentive that is engineered by the fraudsters to trick the members of the public, the so-called investors, is the promise of abnormal rate of returns on investment within a very short period of time. This in other words, is a supreme and prime promise to the world of riches.

The origin and cause of the pyramid schemes and the Ponzi schemes is the mere fact that imperfection does exist in the various markets within an economy. The markets that exist within an economy include the commodity market, the money market, the labour market among other market segments. Mainstream economists have always fantasized with the idea that as long as an economy is a free market (purely based on the forces of demand and supply without any government intervention) then such a market is assumed to regulate itself and hence deemed as a perfect market. This is absolutely wrong because from the outset it is an assumption, and a lame one for that matter.

Courtesy: Data Society

Existence of fraudulent schemes is a pointer that markets are imperfect. There are several factors that lead to imperfections in the market but the outstanding cause that brings about these scams is information asymmetry. Information asymmetry is whereby one party in a transaction or economic activity has more knowledge and/or information than the other party. The Ponzi schemes and pyramid schemes emerge simply because their initiators have more information on the business activity that they seek to advance at the expense of the victims who tend to have very limited information on the business idea/economic activity presented to them. This deficit in information/knowledge with respect to the would-be victims often creates a fertile ground for the scams to thrive.

In fact, there exists a market of information which also has its own demand and supply forces. A perfect information market is one where the supply of information is equal to the demand for information. However, this remains an assumption. In view of the pyramid/Ponzi schemes, the supply of information is excessively limited by the fraudsters and the demand for the requisite information by the victims is very weak. This leads to an imbalance in such a market with the white-collar thieves taking advantage of the naïve members of the public.

The Kenyan Case

The Kenyan economy has played host to various activities advanced by the pyramid schemes as well as the Ponzi schemes. Going by the recent history, pyramid schemes effectively surfaced in the Kenyan economy in 1998. The 1998 pyramid scheme was known as the Kenya Winners Circle Inc. Company Ltd that engaged in the selling of cruise ship tickets and holiday/tour packages at discounted prices as documented in the Report of the Taskforce on the Pyramid Schemes published in 2009. The same document notes that another pyramid scheme came to the fore in the year 2005 and it was known as the Kenya Akiba Micro Finance Ltd.

Investors of the collapsed Deci pyramid scheme protest in Nyeri Town.
Courtesy: Daily Nation

Between 2006 and 2007, there was an exponential increase in the number of the fraudulent schemes in Kenya. The pyramid/Ponzi schemes that came up at that particular point in time include the dreaded DECI, Acid, Pesanet Ltd, Mont Blanq Afrique, Global Entrepreneurship, Sasanet Investment Ltd, Kenya Multipurpose Business Ltd, Kings Script Publishers Ltd, CLIP Investment Sacco Society Ltd, Tujibebe Sacco Society Ltd, Jitegemee Entrepreneurs Sacco Ltd, Kenya Business Community Sacco and Sasanet Investment Sacco Society, Family in Need Organization (FINO), Spell Investment, Amity Investment ,Smart Welfare among others.

The emergence of these swindling enterprises at around the 2006/07 period was caused by the increased liquidity in the Kenyan economy caused by the relatively lower interest rates advocated for by the NARC administration and the good performance of the stock market. It is out of the latter two factors; low interest rates and good performance of the stock market that the fraudsters established the schemes. They tricked people by packaging the schemes in such a manner that they would offer loans at very low interest rates and deposits made would attract rates of over 10% far much higher than what the banking institutions were offering. The schemes at this period were tied to the money and/or financial market segments of the economy. Information from the relevant government agencies indicates that 270 schemes were formed and they swindled approximately Kshs.34 billion or more from Kenyans between 2006 and 2007.

This year, there have been revelations of how some Kenyans have lost money to these fraudsters through well-choreographed schemes that would otherwise have guaranteed the victims the ownership of homes and land. The firms that fronted such home ownership pyramid schemes include the Simple Homes and the Gakuyo real estate firm in conjunction with Ekeza Sacco. Naïve Kenyans are said to have lost billions of shillings to the two real estate firms. The tune seems to have changed this time round as the fraudulent schemes are now prevalent in the real estate segment of the economy. With the booming construction sector, there is no doubt that there exists other pyramid schemes that are sucking Kenyans’ financial resources in the property market.

In October 2016, the Daily Nation reported that a pyramid scheme associated with a well-known Russian con artist and fraudster, MMM Global was setting shop in the country under the name MMM Kenya. The Russian, Sergey Mavrodi is currently convicted. MMM Global promises its members of rewards when they donate money to the needy and will earn points through the electronic currency known as bitcoin in addition to being promised financial freedom.

Take notice of the trend; the pyramid schemes and the Ponzi schemes will always target the segment or sector of the economy that is thriving or experiencing relatively high growth rates.

Institutional, Policy & Legal Framework

The prevalence of the pyramid schemes in Kenya pushed the government to formulate the necessary and/or relevant policies and pieces of legislation to curb this economic crime. In 2009, the Ministry of Co-operative Development, Parliament and Central Bank of Kenya formed a taskforce led by Francis Nyenze that was charged with the responsibility of investigating the illicit activities of the pyramid schemes and make recommendations that would prevent such incidences from recurring. The taskforce compiled its findings in a document known as the Report of the Taskforce on Pyramid Schemes. The overarching recommendation of this report was the proposal for the enactment of an anti-pyramid scheme piece of legislation. The taskforce was however mandated to:

  • Formulate and recommend strategies for public awareness campaigns on pyramid schemes and other related
  • Formulate and recommend regulations to guide banks in dealing with pyramid and other related schemes.
  • Formulate and recommend strategies to apprehend existing and would be offenders.
  • Review and make recommendations on a legal text to prohibit illegal deposit-taking by pyramid and other related

Despite the fact that a number of the relevant recommendations in form of legislations and policies have been made, there still exists a loophole and vacuum which allows the pyramid schemes to operate in Kenya. This systemic weakness in the implementation of the policies and relevant laws is largely due to the following:

  • Lack of a strong political will to decimate the pyramid schemes as some of the politicians have direct or indirect interests in their activities.
  • The concerned regulatory institutions and agencies such as the Sacco Societies Regulatory Authority (SASRA) and others have corrupt officers who aid the pyramid schemes to obtain licenses to carry out their activities as fraudulent SACCOs.
  • Laxity among the law enforcement agencies to set up effective and efficient detective systems and prosecution mechanisms.

Recommendations

The existence of pyramid schemes in Kenya as highlighted in this article is a pointer that more needs to be done to decrease the incentives which attract the pyramid schemes in the Kenyan economy. The following are the prescriptions that will create a hostile environment for the pyramid schemes to operate:

  • The registration process for the SACCOs, companies and non-governmental organizations (NGOs) should be stringent in order to help in the detection of any form of pyramid schemes.
  • Relevant supervisory and regulatory institutions and government agencies such as the Central Bank of Kenya, SASRA, the Capital Markets Authority (CMA) and others should up their game and weed out the corrupt members of staff who convolute with the pyramid schemes.
  • The law enforcement agencies ought to establish efficient systems which will lead to the detection and prosecution of individuals promoting the pyramid schemes. They must also ensure that the existing anti-pyramid scheme laws and anti-money laundering laws are fully adhered to.

Above all, the periodic emergence of the pyramid schemes in Kenya’s economic landscape is a pointer to the existing inconsistency in the implementation of the formulated policies and the enacted laws. The concerned government agencies and institutions need to rise to the occasion and fully implement the proposed frameworks.

 

The writers are consultants on research & public policy at Savic Consultants’ Centre for Economic & Public Policy Analysis (CEPPA).

 

 

 

 

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