Pyramid schemes and other related practices: what you need to know.


In terms of our law, a pyramid scheme is an unlawful practice in terms whereof the newest members fund the “investments” of the existing members. The return on “investment” is usually too good to be true and not at all market related. As soon as new members stop joining the scheme, it falls apart resulting in the newest members losing the most.

The law

The Consumer Protection Act 68 of 2008 (“CPA” or the “Act”) defines a pyramid scheme along with the other related schemes falling within the ambit of the CPA. The general prohibition on these schemes is found in section 43(2) of the Act, and includes multiplication schemes and chain letter schemes.

“(2)      A person must not directly or indirectly promote, or knowingly join, enter or participate in—

  1. a) a multiplication scheme, as described in subsection (3);
  2. b) a pyramid scheme, as described in subsection (4);
  3. c) a chain letter scheme, as described in subsection (5); or
  4. d) any other scheme declared by the Minister in terms of subsection (6), or cause any other person to do so.”

Let’s look at these schemes in more detail:

Pyramid scheme

A pyramid scheme is a system into which people buy in exchange for a pay-out at a later stage when new members are introduced into the system. One normally pays a “joining” or “admin” fee to become a member of the scheme. The people who recruit the new members are paid out from the new members’ joining and admin fees. In some instances the scheme will involve the new members purchasing a product; however the product is of very low value and is a distraction from the main objective of the scheme.

The new money coming into the scheme is not used to derive profits but is merely used in order to pay out the existing members of the scheme: repayments are paid from new capital and not from profits generated. As soon as people stop joining the scheme it will start to fail and eventually collapse.

In terms of the CPA a pyramid scheme is defined as follows:

“(4)      An arrangement, agreement, practice or scheme is a pyramid scheme if—

  1. a) participants in the scheme receive compensation derived primarily from their respective recruitment of other persons as participants, rather than from the sale of any goods or services; or
  2. b) the emphasis in the promotion of the scheme indicates an arrangement or practice contemplated in paragraph (a).”

Multiplication scheme

A multiplication scheme is different to a pyramid scheme in that the CPA clearly states that it will only occur when the return on investment is 20% above the REPO rate at the date when the person invested into the scheme. A multiplication scheme occurs as soon as the investor is offered, promised or guaranteed returns that are 20% above the repo rate. Multiplication schemes do not have a hierarchical structure like pyramid schemes but generate revenue through repeated or once-off investments of varying amounts by members. The investments are then used to finance the interest pay-outs owed on investments made at an earlier date.

In terms of the CPA a multiplication scheme is defined as follows:

“(3)      A multiplication scheme exists when a person offers, promises or guarantees to any consumer, investor or participant an effective annual interest rate, as calculated in the prescribed manner, that is at least 20 per cent above the REPO Rate determined by the South African Reserve Bank as at the date of investment or commencement of participation, irrespective of whether the consumer, investor or participant becomes a member of the lending party.”

Chain letter scheme

Chan letter schemes require participants to continually recruit more participants in order to start receiving pay outs from their investment. The investment made is a joining fee of sorts. Each new participant joins at the lowest level in the scheme and “move up” by recruiting new members below them. Once a participant reaches the highest level of the scheme they are removed from the scheme.

In terms of the CPA a chain letter scheme is defined as follows:

“(5)      An arrangement, agreement, practice or scheme is a chain letter scheme if—

  1. a) it has various levels of participation;
  2. b) existing participants canvass and recruit new participants; or
  3. c) each successive newly recruited participant—
  4. i) upon joining—
  5. aa) is required to pay certain consideration, which is distributed to one, some or all of the previously existing participants, irrespective of whether the new participant receives any goods or services in exchange for that consideration; and
  6. bb) is assigned to the lowest level of participation in the scheme; and
  7. ii) upon recruiting further new participants, or upon those new participants recruiting further new participants, and so on in continual succession—
  8. aa) may participate in the distribution of the consideration paid by any such new recruit; and
  9. bb) moves to a higher level within the scheme, until being removed from the scheme after reaching the highest level.”

Characteristics of these schemes

The characteristics of these schemes include:

  • No product or product of little value being purchased by new participants.
  • A hierarchical, pyramid shaped structure where the members at the top benefit the most and the members nearer the bottom only benefit after the “top dogs” have been paid.
  • The incentive to recruit members is to ensure that a pay-out to the existing member recruiting and not in order to sell them a product of value.
  • The main source of income generated is from the introduction of new members and not through investment or other forms of wealth creation.

Outcomes of these schemes

  • The possible outcomes to these schemes:
    • The founding member or principal of the scheme gathers as much money from the scheme as possible and disappear with the funds.
    • The scheme collapses due to its “weight”. The scheme starts to lose speed as fewer members join resulting in a lack of funds available for existing members.
    • The scheme is unveiled as a pyramid or other prohibited scheme and authorities put a stop to the scheme.

Can members claim money back?

It is possible for the investors in pyramid schemes to attempt to claim their money back once the scheme collapses, however, chances of successfully retrieving all the funds you have invested are slim. Once the schemes collapse they are liquidated, as the scheme is declared insolvent. The liquidators will ensure that they receive their fee along with as many creditors of the scheme getting paid at least a portion of their outstanding debts leaving little to nothing for the victims of the scheme.

Prosecuting pyramid and related schemes along with their founding members is a major concern and problem faced by the South African Reserve Bank. Investigations into the schemes can take years to complete, depending on the complexity of the scheme. Another catalyst to the extended investigation period is the fact that the initiators of the schemes tend to disappear with investor funds as soon as the scheme starts showing signs of collapsing or gains too much attention from authorities.

The Companies Act, 2008, provides a mechanism for placing financially distressed businesses under “business rescue proceedings”. These proceedings are also often a barrier to investigation by the Reserve Bank and further prosecution.

Consequences for the person starting the scheme

Charges that could be laid against the founders of such schemes, as well as any persons involved in the schemes who should have noticed that fraudulent schemes were taking place include: theft, fraud, reckless trading, forgery and uttering, tax evasion, contravention of the Gambling Act, contravention of the Companies Act and contravention of the Banking Act.

Things to look out for

  • Interest rates that are “too good to be true” and much higher than interest rates offered by established institutions, such as banks and investment portfolios.
  • Promises of a guaranteed return on investment in a short amount of time.
  • The requirement to recruit additional members.
  • No link to established organisations.
  • When the investment does not disclose how returns are made.
  • The institution running the scheme is not licensed as a financial services provider with the Financial Services Board.
  • Where there is little or no information or an official mandate or documentation relating to the scheme.

Recent developments

The National Consumer Commission (NCC) have over the last 6 months launched investigations into the business practices of various companies, based on suspected pyramid scheme practices and other prohibited practices in terms of the CPA.

One example is the DiPESA scheme that was investigated earlier this year, but the investigation indicated that the business was in fact legitimate as it did not meet all the characteristics of any of the prohibited schemes in terms of the CPA.


In economically distressed times, companies may consider and initiate different kinds of business opportunities. It is important to understand that when considering your business model, prohibited practice in terms of consumer laws like the CPA, should be considered as a first step.

When considering pyramid and other related schemes it is also important to also take into account section 38 of the CPA, which regulates referral selling. The prohibited referral selling model aims to protect consumers against “unfair” marketing practices in terms whereof the consumer would agree to enter into an agreement (and pay for) goods or services on the basis that the consumer could possibly receive a benefit after entering into the agreement.

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