Financial pyramids cannot crash the economy, but they can harm financial institutions. Additionally, entrepreneurs often become victims of these schemes. Experts shared how to avoid encountering financial pyramids and not fall victim to fraud.
Despite a wealth of information about the structure of financial pyramids and their consequences, people continue to invest in dubious companies, trusting promises of fabulous profits without any effort or active involvement, thereby contributing to the growth of fraudulent structures.
According to the Ministry of Internal Affairs of Kazakhstan, 351 cases of creating financial pyramids were registered in the first four months of 2017. In comparison, only 350 criminal cases were under investigation in 2016.
One of the most high-profile cases in the Kyzylorda region was the exposure of the foreign company Questra Holdings Inc. The company attracted investors by concluding agreements for the amount of 30,000 tenge, transferred to the company's account, with a reward of 40,000 tenge paid out over six months.
Earlier this year in Astana, the activities of a fraudulent group were stopped. They offered unsecured loans up to 1,000 euros at low-interest rates. Contracts were concluded with over 1,000 misled clients for loan issuance, but after collecting initial deposits, ranging from 75,000 to almost 7 million tenge, the fraudsters disappeared.
Another significant case occurred in Semey, where two native women from East Kazakhstan created an investment online platform. A registered user would deposit money into the account, taking a place in line behind the person who invited them. That user would then invite two more people, who would invite two more each. Once six people were gathered, the participant would receive a 180,000 tenge reward. Over two years, more than 70 million tenge was involved in the scheme, with over 2,000 participants registered.
How not to become a victim of investment fraud?
“A financial pyramid is a way to ensure income for members of the structure by constantly attracting funds. It is a model where money is redistributed from lower-level participants to those positioned above. Often, financial pyramids are disguised as investment funds or various commercial projects that supposedly invest your money in high-return financial instruments or ultra-profitable projects,” explained experts from JSC Nurbank.
A financial pyramid has classic signs. According to the Prosecutor General's Office of Kazakhstan, these are promises of significant profit without tangible activity, merely through investment and earning high returns in a short time. A client is required to attract new participants, for which project leaders guarantee a monetary reward. Generally, fraudsters do not provide clear information on how they earn.
JSC Nurbank also notes that pyramids are widely propagated through media channels. Such organizations do not have official registration, statutes, or permits for their activities.
How to protect yourself?
To avoid falling victim to financial pyramids, Deputy General Director of IK FINAM Yaroslav Kabakov advises working only with licensed financial service companies and exclusively through contracts. It is crucial to carefully review the contract and consult with lawyers in case of doubts.
Alarm should be raised if the following occurs: “The project is presented as a know-how. It features too unconventional work schemes that arouse suspicion. The project's office is lacking for a 'super successful' and 'rapidly growing business,' or it is absent altogether,” highlighted JSC Nurbank.
It is important to understand that the main difference between a pyramid and a real project is the source of income payment. “If the payout consistently exceeds the value added by the business, the project is a pyramid,” noted the bank’s press service.
Threats to banks?
Mr. Kabakov says, for financial institutions, pyramids pose a threat by depleting the banks' client base and bankrupting the population.
JSC Nurbank notes that both the stock market and banking sector are unstable, with bank deposit rates falling. This leads to the emergence of organizations promising above-market returns, which subsequently disappear with client funds.
“Any entity that guarantees (specifically guarantees) returns significantly exceeding bank deposit rates should raise suspicions in a reasonable person,” noted Mr. Kabakov.
Among financial pyramids are projects offering to refinance and/or co-finance individuals’ creditor debt with banks and microfinance organizations. “The operational scheme of this financial pyramid involves the client transferring funds, about 30-40% of a previously taken credit or loan, to the company, with the company promising to repay all obligations to the bank or microfinance organization. This type of financial pyramid is particularly dangerous because its collapse harms not only the population but also financial organizations that provided the loans and credits,” stated JSC Nurbank.
The instability of pyramids
“If it could become stable, it would not be a financial pyramid,” Mr. Kabakov states. He believes that a pyramid cannot stay stable for purely mathematical reasons due to the limited number of participants and available funds. Thus, when growth rates slow, the pyramid becomes unsustainable and unable to meet obligations to previously involved participants.
“Currently, almost all financial pyramids operate on the internet. Money is collected through online payment systems. There is no personal contact between the organizer and the clients. The main reason financial pyramids continue to exist, and probably will never disappear, is human greed and the desire for quick enrichment,” explained JSC Nurbank.
Who becomes a victim?
One might think the most susceptible to the lure of large and easy money are the needy or financially illiterate citizens, but this is not always the case. “As past experiences show, the pyramid victims are more often those who, theoretically, should be less susceptible – educated people and entrepreneurs. The reasons for this are unclear, posing a question for sociopsychologists. Possibly, more openness to new opportunities, broader social circles, or more targeted fraudster efforts play a role,” shared Mr. Kabakov.
JSC Nurbank notes that the key audience of many pyramids is retirees and low-income individuals with poor financial literacy. “Interestingly, the victims are often poor people who lack money and are willing to borrow to quickly earn high returns on their investments,” believes the bank.
Economic Damage
According to Mr. Kabakov, developed countries currently have mechanisms to combat these organizations, or rather, curb their excessive growth. “Although imperfect and often failing at ground levels, they prevent schemes from reaching the scale of John Law's pyramid in early 18th century France, which crashed the national economy. It is another matter when the state builds the pyramid itself, as in the case of Russian government securities in the 1990s, which could lead to rampant inflation and the mass bankruptcies of financial companies and their investors,” he concluded.