Beware the pyramid party scheme
By Julie Sturgeon • Bankrate.com

Lisa Bernfeld is a rare woman not because she was duped out of $4,000 but because she publicly admits it.

Six years ago, she accepted an invitation from a girlfriend to attend a financial meeting. An independent publicist, Bernfeld was open to wealth-increasing strategies. She drove to the home of an interior decorator whose floor space was packed with people interested in learning more about The Platinum Gift Club.

"The host was gorgeous, throwing this party with the help of his sweet, dear mom," Bernfeld recalls. By the end of that perfect fall night in Southern California, Bernfeld bought two opportunities for $2,000 each with the understanding that her investment would eventually reap $32,000 as more people learned about this great way to invest their cash.

"I knew I'd have troubles getting my circle of friends involved. I relied on the friend who recruited me to pitch in with invitations on my behalf," Bernfeld says. It might have worked given all the time in the world, but after the holidays, the group meetings ceased.

She didn't get rich; she was out $4,000.

Costly "parties"
Bernfeld is not alone. Across the country, people, particularly women, are targets of this latest cottage-industry craze. They are pitched as parties to help others earn money, but critics and law enforcement officers warn that the gatherings are scams.

The names vary -- Friends Helping Friends, Women Helping Women, The Friendship Investment Club, The Spirit of Giving -- but the concept is the same. To become a member, the new member makes a cash gift to the person at the top. Once this head honcho receives a predetermined amount in gifts, he or she vacates the chair, the group divides into two and everyone moves up to the next level.

James Walsh, author of You Can't Cheat an Honest Man: How Ponzi Schemes and Pyramids Work and Why They're More Popular Than Ever, calls these invitations by their true name: pyramid schemes, a transfer of capital not based on any profit-earning activity. For each investor to recoup money, two more must join the club.

The imagery built around the operation varies. Some use dinner-menu symbols where participants move from entrees to dessert. Others construct a birthday party theme where the person on top unwraps wonderful cash presents. The party version operates on amounts ranging from $500 to $2,000. The occasional club requires a $5,000 buy-in. That price, says Les Henderson, author of Crimes of Persuasion, is the first sign you're dealing with professional swindlers rather than naïve citizens.

The gifting investments typically offer a more informal setting and seek to capitalize on a network-marketing emphasis. But don't confuse gift clubs with multilevel marketing, Walsh warns.

"Even a poor MLM sells a product and you must take a risk. There's no such thing as guaranteed profit. Risk-ratio awards are one of the eternal truisms of a capitalist economy," he says. The Federal Trade Commission rule of thumb: If a group bases more than 30 percent of its compensation on recruiting new members, watch out.

No members, no money
Investors typically lose their money when the group runs out of steam on the recruiting side.

In Bernfeld's case, the organizer announced he intended to devote time to establishing gift clubs in Oklahoma and had no more time for his California ventures. The sheep in his pasture tried to carry on, but the effort soon petered out.

Left out in the cold, most pyramid participants rationalize or blame external forces: bad press, overzealous government attorneys, sexist oppressors who don't want women to help each other make money.

"People just don't realize these are scams. They think of them as bad consumer dealings, poor recruiters or unlucky investors," Henderson says.

That's perfectly understandable, given the truckloads of assurances the hosts spoon-feed at every meeting, Walsh says. The clubs tend to spend a large part of the meetings defending their tactics. Most attack the legalities head on, claiming they're not pyramids because the host is eventually forced to retire rather that keep raking in the dough as is typical of pyramid schemes. They also devote reams of paper to approval statements from vague authorities like "a police officer" or "a federal judge."

Bernfeld says she knew at first glance the club was illegal but still joined. "I'm a risk taker," she explains. "I saw the money in action and understood the logic. As long as you get people to buy, you move up the ladder."

Her candor is rare. Henderson has found that most participants get sucked in because they can't say no to a friend. Walsh blames the fun atmosphere cloaking the parties. "It's like a Tupperware or Pampered Chef gathering," he notes.

And many experts hold the economy responsible for the growing number of people willing to throw their money into the pot.

"Generally, these schemes signal a growing gulf between the haves and have-nots," says Walsh. "One of the dangers of the dot.com bubble was that it de-linked notions of real value with compensation. When the unsophisticated investor lost in the downfall, he decided the whole system was a crooked scheme anyhow, so this little party isn't any worse than eToys."

Striking back with limited results
Bernfeld took her beef against the gift club host to small claims court, where the charismatic creator failed to show. The judge was amused by her bald-faced assertion that she thought the investment legal but ruled in her favor anyhow.

During the collection process, Bernfeld learned her host hadn't used his real name. She invested hundreds of hours into tracking him down only to find him living in a nice home nowhere near Oklahoma.

Other disillusioned folks share her pain. Pyramid schemes are difficult to litigate because most attorneys won't jump into the fray for amounts less than $50,000, says Walsh. "Most gift club perpetrators count on the nuisance value. They hope the legal hoops are more than what most people will bear. They're right."

The clubs also avoid prosecution by employing cash-only transactions to sidestep proof. Some insist members use only their first names.

The tide, however, is turning. In 2003, club busts and pending charges have been reported in California, Hawaii, Oregon, North Carolina, Maine, Iowa, Pennsylvania, Texas, Oklahoma and New Mexico. In addition to seeking the usual criminal penalties, some prosecutors want club sponsors to make restitution to the victims. But the chances are slim that the once-enthusiastic club members will ever get their money back. As Bernfeld learned, even when repayment is ordered, collection isn't easy.

The best defense, Walsh maintains, is to avoid forking over the dough in the first place, despite the friendships involved.

"Ask, 'What is the business?' What are we selling? Recognize that 'networking opportunities' is not a commodity," he reminds. "Don't accept the gibberish about the new economy and the velocity of money. Keep asking, 'What's the underlying transaction?'"

And keep the questions handy. Henderson doesn't expect gift clubs to disappear. "Nothing will ever stop it," he says. "They will continue to work because human nature never changes."

Julie Sturgeon is a freelance writer based in Indiana.