The Penny-Stock Pyramid Scheme (cont'd)
The merger of the shell with a private company provides the penny stock scheme with a certain validity. An empty shell was taken public; people invested; shares are bought and sold on the basis of this future transaction. But, in reality, the merger itself was as worthless to shareholders as the original shell. Its only purpose was to excite investors. The real money is to be made in the buying and reselling of the stock, not in any tangible business activity of the merged company itself.
As more penny stock investors are solicited, the stock keeps rising. Soon the stock goes to five and then seven and perhaps eventually to twelve! For those on the inside, this is a veritable gold mine. For some shareholders who invested early, the program appears to be a wonderful and fully legitimate investment. Who can argue with making money by buying and selling stock? It's as American as apple pie. It's legal. It's just supply and demand. This is capitalism at its finest. What a system! The brokerage house has been earning huge commission rates on trades with stock rising at 50, 100 and 200% increments. The inside investors associated with the brokerage firm have been reaping massive profits.
But the bonanza does go not forever. The stock is astronomically overpriced relative to the assets of the company. Further, the number of investors needed to keep the stock propped up is becoming impossible to recruit. Some shareholders are beginning to ask questions about the actual business of this merged company. A point is reached at which the stock cannot be resold at a higher price. The collapse begins. Those holding the stock at this point suffer major losses on their investments. The real value of the stock is now revealed to be what is what it was all along, a small fraction of a penny or perhaps nothing at all.
"Collapse" Only Affects Latest Investors, Not the Organizers and Upliners
The penny stock brokerage firm, it should be remembered, is not in any way harmed when the stock collapses. Only the most recent investors lose. The firm can move forward to create yet another similar scheme. It could also repurchase the shares from the losers and begin the entire process again with yet another "story" about the firms great potential.
Pyramid schemes do not necessarily collapse, but most investors do always lose. The scheme can keep going. The losses or "collapse" are borne by the investors.
It should be noted that taking companies public with very low stock prices and even using the merger with a blind pool or shell is not inherently fraudulent. It can be a valid method of helping a new company grow rapidly. Rather, it was the selling of grossly overpriced stocks (even though the selling price was only one penny a share) and then manipulating the price to entice more shareholders into schemes in which most were destined to lose money that constituted the fraud.
Likewise, a distribution system that allows distributors to appoint sub-distributors is not inherently fraudulent. It becomes fraud only when the company and the upliners place the majority of their efforts on recruitment of distributors rather than sales of products. Unfortunately, this kind of abuse pervades and characterizes the multi-level marketing industry.
The MLM industry operates under the thin protection of a 20-year old ruling by an FTC judge that declared the basic business model legal. However, unlike the penny stock business, MLM does not have a federal or even state agency that specifically oversees its operations. There is no testing or certification for distributors. Companies do not register with any MLM regulatory body or send quarterly reports of sales activities as did the penny stock brokers. Even when an MLM company sells stock to the public, its day-to-day sales and marketing activities are not regulated, only its stock sales.
Some analysts have argued that MLM distributorships are, in fact, securities. They are bought on speculation. Their value rests on future transactions of downliners and are promoted this way. Buy in now! Get in on the ground floor! One of your downliners may become a superstar and take you to unimaginable wealth! The MLM industry naturally opposes this regulation. Few people favor greater government regulation of any business. Yet, regulation normally occurs only where abuse has been rampant. Until the MLM business goes back to selling products to consumers rather than making its money by using new distributors as its unwitting customers, the call for regulation will grow.