Franchise fraud is defined by the United States Federal Bureau of Investigation (FBI) as a pyramid scheme:
|“Pyramid schemes – also referred to as franchise fraud or chain referral schemes – are marketing and investment frauds in which an individual is offered a distributorship or franchise to market a particular product. The real profit is earned, not by the sale of the product, but by the sale of new distributorships. Emphasis on selling franchises rather than the product eventually leads to a point where the supply of potential investors is exhausted and the pyramid collapses.”
A pyramid scheme is a non-sustainable business model that involves paying participants primarily for enrolling other people into the scheme, rather than supplying products or services to the public. Pyramid schemes should not be confused with legitimate multi-level market plans (MLM plans) that provide products and/or services to the public, while paying incentives to their sales force for recruiting additional people to market the firm's products and/or services.
A Ponzi scheme is a fraudulent investment operation that pays investors back with either their own money, or the money of new investors, rather than from profits earned. Ponzi schemes use the promise of high returns to entice investors to turn over their money, and to recruit new investors among their relatives and friends. As money comes in, the operators of the scheme take funds for their personal use while using a portion of the funds to perpetuate the scheme as long as possible before it collapses or comes to the attention of law enforcement authorities. The scheme is named after Charles Ponzi who used the technique in 1920. The Bernie Madoff investment scandal was the largest Ponzi scheme in history.