The insolvency of the North Rhine-Westphalian real estate company DM holdings has shown once again how devastating pyramid schemes can be for investors. In this blog post, the legal assessment of such systems is to be presented from a lawyer’s point of view and possible consequences for affected investors are to be explained.
What are Ponzi schemes?
Ponzi schemes are illegally operated distribution systems (so-called multi-level marketing or structured distribution), which are designed to constantly attract new investors in order to use the money from these investors to service the interest and repayments to existing investors. The system works as long as enough new investors are found to pay off the old ones. Once this is no longer the case, the system collapses and investors lose their money.
What is a well-known company that has used a Ponzi scheme?
A well-known recent example of a Ponzi scheme is the company Wirecard. The company, which is considered one of the most successful fintech companies in Germany, had given false sales and profit figures for years and thus led investors, investors and the financial regulator to believe that the situation was far better than it actually was. When the snowball system blew up, the share price collapsed and Wirecard had to file for bankruptcy. Tens of thousands of investors lost their money, the total damage amounts to several billion euros. The Wirecard case shows that pyramid schemes not only affect small dubious companies, but also large and successful corporations that many investors and experts trust. The disclosure of Wirecard has also shown that financial supervision has failed in this area and that improvements in the regulation of financial markets and products are still necessary.
Another example of a Ponzi scheme is the Ponzi scheme Bernard L. Madoff. Madoff had lured investors with high returns for decades and operated a Ponzi scheme. He paid early investors high returns on the deposits of new investors without actually generating any income. This went well as long as Madoff found enough new investors who would trust him with money. However, when the financial crisis broke out in 2008 and many investors demanded their money back, the system collapsed. Madoff was sentenced to 150 years in prison.
What are the typical characteristics of pyramid schemes?
Well, how does the pyramid scheme work, what are the characteristics of a pyramid scheme?
- Promise of high profits:
The operators of the pyramid scheme often promise unrealistically high profits in order to attract new participants. - Structure:
Ponzi schemes have a pyramidal structure, with more and more participants below the initiator or group of initiators. - Recruitment of new participants:
Participants are often encouraged to recruit other people to increase their own profits. - No real added value:
Ponzi schemes have no real value creation or product performance underlying the high profits. The only thing that keeps the system running is recruiting new participants. - Unclear or veiled business practices:
Ponzi schemes often operate in the dark, obscuring their business practices and organizational structure to prevent the scheme’s true intentions from being revealed.
It is important to emphasize that not all companies or business models that exhibit a pyramidal structure are automatically Ponzi schemes. Rather, pyramid schemes are characterized by the fact that they have no real added value or product performance and aim to generate profits by constantly attracting new participants.
Ponzi schemes and the UWG
Why are pyramid schemes forbidden? In Germany, pyramid schemes are after § 16 paragraph 2 of the law against unfair competition (UWG) punishable. According to this provision, constructive customer acquisition, ie attracting new investors by promising special advantages for the similar acquisition of other customers, is only permissible if the focus is on selling the product and not building up the system by constantly accepting new sales participants.
It can also mislead you about the odds of winning § 5 UWG exist, which is almost always the case with pyramid schemes. Even if the customer is aware of the dangers of the system, dishonesty may exist due to inappropriate influencing, exploiting inexperience or deliberate hindrance to competitors.
civil consequences
According to §§ 134, 138 Abs. 1 Civil Code (BGB) void. This means that the contracts are void ab initio and affected investors cannot reclaim their investments.
For the investors affected, this means that they will generally not get back the money they have invested. However, you can try to assert claims for damages against those responsible. It is advisable to consult a lawyer who specializes in investor protection.
assessment of the situation
The example of DM Beteiligungen shows that pyramid schemes still pose a threat to investors. The affected investors now face an uncertain future and must fear for their investments. In this context, it is important to contact competent lawyers in order to assert claims for damages and to examine the legal options.
The legal situation is clear: Pyramid schemes are inadmissible and punishable under Section 16 (2) UWG. In addition, affected investors can § 5 UWGwhich prohibits misleading about odds of winning, as well as on § 4 UWG, which prohibits unfair business dealings. Under civil law, all legal transactions in connection with the implementation of progressive customer advertising are void in accordance with §§ 134, 138 Para. 1 BGB.
Current laws and judgments
In recent years, the legislator has increasingly tried to take action against pyramid schemes. In 2017, for example, the ban on pyramid schemes was included in the Criminal Code (Section 264a of the Criminal Code).
In 2021, the Law on Strengthening Investor Protection and Improving the Functioning of the Capital Market (AnsFuG) adopted, which came into force on January 1, 2022. Among other things, the law stipulates that providers of investments will in future require a permit from the Federal Financial Supervisory Authority (BaFin) and must fulfill certain information obligations.
In addition, there are a number of court decisions dealing with pyramid schemes and progressive solicitation. For example, the Higher Regional Court of Munich ruled in a judgment dated May 27, 2021 (Az. 19 U 3345/19) that a provider of capital investments who is active in the context of progressive customer acquisition must inform the investors concerned about the actual risks.
Conclusion on pyramid schemes
Pyramid schemes and chain letters continue to pose a threat to investors and can lead to existential economic damage. It is therefore important to contact competent lawyers to examine the legal options and to assert claims for damages. The legal situation is clear: Pyramid schemes are inadmissible and punishable under Section 16 (2) UWG. Under civil law, all legal transactions for the implementation of progressive customer acquisition according to §§ 134, 138 Para. 1 BGB are void.
