HOW PYRAMID SCHEMES AFFECT POVETY REDUCTION

PROGRAMMES IN KENYA: A LITERATURE REVIEW

BY

DR. ZAKAYO ONYIEGO

A PAPER PRESENTED TO MOUNT KENYA UNIVERSITY SYMPOSIUM

AT NAKURU CAMPUS

DATE OF PRESENTATION: 31ST July 2010

 Abstract

This study focuses on the impact of pyramid schemes on socio-economic welfare in Kenya.
Pyramid schemes are basically false investment mechanisms in which investors are promised
large returns on their investment over a short period of time. The business activities that lead to
the promised returns largely remain unclear. Since these schemes - as recently witnessed in
Kenya - lead to enormous losses, this research study investigates their impact on poverty
reduction efforts. The study examines global imperatives of pyramid schemes and their socio-
economic implications. These imperatives are then translated into Kenyan context with special
focus on how the schemes emerge, their persuasive power, and impact on social and economic
life of Kenyans. Largely, this writer is informed and guided by pertinent theoretical and
empirical literature from authoritative sources. The literature is rigorously and chronologically
reviewed to draw some patterns and trends that may culminate in adverse effects. Chiefly, the
study addresses and attempts to answer salient questions: Who are the easy victims in these
schemes, what are the investment motives? To what extent is the Kenyan society affected? What
is the magnitude of funds involved? To what level are the schemes likely to impact financial
institutions, especial microfinance? What is likely to happen in the absence of meaningful
government intervention? It also attempts to establish the participation level in these schemes
by the people of Kenya as well as the sources of funds used to invest in them. Major conclusions
include family life disruption, untold financial losses, significant reduction in wealth creation,
stagnation of government projects, potential distortion of government economic policy, civil
disobedience, and that the activities hardly add any net value to society. In sum, this frustrates
the government’s effort to reduce poverty and the nation’s economic trajectory towards middle-
income society as envisaged in the vision 2030. It is hoped that this study will serve as a wake up
call on the schemes’ potential destructive effect on socio-economic and political wellbeing in
Kenya. It will then assist relevant government organs to develop and implement legal and
regulatory mechanisms to at least minimize activities of the schemes, if not eliminate them
altogether.

Introduction
One of the most basic functions of government is to improve the social welfare of its people.
Governments the world over are continually engaged in designing and developing better poverty
reduction programmes. This concerted effort to enhance the standards of living of their citizens
is a fundamental expectation of the people. Kenya is not exempted from this functional
expectation.

Across time since independence, the Kenya government has been progressively putting in place
various mechanisms to reduce poverty. In recent times, for instance, the government
implemented the youth and women fund policy in an attempt to better the economic and social
wellbeing of the target groups. However, these crucial economic programmes have been and
continue to be frustrated in various ways. Some of the glaring ways in which the successes of

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poverty reduction programmes have been frustrated include ubiquitous corruption, widespread
illiteracy, and the recent wave of pyramid schemes. The centrality of this study is the effects of
pyramid schemes on socio-economic welfare of Kenyans.

There are many forms of pyramid schemes depending on the conceptualization of the schemer.
The type recently witnessed in Kenya is reminiscent of a “Ponzi” scheme. Ponzi schemes are
types of illegal pyramid schemes named for Charles Ponzi, who duped thousands of New
England residents into investing in a postage-stamp speculation scheme back in the 1920s. Ponzi
thought he could take advantage of differences between US and foreign currencies used to buy
and sell international mail coupons. Ponzi told investors that he could provide a 40% return in
just 90 days compared to 5% for bank savings accounts. Ponzi was deluged with funds from
investors, taking in $ 1 million during a one three hour period and this was 1921! Though a few
early investors were paid off to make the scheme look legitimate, an investigation found that
Ponzi had only purchased about $30 worth of the international mail coupons. Decades later, the
Ponzi scheme continues to work on the “rob- Peter- to-pay-Paul” principle, as money from new
investors is used to pay earlier investors until the whole scheme collapses.

The pyramids that were about to infiltrate the entire Kenyan economic system closely ebb Ponzi
schemes. The promoters made potential investors believe that they could reap returns of 50% to
200% within a period of eight weeks. Convinced of this “god given” potential, there was a
beehive of activities at the offices of the schemers. This was in the earlier stages of the scheme’s
debut. Indeed the ‘early bird’ investors were handsomely rewarded.

The pyramid schemes are able to succeed initially because of the promoter’s socio-
psychological savvy. Verbal construction that sound impressive but are essentially meaningless
will be used to dazzle investors- terms such as ‘hedge futures trading’, ‘high yield investment
programs’, ‘off-shore investment’ might be used. The promoter will then proceed to selling
stakes to investors who are basically victims of confidence trick. There are no productive
activities that the schemers engage in that could engender returns the investors are promised.

Ultimately, the scheme collapses under its own weight. Vast majority of investors lose their
money – most of the losers sustain an indelible psychological scar and some even commit
suicide. This represents a monumental social cost to the nationhood. The socio-economic woes
currently afflicting the country can be partially attributed to the recent wave of pyramid schemes.
The impetus behind this study is the need to understand the extent to which pyramid schemes
affect the success of poverty reduction programmes as envisaged by the Kenyan government.
There are important questions that remain unanswered as pertains to this phenomenon: What is
the scope of pyramid schemes in Kenya? Who are the easy victims of such schemes? What is the
source of the so called “seed money” invested in such schemes? To what level pyramid schemes
contributed to poverty in Kenya? The paper aims at answering these questions as candidly as the
available documented material can allow. At minimum, the paper examines the effects of
pyramid schemes on the government’s efforts to improve the well being of its citizens.

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The problem
In the year 2008 and part of 2009, Kenya was engulfed in a sea of pyramid schemes. All this
happened in the midst of a dwindling economy in Kenya and a general decline of the world
economic activities. A general world financial crunch was looming. The beauty of the scheme in
the eyes of the naïve was the promise of amazing returns with, zero risk. A lot of working and
non – working Kenyans fell into the booby trap. Large sums of money were mopped up from the
economy into the pyramid schemes that had mushroomed all over major towns in Kenya.
Lifetime savings, salaries, proceeds from sale of properties, borrowing from microfinance
intuitions, and bank loans were, for most part, sunk into the schemes. Banking and investment
professionals were not sparred albeit the basic investments principle that high returns on
investment call for high risk.

In the end, the schemes collapsed with billions of investor’s money. This caused undue
heartache, stress, undue debt, suicidal tendencies and family disability among the investors. The
economic hole and financial gap created by this wave of pyramid schemes appear to be massive.
The people of Kenya seem to be sinking deeper and deeper into abject poverty. The banks have
tightened their cash vaults and some lenders have zipped up their wallets all together. Further,
public trust on microfinance institutions has markedly dwindled. This is because it is some of
these institutions that turned into pyramid schemes.

Although this perpetual sorry state of the economy cannot be attributed to the activities of these
schemes in its entirety, they may indeed have played a substantial role. The extent to which they
may have contributed to the state of the economy is not known. It is suspected that even though
the government is planning and implementing sound poverty reduction programs, there has been
no noticeable improvement. It is possible that the schemes are on hiatus or clandestinely
operational and may return with vengeance to completely cripple the economy with a ripple
effect on socio-political welfare. This study therefore hopes to find out the secrets behind these
schemes, their persuasive clout, and the extent to which they contribute to poverty levels in
Kenya. This will help Kenyans shun such schemes and the government to design and implement
more effective policies to at least curtail the activities if not eliminate them all together.

The aim of the study

This study investigates the factors contributing to proliferation of pyramid schemes in Kenya-
focusing on the most vulnerable victims of pyramid schemes. It rigorously attempts to shed light
on the effects of such pyramid schemes on poverty reduction programs initiated by the
government of Kenya. The schemes do not sell any goods or services that add value and thus
their activities are equally valueless. Depending on the scope of the activities, they can be highly
damaging to the economy. In the absence of regulatory framework to curtail the pyramids’
onslaught, the consequences can be catastrophic. An effort has also been made to determine
whether there are still such informal false businesses in Kenya.

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Objectively, the study establishes an estimate of the number of people who may have fallen
victim of the schemes. The economic effects have been well investigated relative to the sources
of funds invested in the now mostly defunct pyramid schemes.

How to identify a pyramid scheme

1) Pyramid schemes are about, quick, short-term profit. They are the quintessential get-rich-
quick scam. Leveraging a continuously growing base of new investors can produce enormous
revenue to the perpetrators at the top. No need to wait for profits from offering a real service or
product to real consumers, the pyramid just siphons off investment funds and transfers them to
those "positioned" at or near the top. A long-term customer base is also not required since a
steady flow of new buyers can be churned annually by attaching the promises of fast wealth to
the product.

2) Pyramid schemes require an unconscionable lack of responsibility toward others. Profit is

gained from someone else's loss. Value is not exchanged. Even when products are involved, the
scheme is not a real business. "Profit" requires enrolling an endless chain of new salespersons
and falsely promising them the same opportunity. In such a program, the vast majority must
always be at the bottom where they can't earn a profit because they have no 'down-line.' Pyramid
sales schemes often couch this predatory behavior as "American individualism" and "personal
responsibility", as if being responsible for yourself exempts you from responsibility to others and
excuses deception. The values of the pyramid are those of the scavenger.

3) Pyramids are inherently deceptive. Deception in the pyramid involves lying to others and
lying to oneself. In the pyramid sales schemes, for example, the real business is not vitamins or
water filters, but recruiting other investor/salespeople. Almost no one actually makes money in a
program hyped as the "opportunity of a lifetime." The speakers on the stage are not making the
incomes they claim they are. This is not a program of "winners" at all. Indeed, 50-70% will quit
the program in the first year and 99.9% actually lose money!

In the "gifting" schemes, for example, no one is really giving "gifts." They are buying positions
in a scam that promises an 800% return. The women in the "women helping women" gifting
schemes do not tell their friends that 90% will lose in the scheme, even if they realize this. If
they don't realize this, it is because, to some extent, they willfully chose not to look at the facts.
The scheme is not about "helping" others but about helping oneself at the direct expense of
others. Like an onion, as each layer is peeled away, yet another level of deception and
manipulation is revealed.

4) Ultimately, pyramid schemes steal. They are a form of organized thievery carried out within a
system of money transfers in which everyone, to some extent, is seeking to steal from someone
else. A kind of looters' mentality takes hold to justify this behavior. If everyone is doing it, why
can't I? And, it is okay to steal from those who are trying to do the same thing?

5) And, finally, no one who studies pyramid schemes can fail to notice that pyramid schemes are
characterized by a kind of lapse in common sense and normal intelligence. Denial and delusion,
perhaps associated with desperation that is now being let loose with visions of quick riches, are
in full swing. Well educated women will insist that a pyramid - in which each person gets the
money paid in by eight others, and those eight will do the same with the process continuing

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indefinitely - is completely sustainable forever. They adamantly deny its inevitable collapse.
They refuse to do the math. Nor, will they admit that 90% must, always, and by design, lose.

Multi-level marketing zealots, who have lost thousands already, will insist the program is valid
and that "success" is just around the corner. They will reject any analysis or disclosure of actual
financial results of all distributors as just "negativity". They will assert that all those who lose
even if it's 99.9% - cause the losses themselves due to laziness, lack of character or refusal to
learn the "secrets" of success.

Significance of the study

This study definitively establishes the reasons why people fall prey to pyramid schemes. Further
it analyses the extent to which the schemes have negatively impacted the government’s efforts to
reduce poverty r in Kenya. This study is particularly important during these challenging
economic times as the government attempts to revive the economy and set the country on a
stable path towards realization of vision 2030. Any offending variables that may impede such
efforts ought to be identified for the purposes of mitigating or eliminating them. The findings of
the study will be used to create awareness and educate the people of Kenya on economic effects
of the pyramid schemes. This will help the people to safeguard their investment portfolios
against frivolous promoters of unviable schemes. The government can also use the study findings
to devise better and stringent regulatory framework against such economically devastating
investments schemes.

Discussion
In the quests to improve social and economic wellbeing of mankind, there are major challenges.
One of such challenges emanates from peddlers of unjust, get-rich-quick schemes. In the last
two-years, Kenya has suffered unprecedented economic turbulence felt by small scale
entrepreneurs owing to the collapse of several pyramid schemes, among them DECI-
“Development, Entrepreneurship for Community Initiative, which had the most devastating
effects”(Nation Editorial, 2008). Despite their monumental negative effects, these schemes were
largely operating with full knowledge of government agencies charged with financial and
investments oversight. This apathy on part of the government to act led to these pyramid
schemes spreading like wild fire within the Kenyan state.

As the schemes continued to flourish and boast thousands of investors, problems started to
surface as the promised payouts were no long sustainable. This is when the authorities started to
take notice. In an editorial titled Pyramid Schemes Illegal and should be Closed, the standard
sums up the problem in Kenya as follows:
Kenyans frustrated with long queues in banks and brokerage companies, have
been withdrawing savings and selling shares to invest in the schemes. But
investors should beware for they stand to lose heavily because the projects are not
sustainable. Some of the schemes boast more than 5000 members.

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 The public should be warned of the inherent dangers of putting money in these
schemes. They promise very high interest rates of 10 to 20 per cent a month,
compared to bank savings whose return is five percent or less a year. When the
deal is too good, think twice.
An avalanche of such warnings littered newspapers and media houses upon which the central
bank of Kenya started to act. According to Vinci (2009), failure by financial regulators to do
their job is to blame for the recent blossoming of pyramid schemes in which Kenyans have lost
at Ksh34billion. Security agencies are also to blame for complicity in the exponential growth of
unregulated investments schemes that collapsed at the end of 2007 leaving thousands of people
with huge financial losses. Although pyramid schemes have been in existence predating
industrial period, and will continue to exist, it is interesting to note that these schemes were at
their peak during election year in Kenya and collapsed at the end of it. It is hard to believe that
one can collect billions of shillings from the public without the knowledge of any regulator.

The sheer number of people who bought into the idea of investing in pyramid schemes clearly
points to the risk tolerance level of Kenyans in investment. The basic principal of investment has
it that the riskier the investment, the higher probable rate of return. True, but those who have
made it under the scenario are those willing to wait a little longer. Opiyo (2009) asserts that,
“from the historic mass loss of pyramid schemes, it is possible that although they were unaware
of their risk profiles, many Kenyans would seem to have adequate tolerance to have any risky
investment that could lead to greater returns.”

The problem however is that this risk profile of Kenyans as a tool to economic prosperity has
not been constructively engaged. Awareness of risk profiles and risk return relationships has
been instrumental in guiding potential investors in avoiding fraudulent investments which always
appear to provide high returns with no risk attached after a short period. The vast majority are
clearly either ignorant or negligent of this fundamental fact. “Out of the ten thousands of people
in Mombasa who deposited their money in the scheme, only 321 were able to be traced by a
committee coordinating the recovery of the money. They, together, deposited Ksh28, 817,405
(Opiyo and Kwena, 2007)

Pyramid schemes, if unchecked can have horrendous economic and social devastation. There
have been cases of people who ailed from depression after losing their money in the pyramid
schemes as the investments which were intended to be a route out of poverty led them into
serious debts and financial losses. These schemes are widespread globally and have profound
effects in varied ways. Lessons from Albania’s pyramid schemes can teach other countries the
danger of letting pyramid schemes have a free ride. Javis (2000) describes the case a follows:

The pyramid schemes phenomenon in Albania is important because of its scale relative to
the size of the economy was unprecedented and because the political and social
consequences of the collapse of the pyramid schemes were profound. At their peak, the
nominal value of the pyramid schemes liabilities amounted to almost half of the country’s

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 GDP. Many Albania’s - about two thirds of the population – invested in them. When the
schemes collapsed, there were uncontained riots, the government fell, and the country
descended into anarchy and a near civil war in which some 2,000 people were killed.

Albania’s experience has significant implications for the countries in which conditions are
similar to those that led to the schemes rise in Albania. Kenya has a lot to learn from the way the
Albanian authorities’ handled and mishandle the crisis. Apparently, the schemes can bring down
an entire nation and Kenya is not an exception. The cascading effects of the schemes are
phenomenal in Kenya. Families have been broken, costly litigations were instituted and many
more are on the works. Although the government agencies had no clear hand on these activities,
people continue pointing fingers at the state for having failed to protect them.

The Kenyan authorities ought to be particularly vigilant in respect of investment opportunities

that are floated around the country. Most Kenyans are obviously not investment savvy. In
Mwaka’s (2003) article, Investing is Simple Not Easy, he notes that when people have the notion
that a company is somewhat great is more likely to cause people to overpay for the stock than
anything else. Kenyans gambled and overpaid for stocks they did not know leave alone
understood. Some went as far as selling their livestock and even plots to buy stocks. All this
happened with an expectation to offload them in short order and realize enormous returns.
According to Opiyo (2009) those who are ready to venture into risky investments with good
return but are not willing to wait will burn their fingers. A lot of people did exactly that in the
aftermath of Safaricom stock mania. .

Currently, pyramid schemes may appear to be a benign cancer but can easily turn terminal to the
economy. As the government beefs up its efforts to realize a turn-around on the economy,
pyramid schemes would easily derail it all. Much of this anomaly can be associated to poor
government regulatory framework and rudimentary informational infrastructure. As Oluba
(2009) correctly points out, Africa is clearly very far behind the rest of the world with regard to
information and communication technology. Information is power and its absence can cause
major economic losses. It is therefore critical that public information flows are well developed
in order to minimize the probability of such huge loses.

The money invested in the pyramid schemes could be the money allocated by the government for
development projects. The government of Kenya has initiated several projects aimed at meeting
the 2030 vision. A stable economic environment works in favour of the poor who stand to lose
the most in periods of high inflation. All the projects proposed under vision 2030 will, therefore
be subjected to the parameters set under the macro- economic stability framework, as reviewed
on a continuous basis by the ministry of finance and the central bank of Kenya (GOK, 2007).

Despite the ambitions plans to transform Kenya into a world class economic hub, there is glaring
lack of financial strategy. Schwartz (1999), observes that, under normal conditions people prefer
to invest there money in the established organizations. Kenya is not currently undergoing normal
economic conditions – people can be easily persuaded to move money from conventional

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investment into a promoter’s harvest. The movement of money from conventional savings
facilities into losing schemes wills certainly compromise capital accumulation- the road map to
achieving vision 2030 will then be blurred.

People may be having power and the desire to save but the actual savings available depends upon
the facilities available to them for accumulating their savings. For maximization of savings, there
must be stability in the purchasing power of money. “A falling purchasing power is a great
discouragement for saving” (Chopra 1990). It is then incumbent upon the government to create
an enabling environment to encourage savings that can be mobilized into investments. One way
to achieve this is to stabilize prices of essential commodities, the temptation to move funds from
conventional investment institutions into poorly established informal sachems can be attributed
to people’s quest to make and meet due to upward spiraling prices.

Infrasture is crucial to the development of our country therefore investors can consider investing
in our infrastructure developments, especially in the construction of roads, rail, airports and
maritime ports, notes Ochola (2008). This is the kind of message which needs to be passed to the
general population. Favourable conditions should be created to persuade people to put money in
such developments initiatives rather than taking major risks by investing in pyramid schemes.
This way economic and social progress can become a reality resulting in desired results of
poverty reduction.

Although pyramid schemes in Kenya have disappeared from the limelight at least for the
moment, they may be in hiatus or taking a low profile. Given the vulnerability of the Kenyan
population, they, may be lurking somewhere ready to strike with a vengeance. Indeed there is a
litany of the so called Ponzi schemes. On the basis of the Albania case, Christopher states this:
The informal companies were initially regarded as benign and even as making an
important economic contribution. Operating alongside them, however, were
deposit taking companies that invested on their own account instead of making
loans. These companies were the ones that turned into pyramid schemes.

There is a myriad deposit taking saving and credit institutions in Kenya and many other micro
credit financial institutions. For most part, these are clearly legitimate institutions that encourage
savings and hence investments. They contribute a great deal to the government’s effort to reduce
poverty. Nevertheless, if Albania case is anything to go by, it is prudent that these institutions are
closely monitored and controlled. This will keep in check the possibility of them becoming
pyramid schemes.

“A true Ponzi scheme usually promotes what appears to be a real investment opportunities which
investors may contribute to without actually being an affiliate, distributor and so forth. A
pyramid scheme on the other hand, usually requires that participants make other people join the
scheme, at which point they will receive money” Kimaru (2008). In any case people lose money.
Pyramids come in many forms and shades. The promoters are always actively engaged in
coming up with new strategies to dupe authorities and the public about their legitimacy. It is

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therefore possible that pyramid schemes are alive and well. They are complex and difficult to
identify, more particularly to unsuspecting investor.
The general trend the world over however is that these activities are on the rise notwithstanding
the fact they are unsustainable at face value. What is even more interesting is that everyone is a
potential victim. This puzzling question of what the proliferation of these schemes says about us
as a people and our country goes beyond the other more specific inquiries typically obtainable
from the media and consumers regarding the legality or the details of operation of these frauds.

Lax enforcement of pyramid laws and political protection gained with campaign contributions
offer some explanation for the pyramids' spread. Hard times, rising consumer debt, downsizing
and general job insecurity undoubtedly account for some of the motives of participants. And
clever disguises of the pyramids as "direct selling" businesses, gifting clubs and voluntary
investment groups are also valid factors for their continuation.

But these answers are still unsatisfying. Millions of Kenyans could not all be so naïve.
Government regulators are not all so corrupted or inept. And the tens of thousands in each city
who join the scams are not so economically distressed that they must forsake conventional ethics
and values just to survive. Something more is at work in Kenya and other vulnerable states that
contributes to this massive breakdown in ethics, values, personal responsibility and common
sense.

According to report of the Taskforce on Pyramid Schemes, 148,784 investors registered as

having invested a total sum of Ksh8, 178,737,402 in a variety of pyramid schemes. This figure
reflects the principal amount invested and does not include the expected returns. The figure
however is not conclusive since the investors were still presenting themselves for registration
after the closure of the exercise. Besides, a substantial number of the victims were too
embarrassed to volunteer for registration. The task force recorded a long list of diverse pyramid
schemes that succeeded to rob gullible Kenyans and leave them in dire economic straits.

Conclusions

Based on the foregoing analysis and discussion of pyramid schemes, it is safe to make the
following conclusions.
• Pyramid schemes are widespread and old trade that traverses traditional values and
fundamental ethics of financial investment.
• Pyramid schemes can have catastrophic effect on national economy if unchecked.
• The number of people who fall victim of the pyramid schemes is big enough to devastate
the national economy.
• There is dangerous laxity within government agencies in enforcing securities and
exchange laws albeit they are weak.
• The potential for civil disobedience in the event of widespread pyramid schemes
activities is real and this may destabilize government functions and threaten national
security as witnessed in Albania.
• Pyramid schemes do not add value to investors as money is mopped up from lower layers
of the hierarchy to unjustly enrich a few people at the top of the pyramid.

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Recommendations
As evidenced from the foregoing discussion and analysis, it is very difficult for the victims of
the schemes to seek and obtain justice from a court of law in Kenya. The government should
therefore legislate on pyramid schemes to provide a regulatory framework and redress process
for victims. The law should provide deterrent penalties for establishing and operating such
pyramid schemes. It is also clear that the majority of the population is not familiar with potential
risks involved in investing in these schemes. In effect, the government should establish and
implement information networks to educate people on the dangers and adverse economic effects
of engaging in these frivolous investment schemes. More importantly, it does seem that Kenyans
have strong will and power to invest in gainful security instruments. It is therefore fundamental
to point out legitimate security instruments in which people can invest their money with minimal
risk although returns will be relatively modest. In light of all these, the government should make
sure proper enforcement structures are in place.

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