Regulators and businesses are actively combating the growing manifestations of fraud and financial crimes. Fintech expert Sergey Kondratenko reports that the most common types are scam projects and pyramids, which investors most often fall for. According to his view, the development of digital banking and the acceleration of digital payments contribute to financial fraud.
According to a PYMNTS study in 2022, the number of financial institutions that have encountered an increase in fraud cases rose by 43%. The average cost of fraud cases for financial organisations with assets over $5 billion increased by 65% – from $2.3 million to $3.8 million in 2023.
In response, financial institutions and companies are stepping up their efforts to find ways to counter the increase in fraudulent operations and, consequently, financial losses.
Sergey Kondratenko: Characteristics of Financial Pyramids and Their Schemes
A financial pyramid is a business strategy characterised by an unstable organisational model. In such a model, profit is generated not from selling real goods or services but from the investments of new participants.
“The feature of a financial pyramid is that new participants must make an upfront payment to join the system,” explains Sergey Kondratenko. “The funds received from them are used to pay profits to the first investors. In return, newcomers are promised a profit if they can attract even more participants to the system.”
However, such a scheme is very fragile and often does not last long. Profits are generated not from real economic activity but from attracting new investments.
It should be noted that each financial pyramid has its unique structure, principles, and methods of attracting new participants. Sergey Kondratenko proposes to consider the main schemes of financial pyramids and the principle of their operation.
A single-level pyramid represents the simplest scheme, the so-called Ponzi scheme. Here, the organiser issues securities without real backing and attracts investors. At the same time, he pays income to the first ones at the expense of funds from new participants. However, such a scheme will collapse when the promised profit is insufficient for all investors.
A multi-level pyramid is already more complex and involves attracting new participants not only to invest but also to invite others. The more levels, the more profitable those at the top become. However, with the decrease in the number of potential newcomers, such a pyramid is doomed to collapse.
The eight-ball model represents an attempt to circumvent established stereotypes and hide the pyramidal nature of the scheme. Here, each participant is only required to attract two new clients, which seems easier and more accessible but still maintains a pyramidal structure.
The matrix scheme, in Sergey Kondratenko’s view, is even more complex and involves forming cells with a certain number of participants who then move up to new levels. They do this by attracting new clients and receiving bonuses.
Sergey Kondratenko: Concept and Signs of Financial Fraud in Corporate Companies
Fraud in a corporate company is the theft of an organisation’s assets or the distortion of financial statements with the purpose of deceiving so-called stakeholders. According to Sergey Kondratenko, stakeholders are people or organisations whose interests are linked to the success of the company.
Typically, these include investors and owners, i.e., those who have invested their funds in the company hoping for future profit.
A fraudulent pyramid can infiltrate a corporate company in various ways, often masquerading as legitimate investment opportunities or business models. Here are a few ways this can happen:
1. Offer of “internal investments”: Employees or managers may offer colleagues to invest in a project within the company, which is actually a pyramid. This can be disguised as a corporate project or startup.
2. Partnerships with external companies: The company may partner with external organisations that manage pyramid schemes. These organisations may present their activity as a lucrative investment proposition or innovative business project.
3. Employee incentive programs: Pyramid schemes can be integrated into employee incentive programs where employees receive a reward for bringing new members (colleagues) into the scheme.
4. Seminars and training: Organising training or motivational seminars, which are actually a means to spread pyramid schemes among employees.
5. Disguise under corporate training or development: Offers “unique” opportunities for personal or professional development that require employees’ investments but are actually based on a pyramid model.
The expert explains that corporate fraud is usually committed by company employees and primarily harms the company and its owners. These actions involve false information, abuse of trust, and exceeding authority.
Where the risk of corporate fraud is highest:
1. Investment projects. This sector is often associated with high risks of fraud due to large investment volumes and project complexity. Fraud can occur at the project evaluation stage, with dishonest risk assessment or abuse of power in decision-making.
2. Capital construction. Here, too, there is a high risk of fraud, especially through the inflation of the cost of materials and work, as well as through fake contracts. Corruption and bribery are also common in this area.
3. Cash financial operations. Cash transactions are one of the most vulnerable directions for fraud, as they are the hardest to track and control.
4. Procurement and supply. The risk of fraud in this area includes not only corruption and bribery but also manipulations of the cost of goods and services, as well as the creation of fictitious suppliers.
5. Sales. In this area, the risks of fraud include false representation of products or services and the use of fraudulent schemes to increase sales or commissions.
6. Charity (non-governmental organisations). Despite the noble goals, this sector is also prone to risks related to the improper use of funds, fictitious programs, and abuse of donors’ trust.
Each of these sectors requires specific precautions and controls to minimise the risks of fraud. Assessment and management of these risks must be based on thorough analysis and the implementation of appropriate verification mechanisms and transparency systems.
Sergey Kondratenko believes that corporate fraud poses a serious threat, especially for large companies.
Ponzi scheme: features and principle of operation – Sergey Kondratenko
As the expert notes, the name ‘Ponzi scheme’ comes from the name of Charles Ponzi, who, in the early 20s of the XX century, became famous for using a similar fraudulent scheme.
“A Ponzi scheme is a type of financial fraud in which attackers deceive investors. They promise depositors high returns or payouts that are actually provided by new participants brought into the system. However, these payouts are not provided by actual revenues or profits but depend on money from new participants. This allows the scheme to continue to operate and attract new investors until the flow of new money no longer covers the payouts to the old participants. This eventually leads to the collapse of the whole scheme,” explains Sergey Kondratenko.
The mechanism of a Ponzi scheme can be outlined in the following sequence:
1. Registering the platform and attracting the first clients.
2. Continued search for new victims.
3. Reinvestment of income.
4. Termination of payments.
That is a fraudulent campaign that operates as a Ponzi scheme. It continues its activities as long as it manages to maintain the appearance of a stable business. As soon as clients stop investing money, the swindlers withdraw the funds already invested and launch a new project. The original company closes down, and it becomes almost impossible to recover the funds.
Sergey Kondratenko on the crypto-pyramid model
A crypto-pyramid is a fraudulent investment scheme where income is paid to current investors from funds from new participants.
According to Sergey Kondratenko, it was named ‘pyramid’ because there are usually a large number of new participants at the bottom of the hierarchy, with each subsequent level containing fewer investors.
To understand the crypto-pyramid model, the expert gives the following example:
Project-Y creates a crypto-pyramid and offers five people to invest 1 bitcoin each. He promises to return 2 bitcoins to each participant every month. Project-Y needs 10 bitcoins to fulfil his promise, so he enlists five or more other people whose investment will ensure that the first pool of investors is paid back. This forms the second pyramid level, where five more people contribute 1 bitcoin each.
Now Project-Y can pay out the first tier with 2 bitcoins each, but it is still 10 bitcoins short. So, it invites more people, creates a third tier, and so on.
Sergey Kondratenko emphasises that this process continues until the search for new investors becomes impossible and the scheme collapses. A similar ending awaits all financial fraud schemes that operate on the pyramid principle. They all lead to the loss of participants’ money and the collapse of the project.
Investors need to be particularly vigilant to avoid investing in scam projects and pyramid schemes, which can lead to significant financial losses. It is important to carefully analyse and verify the legitimacy of projects, studying their history, the reputation of the organisers and the reality of the promised income. Projects that offer unusually high returns in a short period of time should be avoided, as this is often a sign of fraud. It is always a good idea to consult financial experts and use information from reliable sources. Investing should be based on transparency and prudence to protect your assets from fraudulent schemes.
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