specifically address pyramid
schemes, such schemes have
been deemed unlawful under the
above clause in the Federal Trade
Commission Act (Section 5).
Inadequate legal definitions. Most of the laws and statutes were crafted before the structure, dynamics, and effects of product- based pyramid schemes were fully understood, so the
definitions within anti-pyramid
statutes do not accurately reflect the root causes of the problems. They tend to focus on
behavior of participants, rather than on objective underlying structural features.
However, there is enough validity in the present legal definitions of pyramid schemes in most jurisdictions that enforcement against such schemes can be effective if the principles in this paper are understood and applied. This is true regardless of the complexity of the compensation plan of any given MLM.
FTC guidelines and most state statutes include a key element in defining pyramid schemes – the payment of money by the company in return for the right to recruit other participants into the scheme. If the primary emphasis is compensation from recruiting, rather than from the sale of products to end users, it is considered a pyramid scheme. How such primary emphasis is to be determined has until now been a formidable challenge for investigators.
Persons investigating MLM must understand compensation plans and why they are so important. Decades ago, psychologists experimenting with both animals and people learned that you get the behavior you reward. For example, if you place a dog in a room with two bowls, the first containing a pound of beef, and the second an ounce of dry dog food, invariably the dog will choose to eat from the first bowl.
You get the behavior you reward.
Similarly, since an MLM compensation plan specifies how participants are rewarded, it reveals whether the primary income emphasis is on recruiting or on retailing – and therefore, whether or not a given MLM is a disguised pyramid scheme.
MLM spokesmen maneuver to divert authorities from examining how participants are rewarded. They speak of the validity of a company’s products, the integrity of its leaders, and the company’s solid financial condition. It seems that the one thing MLM leaders do not want regulators to understand – the compensation plan – is the one thing investigators must grasp in order to answer the question of where the emphasis is – on company payout resulting primarily from recruiting (or product sales to recruits), or primarily from retailing to consumers outside of the MLM’s network of participants.
The problem of evaluating MLM programs is further complicated by a wide array of complex MLM payout formulas, or compensation plans. The problem of identifying emphasis on recruiting vs. retailing in a compensation plan, as well as consumer harm, can be greatly simplified by understanding the four characteristics discussed below – commonalities which are generic to all MLMs, or product-based pyramid schemes. (There is also a fifth characteristic that appears in almost all MLMs which amplifies the fourth characteristic.)
MLM compensation plans can get quite complex. Appendix A illustrates just two examples out of hundreds of MLM compensation plans, showing the complexity of only a portion of a typical MLM compensation plan. Many of the plans are far more extensive and complex than these. This makes it difficult to compare plans from different MLMs. These widely varying plans also illustrate the need for an understanding of the commonalities and distinguishing features that separate MLM from all other forms of business activity.
What is the difference between recruitment-driven MLMs and (hypothetical) retail-focused MLMs? Companies with all four of the following characteristics of a product-based pyramid scheme can be classified as recruitment- driven MLMs, as differentiated from hypothetical retail-focused MLMs, which would primarily reward those who sell products. In reality, MLMs (with the exception of some party plans) are essentially closed systems, which sell products at retail primarily to program participants and cooperating family members – seldom to the general public.
These product purchases could be considered disguised or laundered investments in a product-based pyramid scheme. TOPPs (top-of-the-pyramid promoters), founders, and company executives are rewarded at the expense of a revolving door of unwitting recruits.
How these defining characteristics were derived. Eighteen years of research and feedback confirm this analysis, including a one-year experiential test, direct observa- tions of numerous MLM opportunity meetings, communications with thousands of participants (and ex-participants) and executives from a variety of MLMs – and with consumers as MLM prospects, consultations with top MLM experts and attorneys, the collection and processing of available data (including official company reports), analysis of over 500 MLMs with all types of compensation plans, and surveys of tax professionals.
In the early stages of my research, after months of comparative analysis, I was able to identify a list of characteristics that are common to all MLMs, including the 400 MLMs I have since analyzed. These were compared to characteristics of no-product
pyramid schemes – as well as to legitimate business models to which MLM is often compared, such as direct sales, franchises, distributorships, insurance agencies, etc. (See Appendix 2F for details of this analysis.)
From this comparative analysis, a trained eye can see that when one focuses on the causes of the problems with highly leveraged MLMs, which are compensation plans with perverse reward features (enriching a few at the top at the expense of a huge downline who lose money), certain characteristics, or “red flags,” become apparent. Amazingly, four key characteristics are both causative (causing high loss rates) and defining (clearly distinguishing pyramid schemes from legitimate businesses). I’ll refer to these causative and defining characteristics as “CDCs.” (For terms used in describing MLM compensation plans, see Appendix 2B. See Appendix 2C for additional terms related to MLM.)
The four characteristics (CDCs) of recruitment-driven MLMs, are causal, defining, and legally significant. The set of four characteristics below were found to be exclusive to recruitment-driven MLMs (which included all MLMs in my sample of 400 programs). Based on careful analysis of available data, MLM programs with all of these characteristics have a shocking loss rate – approximately 99.6%26 of ALL
participants lose money (after subtracting ALL expenses)! – not a legitimate business by any reasonable measure.
In the light of these odds, typical promises made by MLM promoters of lucrative incomes are misleading, except for a few at the top of the pyramid who got in early.
Again, it is important to recognize that – These four characteristics are causal because they identify the cause of the harm or consumer losses. They are defining because they
clearly separate what I call “recruitment-driven MLMs” or product- based pyramid schemes from all other forms of commercial activity.
26 See Chapter 7: “MLMs Abysmal Numbers”