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10-1 The Case (for and) against Multi-level Marketing By Jon M. Taylor, MBA, Ph.D., Consumer Awareness Institute Chapter 10: LEGAL AND REGULATORY ISSUES – When is an MLM (multi-level marketing program) a fraudulent business opportunity? Or an illegal pyramid scheme? Are all MLMs technically illegal? What are the most significant legal precedents for MLM cases? Where are the regulators in all this? PREFACE manifested in hundreds of MLM programs currently operating, and – by extension – in Let me begin by admitting I am not an thousands of defunct and future MLMs. attorney and make no pretense about this Substantial evidence for these flaws has being an exhaustive legal treatise on this been summarized. New evidence is also thorny issue. I am a qualified business presented in this book for the first time. analyst, teacher, and entrepreneur-turned Secondly, this book demonstrates that consumer advocate. This career change the degree of unfairness and deceit of MLM came after witnessing what I believe to be as an industry, as well as harm to the most unfair, deceptive, viral, and participants, strongly suggests that MLM is as predatory business practice ever foisted on bad as or worse than any classic, no-product unsuspecting home-based business pyramid scheme. At least, if MLMs were opportunity seekers (and many victims who classified as pyramid schemes, they would be 1 were not seeking anything) – most of whom illegal per se, according to FTC guidelines. had no idea how damaging to their personal Though it is not my primary objective in and financial well-being it can be to commit this book to prove that any given MLM is an 2 to an MLM program. illegal pyramid scheme, it is relevant to When I have consulted with attorneys know whether or not an MLM displays the and/or acted as expert witness in MLM characteristics of a recruitment-driven MLM, cases, I have found it necessary to focus on or what I would label a ―product-based legal precedents for much of my analyses. pyramid scheme‖ because such a model And of course, attorneys must constantly leads to horrendous loss rates among 3 focus on the law and its interpretation, participants. Where data has become regardless of what logic and research may available, 99.6-99.9% of MLM participants 4 suggest. lose money, assuming at least somewhat However, as a consumer advocate and realistic estimates of attrition, incentivized educator, I try to be guided by solid logic purchases, and minimum operating 5 and by research and feedback that I have expenses are factored into the analysis. received from victims and their families worldwide. It is frustrating to those of us © 2011 Jon M. Taylor working for consumer protection to find laws and regulatory actions and rules to be so 1 Letter from Robert Frisby of the FTC, citing section inadequate to meet the needs of vulnerable 5(a)(1) of the Federal Trade Commission Act, 15 consumers. But we do the best we can. In U.S.C. 45 (a)(1). See also Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975) this chapter, I hope to strike a balance 2 Again, I am a business analyst and consumer between the legal issues and the economic advocate, not an attorney and social issues. 3 A more complete discussion of re-pyramiding and The chapters leading up to this one how major MLMs manage to avoid market collapse and endure for decades is found in Chapter 3. serve a dual purpose: First, I have 4 See Chapter 7. Similar results were also reported in attempted to thoroughly analyze and ―The Myth of ‗Income Opportunity‘ in Multi-level expose the inherent flaws in multi-level Marketing,‖ by Robert FitzPatrick, Pyramid Scheme marketing as a business model and as Alert, 2008. 5 See Chapter 7. 10-2 I will in this chapter attempt to LESSONS FROM LANDMARK CASES 10-23 summarize some of the more significant The Koscot precedent statutes, court decisions, and agency rules FTC v. Amway: the 1979 decision that and communications that have been and facilitated the proliferation of could be used in arguing and deciding the product-based pyramid schemes Webster v. Omnitrition challenges merits of one side or the other. I will also ―personal use‖ share observations that I and other Fortuna Alliance, Jewelway, and World Class consumer advocates firmly believe deserve Network: FTC formulating criteria for diligent attention by federal and state Business Opportunity Rule review regulators. It is my hope that this chapter, In 2000, Equinox Int‘l settled with FTC and along with those preceding it, will also eight states, for nearly $40 million in provide information that will be useful for restitution for victims business scholars, media investigative Bigsmart pyramid promoters settle reporters, consumer awareness groups, and The FTC finds 96% of Skybiz participants consumers themselves. lose money George W. Bush rewards his Amway supporters with very little action against MLMs from 2001 to 2008. Blame it all on Amway Chapter contents Other significant regulatory actions Page no. Private or class actions PREFACE 10-1 CURRENT DEVELOPMENTS 10-38 INTRODUCTION: 10-3 Compliance by MLMs with federal and A brief history of pyramid schemes & of MLM state laws are questionable at best. The FTC fails to protect against MLM KEY LEGAL & REGULATORY ISSUES 10-6 as an unfair and deceptive practice. As an endless chain recruitment model, Worldwide expansion of an unfair and MLM is fundamentally flawed. deceptive practice – MLM MLMs vs. pyramid schemes – a distinction without a difference CONCLUSIONS 10-43 Causative and defining characteristics of recruitment-driven MLMs, or product- RECOMMENDED READING AND 10-44 based pyramid schemes ANNOTATED WEB SITES: MLM as simple fraud – or as systemic fraud Complaint-based regulation does not APPENDIX control MLM abuse. 10A: Prohibitions and Restrictions by 10-45 Consumer awareness vs. consumer Federal Agencies and Statutes protective legislation in the 50 States The DSA/MLM cartel 10B: State and Local Provisions 10-49 Are MLM participants employees – or Prohibiting Unfair and/or Deceptive independent contractors? Trade Practices MLM‘s terrible problem – legal indentity 10C: Statement on pyramid schemes 10-54 Political considerations by Debra A. Valentine, FTC General Counsel KEY STATUTES, RULINGS, AND 10D: Some important MLM cases 10-61 COMMUNICATIONS 10-17 10E: How to Start a Pyramid Scheme 10-72 Efforts of states to confront pyramid that Is Very Profitable for the schemes and MLM abuse Founders – and Get Away with It The FTC‘s protection of consumers from 10F: My comments on FTC‘S RPBOR 10-75 MLM as an ―unfair and deceptive Workshop June 1, 2009 practice‖ is crucial – but not happening. Important FTC communications 10-3 INTRODUCTION: A brief history a huge one—the possibilities in a pyramid were almost limitless as new subscribers of pyramid schemes and of feed those who joined before. MLM Furthermore, the machinery of the pyramid is always explained and is, in fact, I will not attempt to provide here a one of its alluring features, whereas Ponzi thorough history of MLM (multi-level plans invariably refer obscurely to exotic investments that are really irrelevant and marketing) or analysis of all the problems usually nonexistent. In some cases the with MLM (or what I like to call product- pyramid seems almost acceptable socially, based pyramid schemes) but merely my as in the cases of chain letters or observations as a qualified consumer distributorship plans, but there has never advocate and business analyst. The history been any question about the vice of Ponzi of pyramid schemes in this country is schemes.‖6 interesting, as you will see from the brief sketch below: “Pay-to-play” chain letters. Later came chain letters, beginning with the Ponzi schemes. When Charles Ponzi ―send-a-dime‖ letter widely appearing in organized the Securities Exchange Denver in 1935, which bore the heading Company in Boston in 1919 and issued ―Prosperity Club‖ and the slogan ―In God promissory notes payable in 90 days with We Trust‖ This led to the $1 chain letter in 50 percent interest, he kicked off a storm of Omaha, chain letter agencies or ―factories, investment frenzy which duped just about and the ―Circle of Gold‖ which spread from everyone, including politicians, law California throughout the country in the late enforcement officers, and reporters. He 1970‘s – all of which used the postal tricked speculators by using the money of system. Participants would send a dollar to new investors to pay old investors huge the person at the top of a list of names that ‗profits.‘ was mailed to you, add their name to the Ponzi took in over $15 million from this bottom of the list, and then mail copies of and other schemes before his house of the letter to persons they know with cards collapsed, causing losses for instructions to do the same. thousands and leading to jail time and his Many of these chain letters went eventual deportation to Italy in 1934. underground because of aggressive Incidentally, there were similar schemes enforcement of federal mail fraud statutes. prior to Ponzi (for example, John Law‘s Still other variations, such as chart and ―Mississippi Bubble‖ scheme in France in airplane games, emerged later. 1719 and William Franklin Miller‘s Franklin Another variation appeared about the Syndicate in 1899—a.k.a. ―520 percent time the Internet was launched. What I call Miller‖), but the Ponzi name stuck for this ―report chains‖ encouraged you to buy type of phenomena. reports listed on a list of names with Some consider Ponzi schemes as addresses and then mail a report on separate and distinct from pyramid anything of interest and add your name to schemes, but as one writer observed, the bottom before mailing it to your list of contacts.
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