CONSUMER AWARENESS INSTITUTE

MULTI-LEVEL MARKETING UNMASKED*

Prefatory pages, Introduction, and Chapters 1-2

By Jon M. Taylor, MBA, Ph.D.

*Formerly titled THE CASE AGAINST MULTI-LEVEL MARKETING – AN UNFAIR AND DECEPTIVE PRACTICE

The most thorough guide to understanding MLM (multi-level marketing) ever published – MLM’s appeal, its unique features and inherent flaws, its deceptions and devastating effects, its culpability to federal and state laws, and needed regulatory reforms. The book also explores key legal cases and answers the most frequently asked questions – all based on 20 years research, worldwide feedback, consultation with top experts, and analysis of over 500 MLMs by a qualified analyst. For federal and state regulators, legislators, attorneys, consumer advocates, financial advisors, researchers, educators, the media, and consumers.

© 2014 Jon M. Taylor, Consumer Awareness Institute Earlier versions under similar titles: The Case Against Multi-level Marketing and Unfair and Deceptive Practice, copyrighted in 2013 and The Case (for and) Against Multi-level Marketing copyrighted in 2011 and 2012

Info-graphics by Alan Connell and Jon Taylor Cartoons by Cal Grondahl and Kristopher Taylor Printed in the USA

How to obtain copies: Download digital copies from mlm-thetruth.com For hard copies, contact Jon Taylor directly: Email – [email protected] Telephone – (801) 671-1870

ACKNOWLEDGEMENTS

My thanks go to scores of committed consumer advocates, government officials, attorneys, media representatives, investment advisors, educators, former MLM (multi-level marketing) victims and participants, web designers, and persons who have shared their experiences and feedback from countries all over the world. I want to give special recognition and thanks to my wife, JoAnn, who – after tolerating my MLM involvement for a year – challenged me to make a decision between her and a prominent MLM – which started me on this quest for the truth about MLMs, or product-based pyramid schemes.

LEGAL DISCLAIMER

These opinions, calculations, analyses, and reports are intended purely to communicate information in accordance with the right of free speech. They do not constitute legal or tax advice. Anyone seeking such advice should consult a competent professional who has expertise on endless chain or pyramid selling schemes (MLMs). Readers are invited to validate the author’s research using the analytical tools provided. Readers are also advised to obey all applicable laws, whether or not enforced in their area. Neither the Consumer Awareness Institute nor the author assumes any responsibility for the consequences of anyone acting according to this information.

TABLE OF CONTENTS

NOTE: To allow for updates, pages are numbered separately within each chapter. Each chapter begins with a descriptive table of contents. Number of pages PREFACE – and endorsements SUMMARY OF FINDINGS ABOUT MLM 4 INTRODUCTION – Summary of research, the powerful appeal of MLM, the need for this investigation, and questions to be answered 6 Chapter 1: MLM UNDER THE MICROSCOPE, Why and how the research upon which this report is based was undertaken, and why the author can speak with authority on the subject 10 Chapter 2: MLM DEFINITIONS AND LEGITIMACY – What MLM is and is not – and the difference – if any – between MLM and pyramid schemes (includes 34 pages of appendices) 74 Chapter 3: MARKET SATURATION AND COLLAPSE – MLMs fundamental flaws, and how MLMs exploit and skirt these flaws in their systems – primarily by re-pyramiding (includes 8-page appendix) 20

Chapter 4: PRODUCTS AND PRICES – Questionable MLM product claims – and overpriced products 10 Chapter 5: RECRUITING A DOWNLINE – Why the emphasis in company communications is on selling, while in practice the emphasis is on recruiting – and what it costs to successfully recruit a downline in Nu Skin and other MLMs 8 Chapter 6: ATTRITION RATES OF MLM PARTICIPANTS – Why few recruits stay, and why it matters 6 Chapter 7: MLM'S ABYSMAL NUMBERS – What the data show about the lack of profitability of MLMs as bogus “business” or “income opportunities” (includes 13 pages of appendices) 56 Chapter 8: MLM - A LITANY OF MISREPRESENTATIONS – MLM as a composite lie (includes 34 pages of appendices) 40 Chapter 9: VILLAINS AND VICTIMS – Who are they? (includes 27 pages of appendices) 37 Chapter 10: IS MLM LEGAL? When is an MLM a fraudulent business opportunity? Or an illegal pyramid scheme? Are all MLMs technically illegal? What are the most significant legal precedents for MLM cases? (80 pages of appendices, including state laws relating to MLM, and $10,000 “unfair and deceptive practices” challenge) 110 Chapter 11: WHERE IS LAW ENFORCEMENT IN ALL THIS? Consumers, investors, the media, and others deserve an answer for blatant inaction by law enforcement – and why victims seldom file formal complaints (includes 17 pages of appendices) 39 Chapter 12: IS MLM A MORAL AND ETHICAL BUSINESS? A terse answer 4 Chapter 13: ACTIONS NEEDED – To recover losses and to prevent harm to consumers (includes 8 pages of appendices) – 15 FINAL CONCLUSIONS for the book

3

PREFACE

This book – and the research behind it – is intended to meet the need for a thorough analysis of the business model called multi-level marketing (MLM – a.k.a. “network marketing”) and its embodiment in the emergence of hundreds of MLM programs (MLMs). Worldwide, tens of thousands of consumers are approached daily with promises of income and independence from joining one of these MLMs. From the research reported here I conclude that tens of millions of consumers lose tens of billions of dollars every year.

At the outset it should be noted that Multi-level Marketing Unmasked is not strictly a report of legal arguments against any MLM, although attorneys and law enforcement officials should find it invaluable in building their cases.

I am writing from the perspective of a qualified business analyst, consumer advocate, instructor in entrepreneurship, management, and ethics, and experienced entrepreneur and salesman. Since I am not an attorney, when commenting on legal matters I have been careful to consult with qualified legal counsel and/or experts with extensive law enforcement experience.

While I have made tedious efforts to edit the report for errors, I do not claim that it is perfect or free for any errors in grammar, spelling, and other minor problems. I supplied descriptive tables of contents for easy reference, but with their detail, there may be some mistakes. Hopefully, the reader will see beyond these and acknowledge the value of the important research reported herein.

Letter of endorsement from Bruce Craig, who litigated some early pyramid scheme cases:

RE: the book MULTI-LEVEL MARKETING UNMASKED (revised title1), and the separate report titled REGULATORY CAPTURE: The FTC’s Flawed Business Opportunity Rule

Dear Dr. Taylor:

As an Assistant Attorney General with the State of Wisconsin (1967- 1997) I litigated a number of pyramid cases and drafted Wisconsin's prohibition of 'Chain Distributor Schemes'. Since retiring, I have been active in attempting to obtain a meaningful regulatory response to these highly destructive schemes. These efforts include a number of contacts with the Federal Trade Commission, the agency primarily responsible for regulation in this area. For at least the past eight years I have been in frequent contact with you, and others, on this topic. I think it would be fair to say that the FTC has been less than effective in dealing with this problem, culminating in its exemption of Multi-level Marketing from the recently enacted Business Opportunity Rule. Your two publications reflect an impressive body of research on this topic, detailed analyses of actual profitability and the mechanics of these plans, considerable and extensive efforts to communicate your concerns to the Commission and other interested parties, and a thoughtful effort to communicate with those contemplating joining these plans. Further, the publications represent a detailed repository of existing pyramid legislation, earnings, evaluations of a large number of multi-level companies, the many legal cases dealing with this subject, explanations of the mechanics of these plans, and detailed communications by interested parties on the subject of effective regulation by the Federal Trade Commission. The comment on 'Regulatory Capture' is compelling and thoroughly documented. You are to be complimented on these efforts. They fill the considerable need for a single source of virtually all information on this subject. I would recommend that those interested in these documents download them from your website, as they contain a number of active hyperlinks to the extensive documentary record involved.

Sincerely,

Bruce A. Craig, former Assistant Attorney General for Wisconsin

1 Originally The Case (for and) against Multi-level Marketing, originally published in 2011

Praise from other MLM experts:

Kudos to Dr. Taylor for shining the light of truth into every nook and cranny of network marketing. Prudent readers should conclude that if the so-called "MLM business opportunity" were presented honestly, no one would buy into it.

– Stephen Barrett, M.D., sponsor, Quackwatch.org and MLMwatch.org

A truly remarkable and comprehensive resource for consumers, lawyers, legislators and regulators. I am particularly impressed with the detailed comparison of state anti-pyramid scheme laws, and the collection of many other legal materials. . . you have done a beautiful job in organizing and presenting it in a methodical fashion. I cannot imagine anyone reading this and coming to any conclusion other than that MLM is a monumental fraud. This book is truly a legacy of which you must be very proud. As I have said before, in the MLM world you are “the voice of one crying in the wilderness.”

– From letter to Jon Taylor from Douglas M. Brooks, a Boston attorney who has tried many MLM cases

NOTE: Both the methodology and calculations in my research were validated by five financial experts – See Appendix 7A at the end of Chapter 7 (“MLMs Abysmal Numbers”)

SUMMARY OF FINDINGS ABOUT MLM (MULTI-LEVEL MARKETING)

By Jon M. Taylor, MBA, Ph.D., Consumer Awareness Institute

My preparation for this book includes As a business model, is MLM legal (but is not limited to) the following: and ethical?2

 MBA with 2 years study in statistics, 1. MLMs depend on unlimited recruitment economics, accounting, and finance of a network of endless chains of  PhD in applied psychology, including participants. behavioral incentives 2. Participants secure and advance to  A review of thousands of pages of ranks or positions in a pyramid research on MLM and home business (“downline”) of participants based on opportunities timing and recruitment, rather than on  Involvement in 48 home business merit or appointment. startups, including several sales 3. As endless entrepreneurial chains, or oriented businesses “opportunity” recruitment schemes,  20 years of worldwide feedback MLMs assume an infinite market, which  Review of applicable federal and state laws does not exist in the real world. They also  One-year test of Nu Skin program, assume virgin markets, which don’t exist followed by publication of the book The for long. They would be doomed to Network Marketing Game eventual market saturation and collapse,  Analysis of the compensation plans of except that some avoid this by over 500 MLMs (MLM programs) expanding (“re-pyramiding”) to other countries and/or through the same With all this background, I come to the markets with new product offerings. conclusions below in answer to key 4. Therefore, as endless chains, MLMs are questions about MLM. inherently flawed, unfair, and deceptive – profitable primarily for those positioned at or near the top of the What is the appeal of multi-level hierarchy of participants, which I call marketing? “TOPPs” (top-of-the-pyramid promoters)

1. The “easy money” appeal of MLM is – who are often the first ones in the often couched in terms such as “time endless chains of recruitment. New freedom” (to do what you want), recruits are being sold a ticket on a flight perpetual or “residual income” (like that has already left the ground. author’s royalties or annuities), and 5. Worldwide feedback suggests that “unlimited income possibilities,” with the MLMs can be extremely viral and success of recruits limited only by their predatory. As endless chains, MLMs efforts. quickly spread from state to state and 2. MLMs are often sold as a viable often to vulnerable foreign markets. As a alternative to an unfavorable job market result, they are far more prevalent than and as a better route to retirement than legitimate business opportunities. traditional plans. 6. I have challenged any one to identify any 3. MLM programs typically sell “pills, “business opportunity” that is systemically potions, and lotions” or other products more unfair and deceptive, and more viral that are consumable, that have unique and predatory than MLM. No one has met appeal, and that can be claimed to the challenge. deliver benefits not available elsewhere. 7. MLMs typically finance their operations 4. One sees a strong sense of belonging, from purchases by participants who are or an “us versus them” cultish mentality. incentivized to buy overpriced products to

2 For a thorough analysis of what separates MLM from other business models, read Chapter 2.

qualify for commissions and for “rank commissions decreasing at each advancement” (to advance to higher levels higher rank level. in the pyramid of participants). With the c) The number of levels on which exception of some party plans, the majority commissions can be paid would be of sales are typically to participants. limited to four (the maximum needed 8. Typically, MLM products are unique to manage any standard sales (making it difficult to compare with function, including branch, division, competing products), consumable (to regional, and national managers). encourage repeat purchases), and Unfair features of breakage and priced higher than products sold highly leveraged breakaway elsewhere (to pay commissions on programs would be banned. many levels of participants). d) There would be no minimum 9. In MLMs, most of the commissions are ongoing purchase requirements to paid to those at or near the top levels in qualify for commissions or rank the hierarchy of participants (TOPPs). It advancement. is this extreme concentration of commissions paid to TOPPs that Unfortunately, to my knowledge, none of motivates them to recruit tirelessly to the MLM founders have taken such steps to expand downlines, thereby assuring not achieve honesty and fairness. (See "What only their outsized income, but the would a good MLM look like" in Chapter 2) MLM’s survival and growth. Continual 13. The villain in MLM abuse is not so much recruitment is needed also to replace the leaders as a flawed system built on dropouts, due to high failure rates. unlimited recruitment of endless chains 10. Relative vertical equality3 in commission of participants as primary customers. structure – which appears benign – MLMs enable the transfer of money results in extreme inequality in from a rapidly churning supply of new distribution of income to participants. recruits to TOPPs, founders, and the This extreme inequality is further proof company itself. that MLM qualifies as an unfair and 14. MLM promises what it cannot deliver. To deceptive practice, which the FTC and be successful, MLM promoters depend on Attorneys General of the 50 states a litany of deceptions, including much self- should be actively combatting. deception. Misrepresentations regarding products, income potential, and legitimacy 11. Most MLMs become even more top- 5 weighted with five or more layers in their are commonplace in MLM. compensation plans – more than are Based on the foregoing and on the functionally justified. research discussed below, if asked if MLM 12. Some have asked if it is possible to is a moral or ethical business model, I would design an MLM that is honest and fair to 6 have to answer “no!” all participants. To accomplish this MLM is clearly an unfair and deceptive would require major adjustments, such practice and should be illegal under Section as the following: 5 of the FTC Act, as well as state statutes a) Commissions would be paid only on that mandate against unfair and deceptive sales to non-participants – and no acts or practices (UDAP). Some states also overrides or commissions paid for 7 have laws against endless chains, and purchases of downline participants.4 MLMs clearly violate these. However, the b) For each sale, over 50% of total Direct Selling Association (DSA) and the commissions and bonuses paid by MLM industry, has lobbied successfully for the company would be paid to the weakening of laws and rules that could offer front-line person who sells the some protection for consumers. products, with amount of

3 See Chapter 7 for a discussion of “relative vertical 5 See Chapter 8 equality in commission structure” – and its effects 6 See Chapter 12 4 See Omnitrition case in Chapter 10.. 7 See Appendixes 10B and 10F in Chapter 10

What are the effects of MLM on having to comply with its Business participants and on society? Opportunity Rule, the market for legitimate non-MLM direct selling and other business 1. Based on available company data, opportunities could be virtually eliminated approximately 99.7% of all MLM in favor of businesses that convert to an participants lose money – spending more MLM format to escape regulation. on company purchases and minimal operating expenses than they receive in Are MLMs legal? If not, what explains commissions from the company. Attrition the inaction by law enforcement? rates are high. And if one removes TOPPs from the calculations of average 1. The case can easily be made that income, the loss rate is closer to 99.99%, virtually all MLMs are violating some which means that the chance of new federal and state laws, although law recruits profiting is virtually ZERO. enforcement seldom acts against them – 2. As is true with any scam, those who partly because victims of endless chains invest the most, lose the most, having rarely file complaints. For the same accepted deceptive claims that the MLM reason (as well as financial support from is a legitimate income opportunity, and MLMs and the DSA – see #3 below), the having continued to invest in the vain Better Business Bureau seldom issues a hope of eventually profiting handsomely. negative report on major MLMs. The 3. Sales reported by MLM companies media have been largely silent. represent losses to participants. So based 2. The DSA, together with major MLMs, on DSA statistics, aggregate losses8 work together as a cartel to weaken suffered by tens of millions of victims laws and regulatory efforts against exceeds ten billion dollars a year in the product-based pyramid schemes. U.S., with additional losses suffered by Through promised votes and carefully vulnerable populations overseas. This placed political contributions to means that total aggregate losses from Attorneys General and other key hundreds of millions of victims worldwide politicians, they have been successful in since the 1979 Amway decision would getting laws passed in Utah and other amount to hundreds of billions of dollars. states that exempt MLMs from 4. Abuses from participation are widespread prosecution as pyramid schemes. They in the MLM industry. In some cases, have donated to the political campaigns monetary losses from MLM participation of presidential candidates and to those lead to heavy indebtedness, bankruptcy, with oversight responsibility for the foreclosed mortgages, and failed education Federal Trade Commission to assure and career pursuits. that no action is taken on the federal 5. Some MLM participants lose more than level by the FTC or any other agency. money. Divorces and rifts among 3. Even the Better Business Bureau is extended families are commonplace. Even corrupted by support from the DSA/MLM suicides and murders related to cartel, members of which are “corporate participation in MLM, have been reported. sponsors” of the BBB. Amway, for 6. Addiction to MLM can result from example, gets an A+ rating from the excessive commitment to MLM – which BBB – which says more about the BBB can become a lifestyle. “MLM junkies” – than it says about Amway. who have internalized its “easy money” 4. Law enforcement officials, the media, appeal – may find it difficult to work and MLM victims, have become again in a normal work setting. conditioned to focus on the question of 7. MLM is an unfair and deceptive practice whether or not an MLM is a pyramid (UDAP) that siphons money away from scheme. Since the DSA/MLM lobby has legitimate businesses. And with the FTC’s successfully obfuscated this issue with granting of an exemption to MLMs from the indeterminate question of what percentage of products are consumed, 8 These losses are counted as “sales” by the DSA and nothing gets done. The issue of whether MLM industry.

or not an MLM is an unfair and deceptive Actions needed practice is more easily determined, as this book proves. 1. Consumers. law enforcement, and 5. Most MLM participants spend no more the media must get informed than a few hundred dollars in products 2. Crucial information must be and services and then drop out. They are disclosed to prospects to make the lucky ones. Despite having spent informed decisions about MLM more than they received, few blame the participation, such as average company for their losses – even losses of commissions from – and payments many thousands of dollars. They have to – the company for all participants. been taught that they – not the company – 3. MLM promoters must not be allowed are responsible for any failures. to make income promises to prospects. 6. The silence of victims of MLMs is also 4. A 7-day waiting period should be explained by the fact that in every endless required before any investment is chain, major victims are also perpetrators, made by prospects. having recruited as many people as 5. Victims must be more active in possible to recover costs of participation. complaining to authorities. So they fear self-incrimination if they file a formal complaint, and they fear Conclusion – defining MLM consequences from or to those they recruited – which often include close I conclude with what I believe is the only friends or family members. accurate, research-based, and consumer- friendly definition of the business model labeled “multi-level marketing”: It applies to MLM not legitimate direct selling over 500 MLMs I have analyzed:

Recruitment-driven MLMs (which is Multi-level marketing (MLM) is a virtually all MLMs) can be distinguished purported income opportunity, in which from legitimate direct selling by the following products are sold by recruitment of persons characteristics in their compensation plans: who are incentivized to buy products and to 1. They assume unlimited recruitment of recruit others in endless chains of endless chains of participants. participants, who must buy products to 2. Except for TOPPs, participants advance qualify for commissions and to advance by recruitment, rather than by upward through multiple levels in company- appointment like other businesses. sponsored pyramids of participants. 3. In order to qualify for commissions or Further – With unlimited recruitment, advancement, participant must make MLM assumes an infinite market, which minimum incentivized or “pay to play” does not exist in the real world. It also purchases of products or services. assumes a virgin market, which cannot exist 4. Compensation plans allow for relative for long. MLM is therefore inherently flawed, vertical equality in commission payout, unfair and deceptive. It can also be which results in extreme inequality in extremely viral and predatory. payout to the entire network of Prospects are typically lured into MLM participants. Most of the override with exaggerated product and income claims. commissions paid by the company are Rewards are stacked in favor of those at or paid to those at or near the top of a near the top of the pyramid, who are often the pyramid of participants – often the first initiators. Since approximately 99% of to join. Founders may also skim a participants lose money, most of them percentage of all revenues. eventually drop out, to be replaced by a 5. For most MLMs, company payout is to five continual stream of new recruits, who are of more levels of participants, with likewise destined for loss and disappointment. commissions to those at the bottom levels seldom enough to cover the cost of “pay to play” purchases and other expenses. Intro 1

INTRODUCTION: MLM’s appeal – and questions to be answered

Contents can earn a little extra cash for Christmas or for family vacations by working seasonally. Table of contents And of course you can’t beat the feeling Preface of camaraderie that MLM offers. You are Letters of endorsement told that you can be in business for yourself, Introduction: MLM’s powerful appeal Intro.1 The Amway precedent ” 1 but not be by yourself, and that in helping A much needed investigation ” 2 yourself, you will be helping others – often The many questions to be answered ” 2 hundreds in the organization you recruit and Is MLM an unfair and deceptive practice? ” 3 build, who look to you for support, as they The book’s title is appropriate. ” 3 each build their own business under you. The author’s “$10,000 ‘unfair and Robert Kiyosaki, author of Rich Dad, deceptive practices’ challenge” ” 4 Poor Dad stated: “MLM levels the playing Qualifications of author/analyst ” 4 field and allows the average person to Source material for this book ” 5 become financially free. This means not Recommended reading & web sites ” 5 having to punch a time clock, the time freedom to pursue other interests without having to worry about money, and the MLM’s powerful appeal 9 means to be in control of your future.” Who People join an MLM for a variety of would not want all that? reasons. Most are recruited by a family member or friend – or from contacts as work. Some learn about a program over the Internet. The Amway precedent The products may seem to answer some unmet need, such as protection from In 1979, Robert Pitofsky of the FTC illness or aging. They may be very unique (Federal Trade Commission) wrote the and offer benefits that promoters claim are controversial decision that Amway was “not a not available elsewhere. pyramid scheme.”10 This ruling assumed The opportunity to be self-employed from Amway’s compliance with home appeals to many who are tired of certain “retail rules” to depending on fickle employers who can lay assure that products were them off at any time. They see their work as sold to the public and not dead-end jobs with no real long term just stockpiled. These potential. Others are unemployed and find in rules were never MLM the chance for at least some income. significantly enforced. Even some professionals tire of trading time MLM promoters cite the Amway for money and like the option of owning a precedent as justification for their programs, in business that promises passive income. spite of mounting evidence of MLM offers an inexpensive alternative to misrepresentations in MLM recruitment more expensive options for owning a campaigns and high loss rates among business. It can cost a small fortune to buy a participants. Thousands of MLMs have come franchise or an established business from and gone since 1979, someone else, and starting a business from and many hundreds scratch may take months to get off the remain – spreading ground. MLM is easy to get into and appears virally from state to to be a good way to be your own boss. state and to vulnerable Some get into MLM because of a markets overseas. Anyone reading the promoter’s promise of virtually unlimited evidence with an open mind will understand income, or at least income proportional to why I and other consumer advocates lament the time and effort put forth. But some get into MLM in hopes of supplementing their 9 income, paying off debts, or financing college Cited in “The Truth about Multi-level Marketing,” by Angela Lee – betternetworker.com, June 26, 2011 for their children. Others are led to believe they 10 93 F.T.C. 618, 716-17 (1979). Intro 2 the Amway ruling – and failure to take The many questions to be remedial action since – as repudiation by FTC answered in this book officials of the agency’s mission to protect consumers from “unfair and deceptive acts or 11  Is MLM a viable business model? Or is it practices in or affecting commerce.” seriously and fundamentally flawed? This is an important topic because since  Is MLM a pyramid scheme in disguise? 1979, hundreds of millions of MLM  How can MLM be participants have in the aggregate been clearly differentiated from affected in amounts totaling hundreds of other business models? billions of dollars worldwide. And whether  What is the impact of these participants were benefitted or MLM on individuals, victimized is a topic of hot debate between families, and on society at those who see MLM as a legitimate type of large? direct selling or home business opportunity – How much money is and those who see it as an inherently flawed  gained or lost individually unfair, and deceptive business model – causing nearly all participants to suffer losses, and in the aggregate? only to enrich founders and those at or near  Are rewards proportional to effort; or do the top of their respective pyramids of those who invest the most, lose the most? participants – who are generally the first ones  Should those who fail, blame themselves to join the endless chains of recruitment. for not “working the system” – or blame the MLM as a scam?  Can MLMs with their endless chain of A much needed investigation recruitment continue indefinitely, or are they destined for saturation and ultimate collapse? This independent detailed investigation  Are MLMs profitable as business is long overdue. A survey of legal and opportunities? And is a lifetime of “residual business journals, Internet web sites, and a income” possible for all who work hard at library of MLM promotional and training MLM? materials yields a mountain of opinions on  Can a person profit from working in MLM both sides of a very contentious and just part-time or seasonally? ONGOING debate about the legitimacy of  Is MLM an honest business, or is it a MLM. But nothing approaching this level of system dependent on misrepresentations research and analysis on the underlying and unfair business practices? business model has ever been undertaken  Are some MLMs legitimate, and others by a qualified independent research entity scams; and how can one tell the difference? not underwritten by the MLM industry. I have brought together not only a brief  Is a “good MLM” an oxymoron? sampling of opinions on both sides, but an  Can everyone profit from MLM? Or is it assimilation of analytical thinking and just the founders and those at the top levels independent research that effectively that reap most of the company payout? answers a host of questions.  Do most recruits merely join to get the To illustrate the many facets of this products at a discount – as promoters claim? topic, the list below is just a sample of the  Are products sold by MLMs what many questions that have arisen in my 20 promoters claim they are? Or are they years of research on this topic – and that will overhyped and misrepresented? be addressed in this publication.  Does MLM cut out the middleman? Or are MLM products overpriced to pay off the many levels of distributors?  Are prices of MLM products competitive enough to be sold at listed retail prices? Or do MLMs depend on purchases by participants for most of their sales revenues?

11 15 U.S.C. § 45(a)(1) Intro 3

 Do MLMs foster good relationships? Or As a business model, is MLM an does a person risk squandering one's social unfair and deceptive practice? capital by participating in MLM?  Does MLM invite openness, or does it Many look at MLM as a legitimate lead to more closed and cultish behavior? business model and attempt to single out  Do endorsements by famous people and individual programs as “bad actors.” However, support of charities make MLM legitimate? in chapters 2 through 8, the reader will find  Do “success tools” really benefit users, compelling evidence for the extreme or do they primarily enrich upline sponsors? unfairness and deceptive nature of MLM as  Does the DSA (Direct Selling business model and as practiced throughout Association), the MLM lobby, serve only the the industry. Technically, this should make interests of its members, or does it also – MLMs subject to prosecution under Section 5 with its “Code of Ethics” – seek to protect of the FTC Act, as well as statutes in some consumers from harmful programs? states against unfair and deceptive practices – or endless chain recruitment schemes.  Do its chance elements qualify MLM as Loss rates are extraordinary – averaging a form of gambling, or as a lottery? 99.7% (or about 99.9% for new recruits) for  Are MLMs legal everywhere? Or are the MLMs for which I have been able to they technically legal in some jurisdictions, obtain relevant data. This in itself would not and not legal in others? be so bad, except that it is promoted as an If MLM is technically illegal in some  “income opportunity” – or even as a “business states, why are they still operating? opportunity” – a misrepresentation in itself. As  Where are consumer protection will be explained in Chapter 7, the odds are agencies, such as the FTC, in all this? Do far better at the gaming tables in Las Vegas. officials have the skills, the resources, and After reading these chapters, the reader the will to challenge fraudulent MLMs? may wonder if it is appropriate to refer to an  Is MLM ethical? Is unethical behavior of MLM such as Nu Skin, with its inherent flaws, participants rewarded more than ethical as a “business” at all. Some who are familiar behavior? with MLM’s abysmal statistics feel it is more  What actions can a victim take to appropriate to refer to any MLM as a scam. recover losses from MLM? • Can a person be addicted to MLM? If so, what can friends and family members do The book unmasks the mystique to deprogram an “MLM junkie”? of multi-level marketing.

• What actions are needed to protect the MLM lobbyists and defenders have public from “unfair and deceptive acts or managed to confuse and obfuscate the practices?” realities of the business model called multi- level marketing. Reduced to its essence, While a resolution of these issues may MLM as a business model is based on seem a daunting task, I am confident that unlimited recruitment of endless chains of these questions are answered here as well participants, as are “pay to play” chain letters as they can be answered from available and classic no-product pyramid schemes – research, and that all who read with an both of which are illegal. In fact, every one of open mind will be better able to answer the compensation plans of the 500 MLMs I these questions for themselves. Hopefully, have analyzed assume an infinite market – readers will also be willing to share this which does not exist in the real world. They information with others to protect them from also assume virgin markets, which don’t exist loss and disappointment. for long, necessitating that the MLM promoters enter – or “re-pyramid”12 into – new markets with the same deceptive promises of “residual” or even “unlimited” income.

12 The term “re-pyramid” will be explained in Chapter 3. Intro 4

MLM is almost always unprofitable for where my research has taken me. At one time participants, except for TOPPs (top-of-the- I was actually quite enthusiastic about MLM. pyramid promoters) at or near the top of the But as my research, experience, and pyramid – who are usually the first ones to understanding of the unfairness and join and who may profit from the purchases of deceptions in the fundamental MLM business what is often a huge “downline” of recruits model grew, I became increasingly critical of churning beneath them. Typically, MLMs have the MLM industry. I am now convinced that little sustainable customer base and are no modern business is more unfair and primarily dependent for revenues from deceptive than multi-level marketing. purchases of a network of participants – 99% Chapters 2 through 7 demonstrate the of whom lose money. unfairness of MLM as a business model and Thus, MLM as a system is fundamentally as an industry. In Chapter 8 (“A Litany of flawed, unfair, and deceptive. In addition, Misrepresentations”) is a list of at least 111 worldwide feedback suggests that MLM is typical misrepresentations used in MLM extremely viral and predatory. The evidence recruitment – which are refuted one by one. from independent research as reported in this book will clearly support these conclusions. This is why the case for MLM is The author’s “$10,000 ‘unfair and not given much attention in this work, though deceptive practices’ challenge” some typical arguments put forth by MLM promoters and defenders are briefly After a total of 20 years’ research on over discussed, where appropriate. 500 MLMs, the author is confident in The FTC considers classic, no-product challenging anyone in law enforcement, pyramid schemes unfair and deceptive and academia, or the media to identify any therefore illegal13. Bruce Craig, former purported business opportunity that is more assistant to the Attorney General of unfair and deceptive – and more viral and Wisconsin (who worked on several early predatory than MLM. If by March 31, 2015, MLM/pyramid scheme cases) wrote: “The any of these officials can meet the challenge premise of ‘multi-level vs. pyramid’ as specified, the author will take $10,000 out marketing may well represent a of his retirement and give it to his/her favorite distinction without a difference.”14 (See charity. The details of the challenge are Appendix 2F) The addition of products may specified in Chapter 10. Appendix 10A. merely serve to disguise or launder the investment in a pyramid scheme. This is not merely author bias. Looked at Qualifications of author/analyst objectively, any independent analyst with One of the common criticisms by pro- basic understanding of markets and statistics industry spokesmen is that I don’t who had objectively reviewed this research understand the MLM business or that I lack would agree with this conclusion. And to the qualifications to make rather harsh those who claim I am biased in my research judgments of the industry. and writings, I would respond that I have gone It might be helpful to list my qualifications – which could be ideal for an 13 In a letter to me dated May 22, 2001, FTC attorney Robert Frisby wrote: Section 5(a)(1) of the Federal expert witness in MLM cases: Trade Commission Act, 15 U.S.C. 45(a)(1), states  Solid business education – a two- that "Unfair methods of competition in or affecting year MLM degree with extensive commerce, and unfair or deceptive acts or practices training in micro economics, in or affecting commerce, are hereby declared statistics, accounting, and finance. unlawful." While the Federal Trade Commission Act does not specifically address pyramid schemes, such  Consultant and expert witness in schemes have been deemed unlawful under the numerous legal cases related to Federal Trade Commission Act. In re Koscot MLM and consultant/advisor to Interplanetary, Inc., 86 F.T.C. 1106 (1975). hundreds of persons seeking advice. 14 Letter dated February 25, 2000, from Bruce Craig to Robert Pitofsky, Chairman of the FTC (Appendix 2F) –  Ph.D., with training in performing a and the official who drafted the Commission’s 1979 research, and subsequent Amway opinion Intro 5

experience at two universities In making decisions on which research evaluating the research of others and comments to include in the book, I  Experience teaching and writing on assume full responsibility. However, I am entrepreneurship, business ethics, confident – based on extensive training, and money management. research and experience (see Chapter 1) –  At least 25 years’ experience and that this book will be the most thorough and research in the field of home reliable overall source of information business opportunities, and the need available on the viability, profitability, or desire to work from home legality, and ethics of MLM as a business  Experience as a distributor in an model; on the consequent unfair and MLM program, having succeeded at deceptive practices in the industry as they recruiting a downline for at least a affect consumers; and on ways to protect year. (Except for top distributors, consumers from major losses. “success” did not yield profits.) The issue of consumer harm – which  20 years’ experience as a consumer this book addresses in depth – has advocate in the field of MLM fraud. relevance both for consumer protection and  Analysis of the compensation plans for legal or regulatory actions. It is my hope of approximately 500 MLMs, after that this book will serve as an invaluable having developed a model that tool for consumer advocates, law defines MLM, or product-based enforcement officials, educators, media pyramid schemes and reveals MLMs reporters, and MLM recruits and prospects to be recruitment-driven, top- faced with decisions about participation. It weighted, and financed primarily by should also be helpful as a primary internal consumption. reference guide for plaintiff attorneys  Author of two books and numerous representing MLM victims. research reports on MLM topics Recommended reading and To put anyone’s mind at ease on this subject, I am telling my story in Chapter 1 annotated web sites

Anyone seeking an expert for consultation For serious students of the subject, I or who wants more information about me is would strongly suggest reading the rather welcome to write for my full vita, or they can lengthy article titled “All you need to know download it from the Consumer Awareness about MLM.” In it you will find thorough Institute page on my web site at – reporting on legal issues related to MLM. www.mlm-thetruth.com Though very factual in her approach, the author has been sued for expressing her opinions and prefers to remain anonymous. Source material for the book For the article and interesting details, go to – http://www.financialindustryscam.com/mlm.htm The information for this book is For general legal background, the compiled from extensive research and serious student will benefit from an older, writing I and other independent analysts but extremely relevant, article published in have done, while incorporating over 20 the William and Mary Law Review entitled: years of worldwide feedback. Most of the “Regulation of Pyramid Sales Ventures,” information about specific MLMs is go to – downloaded from their company web sites. http://scholarship.law.wm.edu/wmlr/vol15/iss1/6/ Additional input from regulators, attorneys, Several treatises written by Robert scholars, and other independent consumer FitzPatrick of Pyramid Scheme Alert are advocates has been utilized. Where very helpful in gaining a better appropriate, communications from MLM understanding of the subject. They can be defenders has been incorporated, even downloaded from his two web sites – though their arguments may seem convoluted, deceptive, and/or misleading. Intro 6 www.pyramidschemealert.org and www.falseprofits.com – which also has some insightful blogs worth reading. Please read this book I also highly recommend the following: carefully, then pass it (and “What’s Wrong with Multi-level Marketing,” our web address) on to by Dean VanDruff, which presents powerful arguments to help grasp the fundamental someone else, or better yet – flaws in MLM. Go to – www.vandruff.com send to your entire email (or www.mlmwatch.org, one of several Facebook) list the link for informative web sites by Dr. Stephen downloading it and suggest Barrett, focusing on questionable supplements and other health quackery, that they do the same. Then which seems to be a favorite product ask that they each category for MLMs. encourage those they www.sequenceinc.com – sponsored by contacted do the same for forensic accountant Tracy Coenen. Check out her articles on pyramid schemes. their contacts. You can help A scholarly article titled “Marketing establish an endless chain of Fraud: An Approach to Differentiating truth-telling to counter the Multilevel Marketing from Pyramid deceptions passed along the Schemes”15 was written by economists Peter VanderNat (with the FTC) and William chains of MLM recruiters. Keep and has been referenced by the FTC in connection with the Business Opportunity Rule, as discussed in Chapter 2. However, A group of us consumer advocates have the article assumes that MLM is a legitimate a web site on which is posted a petition titled: business model, an assumption that must “Global Coalition Petitions FTC to Protect be challenged, based on research and Consumers against Unfair and Deceptive analysis reported in this book. Practices in the MLM (multi-level marketing) Dave Ritchie, who lost the love of his Industry.” Visitors to the site are invited to sign life over her addiction to MLM, presents the petition and post their complaints. Go to – some interesting experiences and insights www.mlmpetition.com in his web site at – www.scamm.org. Many other useful reports and blogs are available at www.mlm-thetruth.com. And check out numerous other recommended web sites, which are annotated for the reader’s convenience. Go to – http://www.mlm-thetruth.com/research/ reports/ recommended-sites/ If you want specific information on specific MLM programs, by going a Google search, you can usually locate numerous web sites touting the MLM. But if you want to know the downside for any given MLM, just enter the name of the company and add search terms such as “scam,” “fraud,” “complaints,” “legal actions,” etc.

15 See Peter J. Vander Nat and William W. Keep, Marketing Fraud: An Approach to Differentiating Multilevel Marketing from Pyramid Schemes, 21 Journal of Public Policy & Marketing (Spring 2002), (‘‘VanderNat and Keep’’) at 140. Ch.1 -1

Chapter 1: MLM UNDER THE MICROSCOPE – why and how the research upon which this book is based was undertaken, and why the author can speak with authority on the subject

Chapter contents  Strong grounding in ethical principles,

My background and qualifications 1-1 including authorship on MLM ethics I go public and initiate serious research 1-5  Extensive writings on MLM quoted by I share my findings with regulators, attorneys, legislators, and the media attorneys, the media, consumers,  Presentations to regulators at and consumer advocates. 1-7 nation-wide conferences on MLM Legislators and regulators yield to  Promotion of legislation and rulings DSA/MLM lobbying, creating a to protect against MLM fraud. vacuum in consumer protection. 1-9 My resolve to do something 1-9  Consultant and expert witness in many legal cases regarding MLM abuses For more specifics on my qualifications, see Appendix 1A. My background & qualifications Some may ask what qualifies me to do Important qualifications for an this research and to pull all this material authority on MLM. If a top consultant were together in an authoritative book. That’s a fair needed to sort out complex issues related to question and deserves an answer. the legitimacy of MLM, what would his ideal Actually, my whole career led to my set of qualifications look like, including expertise and consumer advocacy in this education and both life and arena. Though the following sketch of my career experiences? I think background is lengthy, it should forever put to the following list, which is rest the uninformed opinions of some critics what I bring to the task, that Jon Taylor "doesn't have a clue what answers that need. This is MLM is all about." not to boast – just a As a young man, the last thing I would summary of my background have imagined was my stepping forth as a as it applies to this topic: leading authority on multi-level marketing. But fate – or an overruling providence –  Expertise in business analytical skills seems to have pointed me in that direction – ideally an MBA degree from my early years as a wide-eyed seeker  Doctoral level research, training, and of what the career world had to offer. It is experience evaluating others’ research as though my whole life was somehow  Many years of experience in direct pointed toward this advocacy on behalf of selling and in sales management consumers and regulators struggling with  A wide range of entrepreneurial and the exploding phenomenon of multi-level home-based ventures marketing, or the commonly accepted  Direct experience in a leading MLM acronym “MLM.” and success in building a downline  Experience analyzing hundreds of Analytical skills and a solid MLMs, using a well-researched and background in sales, entrepreneurship, consistent analytical model and ethics. I graduated in education and  Compilation of the experience of taught religion at the secondary level for two thousands of participants in a wide years before returning to Brigham Young range of MLM programs University to complete a full-time MBA  Communications with top executives program at Brigham Young University, and communicators of leading MLMs requiring two years of coursework in Ch.1 -2 economics, statistics, finance, accounting, learned of the vast opportunities available and the analytical skills essential for business outside the standard job market. success. From this training, I gained the skills I sponsored a trade show called “The needed to analyze business options and to Income Opportunity Show,” to showcase assess their profitability and viability. I also income or business opportunities, many of performed research on entrepreneurship and which could be operated from home. led a group project surveying corporate Interestingly, MLM promoters scrambled more executives on “Sales as a Career Option for aggressively than any of the other companies College Graduates.” This was at a time when for the best booth locations. both sales and entrepreneurship were not yet considered respectable topics in academia. Serial entrepreneur for sure. Because In subsequent years, as an adjunct of my creative inclinations and familiarity instructor at four different universities, I taught with the vast array of self-employment personal finance, entrepreneurship, business options, I started one business after another ethics, communications, and management – as a “serial entrepreneur.” I didn’t enjoy all of which came in handy later as a managing them, just creating them from consumer advocate, communicating about scratch – often a business concept that had complex MLM issues. I refined and taught never been tried before. For those ventures skills needed for successful entrepreneurship that failed to show positive results, I learned and sales programs, as well as ethical to cut bait early and not continue throwing business practices. good money after bad. I would shut it down and begin again with another concept for a venture waiting in the wings. Conversely, as soon as a business began to show significant profits, I sold out and went on to create another venture. As expected, some failed, and others succeeded; but in the process I learned Coincidentally, I founded the non-profit some valuable lessons on what is required Consumer Awareness Institute to conduct to start and build a successful home research and teach seminars related to business With careful research and good personal finance and entrepreneurship – marketing, about half of these ventures and wrote several articles that were produced profits within the first few months. published by various consumer and Also, because my funds were limited, entrepreneurship magazines. I’ve also all these business startups were bootstrap published several consumer guides, some operations, requiring little capital. Such for the distribution through group and ventures nearly always required much commercial channels and some for Internet salesmanship, so I honed my sales and consumption. For each project – on an ad marketing skills and trained others in the hoc basis as needed – I consult other skills needed to promote new ventures. I experts in the field or hire help – usually know what legitimate selling entails. college students. Over a period of 30 years, I founded or consulted in the founding of over 40 home- Home income opportunities galore. In based businesses. These included an the late 1970s, as a young widower, I was educational game simulation company, an determined to find ways to support my two advertising and public relations agency, a small children without leaving home. This led training video preview service, a national to extensive research on the whole field of motor home rental referral agency, pre-need home-based business opportunities. I read all funeral sales programs, radio transmission I could on the topic and undertook research for high school driver education, publishing for a planned national Income Opportunity ventures, numerous trade shows, several Directory. The project outgrew me, as I traveling seminars, centralized seminars uncovered thousands of income options. But I transmitted by satellite, a nationwide nanny screening and referral agency, and Ch.1 -3 research-based resume and self-marketing First-hand experience with MLM – programs. One could say I was a bootstrap, “Been there, done that.” I had been serial entrepreneur. aggressively recruited many times by various MLM participants and witnessed firsthand Direct selling experience. Along the their powerful motivation to recruit, using way, I often engaged in direct selling, which dubious and deceptive recruiting methods. proved to be the most profitable of the many But having taught college classes in finance, income options in which I participated. I paid entrepreneurship, and ethics, and having much of my college expenses selling been a successful salesman and encyclopedias, and I won many entrepreneur, I was skeptical of recruitment- salesmanship awards when I sold insurance driven schemes labeled as “network and pre-arranged funeral plans. I do know marketing” or “MLM.” the difference between legitimate direct selling However, under pressure from respected and pyramid or chain selling. friends to join various MLM programs in 1994, I considered doing a one-year test of an MLM “Residual income” – and legitimacy. that my research led me to believe was one of I provided consultation for mid-career the best of the MLMs I could join – Nu Skin. I changers, many of whom were seeking my wanted to prove to myself and guidance in pursuing small business or self- to others whether or not MLM employment options. Also, from authoring was a legitimate business books and from promoting health insurance model. Those who recruited and other programs for small businesses, I me claimed that with my experienced the luxury of “residual income” capabilities and contacts, I – frequently cited by MLM promoters as the could rise to the top level of “Blue Diamond” inevitable result of building within two years – and a downline of distributors that those at this exalted $750,000 per year! I told (or so they claim). level earned an average I was careful to assure myself that if that were of over $750,000 a year. that all of these ventures true, I could live on that. I told myself that if were organized and But if it proved to be just a that were true, I could operated using the strictest disguised pyramid scheme, live on that. But if it of legal and ethical as I suspected, I would tell proved to be just a standards. Based on my the world about it. money trap or disguised MBA training, all this pyramid scheme, as I experience, and the ethical principles I have suspected, I would tell the world about it. always held and taught, I was in a strong Prudence dictated that before finally position to discern between businesses that joining, I do some “due diligence” by reading were legitimate and those that were not. on MLM and by checking out Nu Skin and other MLMs with the Consumer Protection Doctoral studies, research, and Division at Utah’s Department of Commerce, teaching. Midlife in my varied career, I as well as with the Better Business Bureau, completed doctoral studies in Applied which had received few Psychology at the University of Utah. This complaints against Nu Skin. Both gave me research skills that were extremely gave out literature that was helpful in my consulting, in teaching adult favorable to MLM, assuming the education classes and private seminars, and company was financially solid in my independent research on many topics, and that legitimate products were including MLM. Also, for a brief period, I offered. worked on the administrative staff of both I later learned that at least one of the Brigham Young University and the University pieces of literature handed out was supplied of Utah, evaluating the research of others. by the Direct Selling Education Foundation, sponsored by the Direct Selling Association (DSA), which lobbies for the MLM industry. But at the time, it seemed credible. Ch.1 -4

Finally convinced, I dragged my suspicious It soon became apparent that to get to a wife JoAnn out to a couple of Nu Skin level where the money was made, I would opportunity meetings. The pep rally atmosphere have to continue my aggressive recruitment was a big turn-off for her. She concluded, campaign, luring prospects of the Nu Skin "I have a bad feeling about this." “business opportunity” to buy a “business in But I persisted, and she reluctantly gave in to a box,” which consisted mostly of an my promise to try it for a year - and then re- expensive package of products to become a evaluate the program. I felt comfortable with this “business builder.” trial period because in all my previous ventures I could assess the potential profitability of a “Wanna play?” While introducing new business within the first few months. recruits to Nu Skin, I often asked them to As recommended, I bought five of starter attend “opportunity meetings” at which a packages (for about $1,600) to jump-start five high level distributor would give a new recruits, which not only helped me to presentation touting the benefits of Nu Skin advance in the distributor hierarchy through and of what was then referred to as their "fast start" program, but also gave me a “network marketing.” powerful incentive to recruit to recoup my One of these speakers presented Nu investment. Fortunately, as a researcher I kept Skin as a game. Just like any game, the detailed notes of my experiences and records person has to be willing to enter the game of expenses while recruiting for Nu Skin. to gain any fun from participating. He pointed out that the “winners” in this game “I drank the Kool-Aid.” My decision would be handsomely rewarded – as much was to give total dedication to the program as $750,000 a year, which was what Blue for at least a year, as it Diamonds were then averaging. would not be a valid test At the close of his presentation, he otherwise. Even with my would challenge us to “play the game” of the extensive background in Nu Skin version of network marketing. His math, entrepreneurship, and question “Wanna play?” was intended to get sales, I “drank the Kool-Aid” us to sign up right then. He said you never and eventually bought into know how a person you recruit might catch the whole MLM mentality. fire and make you rich from the downline he Looking back, I am ashamed for might build, from which you could draw having overlooked MLM's mathematical commissions. In retrospect, this appeal to trick – the promise of an unlimited income chance is grounds for the application of from an endless chain of recruitment. This lottery statutes to MLM in some states. (See was “cognitive dissonance” personified. I Chapters 2 and 10.) became a believer. I did everything my company and upline The 3-foot rule. I became a serious recommended – subscribed to and tried a player of this network marketing game. I read wide range of their products, recruited everything I could on the subject, followed people I knew, sought any referrals I could suggestions of my upline to the letter, and get, advertised after exhausting my “warm recruited aggressively. I consistently applied market” of friends and family, attended all the “3-foot rule” – everyone within three feet of the training and opportunity meetings me was a prospect. (conducting some myself), and used my best efforts to train and motivate my “It’s Nu Skin or me – take your pick.” recruits. My wife began asking questions after a few I tried selling Nu Skin’s nutritional months of pitifully small commissions, even supplements, but they were expensive, though I had risen to a level of the top 1% of even at wholesale. To satisfy qualifications distributors – assuming all recruits were for commissions as an “executive counted. She did not like the changes that distributor,” I purchased products to give out were occurring in me and in our relationships as samples to any potential prospects – and with treasured friends and family members, hyper-consumed them myself. whom I was attempting to recruit. Ch.1 -5

all distributors were counted), I was still losing about $1,000 a month, after “It’s Nu Skin or me – take subtracting all expenses, including your pick,” she warned. purchases required to maintain qualification for the “Executive” level in the compensation plan – which was necessary to have any hope of profiting after expenses. Finally, at the end of a year, JoAnn threatened to leave me if I continued, as it was changing for the worse the man she Top 1% of distributors, but married. “It’s Nu Skin or me – take your losing $1,000/month. This was pick,” she warned. Where I had ignored my NOT what I signed up for! wife's negative impressions when I first joined Nu Skin, now her ultimatum caused me to take a closer look at my participation It soon became apparent that to earn the – and at our finances. huge income that was promised, I would have to be at or near the top of a huge pyramid of Ethical conflicts. As a former teacher participants, which I believed was possible. But of ethics and one who considers himself an after carefully considering my situation and honest man, one facet of MLM fascinated coming to recognize the foolishness I had me even more than the money. In re- fallen into, I quit Nu Skin and decided to tell the examining my participation in MLM, I world what I had learned – not just about Nu discovered a whole range of ethical conflicts Skin, but about the entire field of MLM (a.k.a., that for me made MLM an unacceptable “network marketing”), about which I had way of conducting a business. undertaken an intensive research overview. In fact, before I quit Nu Skin, after about a year of concentrated effort, I could see clearly what I would have to do to earn the For me to receive that level of huge commission checks that were held out income, thousands would have to to new recruits. I decided it was simply not lose their investment. The money worth it. Why? Because I would have to would have to come from recruit by convincing prospects (like I had somewhere. Also, I would have to been deceived) into believing they too could achieve what I claimed to have achieved – or continue to insist that MLMs were was on the road to achieving. not illegal pyramid schemes, but For me to receive the income that was legitimate direct selling programs. held up as possible, thousands (in such a highly leveraged program) would have to lose their investment. After all, the money I go public and initiate some would have to come from somewhere. In serious research MLM, it would come from purchases of downline distributors, since few products I publish the story of my experience were sold to non-distributors. They were and lessons learned from MLM. After overpriced, and the pay plan was clearly conducting surveys to determine the rewarding those who recruited huge amount of MLM activity in my state and a downlines, not those who sold to non- cross section of citizens’ opinions about it, I participants. Also, I would have to continue wrote a book titled The Network Marketing to insist that MLM programs like Nu Skin Game, which exposed the ethical problems were not illegal pyramid schemes, but of exploiting friends and family for personal legitimate direct selling programs. gain. While on a speaking tour promoting the book, I got feedback from tax Top 1% and losing over $1,200 a accountants who asked why – with all the month. Though I was successful at MLM promoters’ promises of “residual recruiting and climbing the ladder of distributors (again, in the top 1% if Ch.1 -6 income” – they were not seeing profits “We’re not really MLM, we sign up referral reported on tax returns of MLM participants. customers,” etc., etc. My response is that after analyzing the The tax man knows. I decided to compensation plans of hundreds of MLMs interview tax professionals in several counties and the average income for those that have – totaling almost 300 of them over a period of released such data, it is now possible for me several months. This included to make reliable generalizations about MLMs interviews with programmers of (i.e., multi-level or network marketing, tax software and persons entrepreneurial chains, product-based involved in seminars for tax pyramid schemes - or whatever you choose professionals. With a total of over to call them) – as a business model that two million tax returns represented applies to all MLMs. And I have yet to find any nationwide, a clear picture emerged of who exceptions to these generalizations, in spite of was making – and who was losing – money in 20 years of research and worldwide feedback. MLM. The results were startling. Finally, in This is not to boast, just a statement of 2004, this research was published in a report fact: I DO know what I am talking about - if published on my web site entitled Who Profits anyone does. And I DO have the from Multi-Level Marketing? Preparers of background to test and evaluate MLM as a Utah Tax Returns Have the Answer. business model, as well as specific MLM programs - if anyone does. From MLM recruiter to consumer advocate. In 1998, I mailed my initial Sour grapes – or moral imperative? conclusions to the presidents of 60 of the Other critics see my analysis of the MLM most prominent MLM companies, asking industry as merely the 'sour grapes' attitude them to provide specific data to "prove me of a disgruntled ex-distributor who failed at wrong." To this day, this challenge remains MLM. I can only respond that I was unmet. It was published on my web site as successful at becoming one of the Network Marketing Payout Distributions company's top 1% in the hierarchy of Study. I also published MLM or Network distributors – only a small percentage of all Marketing – the Ultimate Pyramid Scheme, 12 recruits reach even “Executive” level. In Nu Tests for Evaluating a Network Marketing Skin’s reporting, dropouts are not counted, “Opportunity, and Product-based Pyramid as these people “never intended to do the Schemes: When Should an MLM or Network business.” This is a convenient falsehood. Marketing Program Be Considered an Illegal However, such success was not reflected Pyramid Scheme? All of these created quite a in any profits, but instead in substantial stir when posted on the internet. losses, after all purchases and operating expenses were subtracted, to say nothing of Why all this detail on my $50,000-$100,000 lost from not working at a background? My reasons for recounting all profitable sales-oriented business during that of the above is to answer the common year. Also, I was fulfilling my initial pledge to charge of critics that “Jon Taylor hasn't a myself to make public what my experiment clue of what MLM is about” – or that I have with MLM taught me, and I feel a moral “no real world experience in how to sell or to imperative to help others avoid the pitfalls manage a business.” The foregoing should inherent in this "industry.” put all such blind assertions to rest. At least, it answers all the qualifications for an ideal expert for this project as outlined above. This is not to boast, just a statement Other MLM promoters charge that my of fact: I DO know what I am experience with MLM was with a "bad MLM" talking about – if anyone does. And – Nu Skin. Their typical comment goes I DO have the background to test something like this. "But – our MLM is and evaluate MLM as a business different. Everyone can make money at this model, as well as specific MLM MLM," or “We have the most powerful programs – if anyone does. compensation plan in the industry,” or Ch.1 -7

Shortly after I began posting my who express their thanks for saving them findings to educate and warn consumers from potential losses.18 against MLMs like Nu Skin, I also reported Finally – multi-level marketing, or on the FTC’s Order for Nu Skin to product-based pyramid schemes, defined discontinue its misrepresentations about - based on extensive research. I spent distributor earnings. This information can be months analyzing features of MLM and downloaded from a page on my web site classic pyramid schemes and comparing titled “Nu Skin’s Naughty Numbers at – them with features of legitimate direct selling http://mlm-thetruth.com/research/mlm- and other home businesses. With my statistics/nuskins-numbers/ extensive background in sales and entrepreneurship, I was able to make some clear distinctions missed by other analysts. I share my findings with regulators, In fact, I had not only done direct selling the media, attorneys, academia, (which MLM adherents claim to be doing), and consumer advocates – as well but had recruited, hired, and trained sales as with victims and potential persons and telemarketers. I knew what victims. characterized legitimate direct selling – and even legitimate recruiting. After months of To reach out to a broader audience of comparative analysis and discussions with consumers, I initiated a website and top experts, five “red flags” or cooperated with other consumer advocates characteristics became apparent that clearly and top experts who were reporting their distinguished chain or pyramid selling findings and experiences with MLM. These schemes (MLMs) from legitimate direct included Robert FitzPatrick16, President of selling businesses. The first four applied to Pyramid Scheme Alert; Bruce Craig, former all MLMs, the fifth to most. assistant Attorney General in Wisconsin; These features, which could be Kristine Lanning, (former) Assistant Attorney identified in MLM’s compensation plans, General of North Carolina; Doug Brooks17, resulted in extremely high loss rates and plaintiff attorney dealing with MLM cases; helped to identify MLMs that could be Susanna Perkins, author and sponsor of considered in violation of laws in most states, mlmsurvivor.com, and Eric Schiebeler, as well as FTC guidelines. In fact, wherever I author of Merchants of Deception. could get the earnings reports of participants With the cooperation of these extremely in MLMs with these “5 Red Flags” in their knowledgeable and capable experts, I pay plan, approximately 99.7% of all organized seminars on product-based participants (including dropouts) lost money, pyramid schemes for state and federal after subtracting all expenses. In fact, with a regulators in Washington, D.C., and at the more strict interpretation of the data (and National White Collar Crime Center in eliminating TOPPs, or top-of-the-pyramid promoters from the calculation), the loss rate Richmond, Virginia. I also cooperated with 19 sponsors of other web sites offering useful for new recruits is closer to 99.9%. information on MLM. These expenses included minimal My research was also presented at operating expenses and “incentivized other national and state anti-fraud purchases” of goods and services from the company (necessary to qualify for conferences. Robert Fitz-Patrick and I have 20 been called upon as expert witnesses in commissions or rank advancement). MLMs several legal cases against MLM even make obviously illegal no-product companies. However, the most gratifying pyramid schemes look profitable in rewards from all this research have been comparison – with the likelihood of profiting the thousands of emails and responses to 10-100 times as great. my web site from persons all over the world

18 For sample feedback, see Appendix for Chapter 9. 16Sponsor of pyramidschemealert.org 19 See Chapter 7. 17 Sole practitioner in Concord, Mass.. 20 See Chapters 5 and 7 Ch.1 -8

The “5 Red Flags.” These five red reporting on whether or not gambling is a flags were then presented in the form of a legitimate business opportunity. It is gambling. “5-step do-it-yourself MLM Evaluation” quiz. In fact, I called Las Vegas gambling It soon caught hold, and thousands of MLM casinos and learned that the odds of profiting prospects have used it to keep themselves from craps or Roulette are far better than the out of MLMs that could have caused likelihood of profiting from MLM22. Please considerable financial loss. don’t misunderstand me. I am not promoting I also published and presented THE 5 gambling; I never gamble. But I am all for RED FLAGS: Five Causal and Defining honest and ethical business practices in any Characteristics of Product-Based Pyramid endeavor. At least gambling casinos are Schemes, or Recruiting MLMs at the 2002 honest enough not to claim that those who and 2004 Economic Crime Summit play at their gaming tables are investing in a Conference, co-sponsored by the National “business opportunity.” White Collar Crime Center.

Business opportunity?

Over the past several years, I have used this “5 Red Flags”21 model to analyze the compensation plans of over 500 MLMs – and correlated them with average income data of participants (where such data was available). All of this has enabled me to make generalizable observations of consistent structures and practices of MLM as an industry – and losses suffered by participants – that would not otherwise have One can do better in Las Vegas – than in MLM! been possible. These observations and the research underlying them will be explained in subsequent chapters. It should be noted that I now include only four causative and defining MLM is not the only game in town. characteristics of a recruitment-driven MLM. From feedback all over the world it became The fifth (five or more levels in the pay plan) apparent that many people are drawn into does not always apply because in rare MLM because they are unaware of the many cases, some MLMs have only four or five self-employment alternatives open to them. levels. They make up for it by increasing the So using my past research and experience, I payout to TOPPs. However, the added wrote the report 1,357 Ways to Make More levels definitely enhance this unfair payout. Money than in MLM. I began posting on my web site the research making up this book, Roulette or Craps – or MLM? The along with suggestions for successful self- numbers don’t lie. Other critics see me as employment and links to websites that biased against MLM in my research and provide additional information and point to reporting. This can be answered with a helpful resources. gambling analogy to explain my position. If the owner of a gambling casino in Las Vegas were to post a “Business Opportunity” sign at his craps or Roulette tables, the Nevada gaming authorities would take action against him. And no one would argue that a writer covering the issue should be impartial in

21 There are really four causative and defining characteristics, and a fifth in most, but not all, MLMs. 22 See Chapter 7. Ch.1 -9

Legislators and regulators yield from unfair and deceptive practices, which to DSA/MLM lobbying, creating a protection is a core mission of the FTC. However, in 2011, the FTC announced vacuum in consumer protection. its final Business Opportunity Rule – exempting MLM! The details of how this Utah and other states duped by DSA. happened are provided in the report titled In 2006, the DSA and local MLM companies “REGULATORY CAPTURE: The FTC’s lobbied intensely for a bill weakening Utah’s Flawed Business Opportunity Rule” Pyramid Scheme Act. I testified at hearings on behalf of consumers who were being victimized My resolve to do something

by what I dubbed “product- Something to get passionate about. based pyramid schemes,” Knowing my grasshopper approach to career or MLMs. But with well- decisions in the past, hopping from one placed political donations startup business to another, friends have and the implication of a powerful voting block asked me what has driven me to stay with my of MLM participants, the bill was passed in consumer advocacy, focusing so intently on 2006, exempting MLMs with consumable this one business model for 20 years. products from prosecution as pyramid My answer is that when I discovered schemes. Even the Attorney General testified how deceptive, unfair, viral, and predatory in favor of the bill, but without disclosing that this industry is, and how few people – MLMs were his chief political donors. Several including regulators – understand the other states have been similarly affected by consequences of MLM participation – to DSA-initiated legislation. individuals, to families, and to society, it

The FTC’s flawed Business seemed appropriate to stand up and use my Opportunity Rule. In 2006, the unique background and skills to challenge FTC proposed a Business the industry and to provide guidance to Opportunity Rule that would prevent consumers from being victimized by require sellers of business fraudulent MLM schemes. It is both the opportunities to disclose average outrage I feel at the unchecked growth of incomes, references, and other this deeply flawed practice, as well as information crucial to a decision on whether or letters of deep appreciation from persons not to participate. Comments were invited, around the world who used my information and the DSA and its members issued appeals to remain solvent by refusing MLM to millions of MLM participants to use their recruiters, that keeps me going. form letters to write in objections to including I go where the facts take me. The MLM in the Rule. Some 17,000 offered abysmal average income (losses) for new comments following their company’s MLM recruits confirms the fundamental flaws suggested form letters. I wrote comments in MLM as a business model, depending as it rebutting the comments of participants and does on the unlimited recruitment of endless spokesmen for over 30 MLMs. chains of participants as primary customers. Also, the DSA influenced 86 Congress- MLM is built on the same endless chain men to object to including MLM concept as the clearly illegal chain letters of in the Rule. The FTC gave in the past, where each person sends $5 to all to the pressure, and in 2008 a the persons on a list and is asked to add his Revised Rule was proposed, name at the end and forward it on to all exempting MLM. Commenting his/her friends, asking them to do the same. for consumers, I objected to So I have no hesitation in gathering the this exemption with additional comments, and evidence and arguments on both sides and in 2009 participated in a workshop at the FTC then showing the flaws in the arguments offices on the proposed final version of the justifying MLM as a “business opportunity.” All Rule – again objecting to the FTC’s of this has been posted on my web site – exemption of MLM from having to provide mlm-thetruth.com. transparency needed to protect consumers Ch.1 -10

Ch.1 -11

When I discovered how unfair and deceptive, and how viral and predatory this industry is and how few people – including regulators – understand the consequences of MLM participation, it seemed appropriate to use my unique background and skills to challenge the industry, to inform regulators and the media, and academia – and to provide guidance to help prevent consumers from being victimized. Ch.2- 1

Chapter 2: MLM DEFINITIONS AND LEGITIMACY: what MLM is and is not, and the difference – if any – between MLM and pyramid schemes

Chapter contents: definitions of what is – and what is not – Introduction and summary 2-1 multi-level marketing. We will consider a Examples of Definitions of MLM by others 2-2 sampling of definitions and then discuss a Needed: A research-based definition of MLM 2-6 much more objective definition based on Four CDCs of recruitment-driven MLMs that comparative research on structural cause harm & distinguish MLM from characteristics and confirmations of its legitimate direct selling 2-10 validity in over 500 MLMs (MLM programs). #1: Endless chains of recruitment 2-10 This research has yielded four (and in Exhibit 2a: CDC #1 2-11 most cases five) causative and defining Exhibit 2b: CDC #2 2-15 #2: Advancement by recruitment 2-16 characteristics (“red flags”) that can be Exhibit 2c: CDC #3 2-17 recognized in the compensation plans of all #3: Pay-to-play requirements 2-18 MLMs – which motivates the behavior of #4: Top-weighted compensation plans 2-21 participants. This definitional model makes Exhibit 2d: CDC #4 2-23 possible a clear distinction between #5: (in most MLMs) Five levels or more 2-24 (1) legitimate direct selling or home-based Exhibit 2e: CDC #5 2-25 businesses, (2) classic no-product pyramid 4 CDCs confirmed by industry-wide research 2-27 schemes, and (3) recruitment-driven MLMs – or Harmful effects of recruitment-driven MLMs 2-27 what I call “product-based pyramid schemes.” Exhibit 2f: Does MLM qualify as legitimate As I shall explain, there are inherent direct selling? – a 7-point checklist 2-29 Exhibit 2g: Legit. direct selling v. MLM 2-31 flaws in any MLM, since all assume unlimited Exhibit 2h: Characteristics & effects recruitment of endless chains of participants – of product-based pyramid schemes 2-32 and a pay plan that is recruitment-driven, top- MLM’s problem with legal identity 2-33 weighted, and financed primarily by What is the difference between Ponzi incentivized purchases of the participants schemes and pyramid schemes? 2-34 themselves. I have looked for exceptions to Are all MLMs pyramid schemes? 2-35 this generalization in the 500 MLMs I have A more descriptive term: “pancake schemes” 2-35 analyzed, but have found none. Comp plans designed for company not partic.’s 2-36 As a business model, MLM operates on Some MLM “players” game the system 2-36 the same principle as a chain letter, in which a What would a “good MLM” look like? 2-37 Conclusions and hypothesis 2-38 person receives a letter with a list of names on A testable hypothesis for MLMs legitimacy 2-38 it, mails a $5 bill to everyone on the list, adds his/her name to the bottom, and then forwards Appendix for Chapter 2 it to friends and relatives to do the same – in 2A: Definitions of relevant terms 2-40 2B: Explanation of compensation plans 2-43 an endless chain of such letters. In such 2C: Sample MLM compensation plans 2-44 schemes, the vast majority are mathematically 2D: Comparative analysis of direct sales, doomed to lose money. “Pay to play” chain no-product pyramid schemes & MLMs 2-51 letters are illegal. (For the history of how chain 2E: List of MLMs evaluated by Dr. Jon Taylor 2-55 letters evolved into MLMs, see Chapter 10. 2F: Petition – Bruce Craig to FTC’s Pitofsky 2-60 Just like the chain letter, MLM founders 2G: Letter – Bruce Craig to Peter Vander Nat 2-63 assume an infinite market, which does not 2H: Definitions of or related to illegal exist in the real world. They also assume a pyramid schemes in state statutes 2-67 virgin market, which cannot exist for long – 2I: MLM programs can be considered which necessitates that an MLM expand – flat line or pancake schemes 2-73 or “re-pyramid” (my term) – into new markets. Thus, MLM with its endless chains Introduction and summary of recruitment, is inherently flawed, unfair, and deceptive. One of the biggest problems with multi- Twenty years of worldwide feedback level marketing (a.k.a., “network marketing”, tells me that MLM is also extremely viral and or “MLM” for short) is the wide variety of predatory. This is advantageous for the Ch.2- 2 founders, TOPPs (top-of-the-pyramid rather than on the fundamental structural promoters), and the MLM company itself, characteristics that clearly distinguish MLM but works to the detriment of new recruits – from all other forms of business activities. who are being sold a ticket on a flight that We will begin by looking at how others has already left the ground. MLM is an define it and then bring together what light unfair and deceptive practice, if there ever can be shed on the subject from legal and was one. MLM takes new recruits from the regulatory sources and from recent real world into a world of make-believe research. “business opportunities” – and in the We will first look at the definitions of process fattens the coffers of the company, multi-level marketing offered by others its founders, and TOPPs. before advancing a set of causative and When discussing the legitimacy of MLM defining characteristics of a “recruitment- in this book, I use the word “legitimate” in the driven MLM,” or “product-based pyramid broadest sense; i.e., “conforming to scheme.” Then I will offer a definition of recognized principles or accepted rules or MLM that satisfies all of the above criteria. standards,”23 as opposed to narrow legal definitions, which may or may not conform to Examples of Definitions of MLM accepted standards in business practices. This chapter concludes with likely the by others – with commentary only accurate real-world, research-based, From Wikipedia (March 2010): and consumer friendly, definition of the Multi-level marketing (MLM), business model termed “multi-level marketing,” (also called network marketing, or “MLM.” In my opinion, a good definition direct selling, referral marketing, would accomplish the following criteria: and pyramid selling) is a term that

1. Distinguish MLM from all other forms of describes a marketing structure used by some companies as part of their business activity. overall marketing strategy. The structure is 2. Distinguish MLM, or product-based designed to create a marketing and sales pyramid schemes from Ponzi schemes force by compensating promoters of (although there are some similarities) company products not only for sales they 3. Address the question of legitimacy – or personally generate, but also for the sales of lack thereof – of the business model. other promoters they introduce to the 4. Address fundamental flaws of all MLMs. company, creating a downline of distributors 5. Explain the problem of incentivizing and a hierarchy of multiple levels of purchases by participants. compensation in the form of a pyramid. 6. Point to the litany of misrepresentations The products and company are usually marketed directly to consumers and potential characteristic of MLM recruitment. business partners by means of relationship 7. Highlight the industry-wide high loss referrals and word of mouth marketing. rates experienced by participants. “Independent, unsalaried salespeople 8. Emphasize the high attrition rate among of multi-level marketing, referred to as MLM participants. distributors (or associates, independent business owners, dealers, franchise owners, A problem of definitions. Much sales consultants, consultants, independent confusion exists on the subject of what is – agents, etc.), represent the company that and is not – multi-level marketing and produces the products or provides the whether and how it can be distinguished services they sell. They are awarded a from illegal pyramid schemes. All of the commission based upon the volume of definitions by industry defenders as well as product sold through their own sales efforts government agencies focus primarily on the as well as that of their downline organization. behavior of participants and the existence of Independent distributors develop their two or more levels for payout purposes, organizations by either building an active customer base, who buy direct from the company, or by recruiting a downline of

23 independent distributors who also build a The New Merriam Webster Dictionary, Springfield, customer base, thereby expanding the MA, 2008 overall organization. Additionally,

Ch.2- 3

distributors can also earn a profit by makes no mention of MLM or network retailing products they purchased from the marketing in his books directed to company at wholesale price. professional salesmen:

MLM spokesmen clearly crafted this Would you like a technical definition? definition, which Wikipedia uncritically Network marketing is a system for distributing accepted in lieu of definitions of consumer goods and services through networks of advocates that would highlight the inherent thousands of independent salespeople, or flaws in MLM. For example, no mention is distributors. The distributors earn money by made of the endless chains of recruitment selling goods and services and also by and a pay plan that is recruitment-driven, recruiting and sponsoring other salespeople top-weighted, and financed primarily by who become part of their downline, or sales organization. Distributors earn monthly incentivized purchases of the participants commissions or bonuses on the sales themselves. These critical features will be revenues generated by their downline. explained later in this chapter. Here’s what network marketing is and is not: From author Richard Poe:  Network marketing, or multi-level Network marketing is not defined in any marketing (MLM), isn’t illegal, standard dictionary of business terms. Nor do fraudulent, or unethical. network marketers themselves agree on what  Network marketing isn’t an it means. For lack of any clear standard, I opportunity to get rich quick off the suggest the following definition: “Any method payments of others who join the or- of marketing that allows independent sales ganization. That’s a pyramid scheme. representatives to recruit other sales  Network marketing isn’t a pyramid representatives and to draw commissions scheme, which is illegal and unethical. from the sales of those recruits.”24  Network marketing isn’t an This overbroad definition would take in opportunity to get rich quick. Period. many sales organizations that are not  Network marketing isn’t built on considered MLM, such as some insurance simple mathematics where many and real estate agencies. And as with the losers pay a few winners. That’s also a pyramid scheme. Wikipedia definition, no mention is made of  Network marketing isn’t just for the inherent flaws in any MLM system – the salespeople. endless chain of recruitment and a pay plan  Network marketing isn’t expensive. that is recruitment-driven, top-weighted, and Unlike most other business financed primarily by incentivized purchases opportunities, the start-up costs are of the participants themselves. low, almost always less than $500 and often under $100. Zig Ziglar (with Dr. John  Network marketing isn’t a way for Hayes) offers his “technical companies to sell huge amounts of definition” of what he claims inventory to distributors. Network network marketing (MLM) is – marketing isn’t a way for and is not. Below is an distributors to sell stuff that nobody wants or uses. interesting definition put forth by  Network marketing isn’t a license to Dr. John Hayes, in cooperation sell products and services at with prominent salesmanship Salesmanship inflated prices. 25 author Zig Ziglar author Zig Ziglar, who incidentally  Network marketing isn’t for people who aren’t willing to work hard.  Network marketing isn’t for anyone who can’t or won’t follow a proven 24 Wave 3: The New Era in Network Marketing, by system that leads to business success. Richard Poe (Prima Publishing: New York, 1995), p. 7-8 While the first paragraph is quite 25 Network Marketing for Dummies, by Zig Ziglar with descriptive and somewhat accurate, as is John P. Hayes, Ph.D. (Hungry Minds, Inc.: New York, the Wikipedia definition, no mention is made NY, 2001), p. 2 of the inherent flaws in MLM – the endless

Ch.2- 4 chains of recruitment and a pay plan that is through a network of independent business recruitment-driven, top-weighted, and people, not only in the United States but financed primarily by incentivized purchases throughout the world. These independent of the participants themselves. These business people or entrepreneurs then critical features will be explained later. sponsor other people to help them distribute the product or service. This people-helping- Also, most of the items on the list of people process may be continued through what network marketing is not would be one or more levels of earnings. vigorously challenged by knowledgeable experts advocating for consumers, based on A search through the business section of extensive research as reported in this book. a local bookstore store reveals that other authors have written on how to be successful Other authors on multi-level marketing at network marketing28, but without offering any offer weak definitions – or don’t even substantive definition of what they are talking attempt to define MLM. Another prominent about, apparently assuming readers all know MLM author, Dr. Charles King, precisely what they are talking about. This may professor of marketing at the be true of MLM veterans, but feedback I have University of Illinois at Chicago received tells me this assumption may not (with James Robinson), offers always be correct, especially for those being an even weaker – and I would recruited for the first time. suggest misleading – definition that would be almost useless in The FTC chooses a definition of making the distinctions multi-level marketing that only creates confusion. In its 2008 announcement by discussed above: Dr. Charles King the FTC of its Revised Proposed Business Network marketing is the low-cost, and Opportunity Rule, exempting now high-tech, industry that invites you to MLM from having to comply with build your own business and earn a potentially high income while working from the Rule, the FTC quoted an home on your own schedule. You earn article in which the following immediate income and serious long-term definition was advanced:

residual income by selling products and Multi-level marketing is one form of services directly to consumers and direct selling, and refers to a business model 26 convincing others to do the same. in which a company distributes products through a network of distributors who earn Again, as with the Wikipedia definition, income from their own retail sales of the no mention is made of the fundamental product and from retail sales made by the flaws inherent in any MLM system – endless distributors’ direct and indirect recruits. chains of recruitment and a pay plan that is Because they earn a commission from the recruitment-driven, top-weighted, and sales their recruits make, each member in the financed primarily by incentivized purchases MLM network has an incentive to continue of the participants themselves. recruiting additional sales representatives into As an example of other authors who have their “down lines.“ - Peter J. Vander Nat and made weak attempts to define multi-level William W. Keep, “Marketing Fraud: An 27 Approach to Differentiating Multilevel marketing, MLM author David Roller Marketing from Pyramid Schemes,” 29 suggests a definition that is rosy and descriptive, but not very helpful in making clear distinctions between MLM and other home- 28 One example is The Ultimate Guide to Network based businesses: Marketing: 37 Top Network Marketing Income

Multi-level marketing or network Earners Share their Most Preciously Guarded Secrets marketing is a system by which a parent to Building Extreme Wealth, edited by Joe Rubino. John Wiley & Sons, Inc., 2006. Another book is by company distributes its services or products MLM promoters Yarnell, Mark, and Reid, Rene, Your First Year in Network Marketing: Overcome Your 26 King, Charles W. and Robinson, James W., The Fears, Experience Success, and Achieve Your New Professionals: The Rise of Network Marketing as Dreams!” Three Rivers Press, 1998. the Next Major Profession, Three Rivers Press, 2000 29 Journal of Public Policy & Marketing (Spring 2002), 27 Roller, David, How to Make Big Money in Multi-level (“Vander Nat and Keep”), p. 140. (Cited in Footnote Marketing, Prentice Hall, 1989 34 at bottom of page 15 of RPBOR) Ch.2- 5

At a workshop hearing on the form for Similarly, since “multi-level marketing” the final Business Opportunity Rule, I sounded too much like a pyramid scheme, pointed out that almost any direct selling MLM promoters coined the term "network company could circumvent the Rule by marketing." Then, since it would sound even paying commissions to two or more levels of less pyramid-like, they sought to be called sales persons, who would have in some "direct selling" companies. So one by one, way been involved in recruiting new sales MLMs joined the Direct Selling Association persons. In fact, many sales organizations and now boldly declare that they are “direct do this, but do not consider themselves selling companies,” since they are members “multi-level marketing.” of the DSA.30 The DSA now divides its With this definition, together with the membership into “single level” and “multi- MLM exemption, the Rule was rendered level” pay plans. almost totally ineffective in curbing abuse. It The Direct Selling Association, has in is a tacit admission by the FTC that it is recent years lobbied aggressively on behalf of giving up on its mission to protect the MLM industry to stop or water down consumers against “unfair and deceptive proposed or existing legislation that protects practices” in this very important arena. As consumers against what I call “product-based will be seen from further analysis, it would pyramid schemes”; i.e., MLMs. They also be difficult to conceive of a more unfair and work to defeat efforts of consumer advocates deceptive practice than MLM, to say nothing to warn against product-based of its extremely viral and predatory nature. pyramid schemes, and to Again, in this FTC definition, as with the convince the public and the Wikipedia definition, no mention is made of media of the legitimacy of MLM the inherent flaws in any MLM system – and of their stated intent to endless chains of recruitment and a pay plan protect the public from unethical practices. that is recruitment-driven, top-weighted, and In 2006, the FTC proposed its Initial financed primarily by incentivized purchases Business Opportunity Rule, which would of the participants themselves. require sellers of business opportunities to disclose certain information to protect The DSA re-brands MLM as “direct consumers. The excerpt below is taken from selling.” The DSA (Direct Selling comments the DSA submitted, objecting to Association) was once an organization including MLMs in the Rule. The DSA’s efforts dedicated to advancing the interests of what to equate MLM with legitimate direct selling were then legitimate direct selling and to justify its exclusion from the Rule are companies like Fuller Brush and World spelled out, as is their definition of MLM:

Book Encyclopedia. But what has happened DSA defines direct selling as: The sale of in recent decades could be illustrated by a a consumer product or service, in a face-to- farmer who has pigs and horses for sale. He face manner, away from a fixed retail location. gets more money for horses, so he attaches . . Multilevel marketing, also known as horse hairs on the buttocks of the pigs and network marketing, is a compensation marches them into the horse corral and structure, not a sales strategy. In a proclaims, "See there, they are no longer multilevel compensation plan, independent pigs, but horses - because they are in the consultants are compensated based not horse corral." only on one’s own product sales, but on the product sales of one’s downline (those individuals the direct sales-person has recruited, or recruits of recruits.) In contrast, in a single level compensation plan, independent consultants are compensated based solely on one’s own product sales. Companies using a multilevel compensation structure may use either a person-to-person or party

Pigs are not horses!

30 See the section “The DSA/MLM lobby” in Chapter 10 Ch.2- 6

plan sales strategy. Eighty-four percent of themselves. These critical features will be direct selling firms use some form of explained later in this chapter. multilevel compensation, and virtually all Needed: A more accurate, research- new companies entering direct selling are using some form of multilevel based definition of MLM that compensation. 31 addresses structural flaws in the model – and harm to participants It should be noted that the DSA definition of direct selling as “the sale of a consumer This book uses the terms “Recruitment- product or service, in a face-to-face manner, driven MLM” (implying an emphasis of away from a fixed retail location” could apply recruitment over selling) and “Product- to MLMs that do much direct selling. But what based Pyramid Scheme”32 as inter- the DSA definition fails to do is to state what changeable terms. And as discussed legitimate direct selling is not; i.e., unlimited previously, these programs have also been recruitment of endless chains of participants called “Multi-level Marketing,” “Network as primary customers. Marketing,” even “direct selling” – though Another statement in the DSA little selling to the public may take place. comments is remarkable: “Recruiting is the More negative sounding titles include lifeblood of the industry.” This is a startling “pyramid selling,” “entrepreneurial chains,” admission of the focus on recruitment, “chain selling,” “multi-level selling,” etc. In which is true of all product-based pyramid this book, a “recruitment-driven MLM” uses schemes. My analysis of the compensation a compensation plan that rewards recruiting plans of over 500 MLMs, including DSA so much more than selling that there is little firms, confirms this. Slight rewards for incentive to sell products. “MLM” is a retailing, together with overpriced products, generic acronym for any type of multi-level make the effort to sell products to non- or endless chain selling program, so for participants a comparative waste of time. brevity, we will use ‘MLM” most of the time. Recruiting must be the focus for anyone No-product pyramid schemes are fairly seeking to profit from MLM. easy to identify, and they seldom last long The suggestion that “the vast majority without law enforcement shutting them of salespeople work only a few hours per down. But when products are offered, and week, with modest financial goals in mind” when consumers are presented with an will be found in subsequent chapters to be income “opportunity” with multiple levels of totally misleading because one cannot build “distributors,” it is not easy for some to and maintain a large downline working part- decide whether or not it is in fact an time, seasonally, or with modest financial exploitive pyramid scheme. Unfortunately, goals. And without a large downline, it is some of the most damaging programs very unlikely that an MLM participant will manage to escape legal action. profit. (See Chapter 7.) Virtually all who After processing extensive data and work part-time in MLM lose money, after posting analytical reports on a web site, I subtracting all expenses, including purchase found myself interacting with the top experts of products necessary to qualify for commissions. in the field. I began offering research and And again, as with the Wikipedia training through the non-profit Consumer definition, no mention is made of the inherent Awareness Institute that I had formed years flaws in any MLM system – endless chains of earlier for other projects – all financed out of recruitment and a pay plan that is recruitment- my own pocket. driven, top-weighted, and financed primarily by incentivized purchases of the participants FTC rationale for considering pyramid schemes unlawful. The Federal Trade Commission Act states that “Unfair 31 #178 FTC Matter No.: R11953 16 CFT Part 437 methods of competition in or affecting Notice of Proposed Rulemaking: Business Opportunity Rule, Comments #522418-12055, -58, - 32 61, -66, -70, -74, -79, -83,-87, -92, and -96 For a brief history of classic, no-product pyramid schemes, and MLM, or product-based pyramid schemes, see Chapter 10. Ch.2- 7 commerce, and unfair or deceptive acts or practices in or affecting commerce, are MLMs are recruitment-driven. I refer to hereby declared unlawful.”33 While the FTC MLMs which recruit aggressively as Act does not specifically address pyramid “recruitment-driven MLMs,” as opposed to schemes, such schemes have been hypothetical “retail-focused MLMs,” which deemed unlawful under the above clause in would allow a person to earn significant profits the Federal Trade Commission Act.34 from retailing products to end users. As will be demonstrated in this and Understanding the difference is the key to subsequent chapters, using the same identifying the features in MLM that cause rationale, MLM should likewise be declared harm to participants – which will be explained unlawful, as it is even more unfair and in later chapters. Actually, retail MLMs would deceptive – and more viral and predatory – be extremely rare. In fact, I found no retail- than are classic, no-product pyramid focused MLM compensation plans out of schemes. The harm is many times that for a hundreds that I have reviewed. no-product scheme. For example, in a 1-2-4-8 no-product pyramid scheme, 14 persons lose their In-home demonstrations ("party plans") investment which goes to one person at the top. But in a typical MLM, or product-based pyramid, a handful of participants profit at the expense of thousands beneath them who lose money after paying for products, sales “tools,” and other business expenses. The average loss rate for MLMs is approximately 99.7%. In fact, it can be demonstrated that the chances of profiting from a classic no- product pyramid scheme is 50-100 times as Party plans do some retailing. The great as the odds of profiting from a typical closest to a retail-focused MLM would be an MLM, or product-based pyramid scheme.35 “in-home demonstration” program, or “party And over 100 typical misrepresentations plan,” which features sales at parties have been identified that are used in MLM sponsored by demonstrators. But determining whether or not the party plan is still “. . . unfair or deceptive acts or recruitment-driven and financed primarily practices in or affecting commerce, through purchases by participants would are hereby declared unlawful.” While require analysis of their compensation plans the FTC does not specifically address and average earnings data, which most such pyramid schemes, such schemes companies have not as yet been willing to provide to the general public. So they remain have been deemed unlawful under the in somewhat of a grey area in my research. above clause in the Federal Trade Commission Act (FTC Act, Section 5). Confusing comparisons. MLM is Using the same rationale, MLM should often compared to legitimate alternative likewise be deemed unlawful, as it is business models, such as franchising, direct even more unfair and deceptive, and sales, insurance, and product distributor- more viral and predatory, than classic, ships. This adds confusion in the minds of no-product pyramid schemes. consumers and law enforcement officials. However, my research suggests that clear recruitment campaigns. 36 . differences can be seen. As explained above, one common strategy for MLM companies to build 33 Section 5(a)(1) of the Federal Trade Commission Act, 15 U.S.C. 45(a)(1) credibility is to go to great lengths to be 34 In re Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975) identified as “direct sales” organizations. 35 See Chapter 7. However, after rigorous comparisons of 36 See Chapter 8: “MLM – a Litany of Misrepresentations.” Ch.2- 8 legitimate business models with why they are so important. Decades ago, compensation plans of “recruitment-driven psychologists experimenting with both MLMs”, when the four characteristics animals and people learned that you get the described below are taken together, clear behavior you reward. For example, if you distinctions between legitimate and place a dog in a room with two bowls, the illegitimate (using the FTC standard of “unfair first containing a pound of beef, and the and deceptive practices”) can be seen. second an ounce of dry dog food, invariably Interestingly, the four characteristics, the dog will choose to eat from the first bowl. which when taken together differentiate these programs from legitimate businesses, are the same features that cause an extremely high loss rate and other problems for participants. I call them “causal and defining characteristics of product-based pyramid schemes” because they both cause the harm and also serve to define MLMs as You get the behavior you reward. product-based pyramid selling schemes, or recruitment-driven MLMs. Properly applied, Similarly, since an MLM compensation they can also be highly effective in plan specifies how participants are rewarded, identifying programs that violate federal and it reveals whether the primary income state laws against pyramid schemes. emphasis is on recruiting or on retailing – and therefore, whether or not a given MLM Inadequate legal definitions. Most of is a disguised pyramid scheme. the laws and statutes were crafted before the MLM spokesmen maneuver to divert structure, dynamics, and effects of product- authorities from examining how participants based pyramid schemes were fully are rewarded. They speak of the validity of a understood, so the definitions within anti- company’s products, the integrity of its pyramid statutes do not accurately reflect the leaders, and the company’s solid financial root causes of the problems. They tend to condition. It seems that the one thing MLM focus on behavior of participants, rather than leaders do not want regulators to understand on underlying structural features. – the compensation plan – is the one thing However, there is enough validity in the investigators must grasp in order to answer present legal definitions of pyramid schemes in the question of where the emphasis is – on most jurisdictions that enforcement against company payout resulting primarily from such schemes can be effective if the principles recruiting (usually from commissions for in this paper are understood and applied. This product sales to downline recruits), or is true regardless of the complexity of the primarily from retailing to consumers outside compensation plan of any given MLM. of the MLM’s network of participants. To FTC guidelines and most state statutes dramatize the importance of concentrating on include a key element in defining pyramid the compensation plan, rather than people or schemes – the payment of money by the products, read and enjoy “The Parable of the company in return for the right to recruit other Missing Children” in Appendix 9A (Chapter 9). participants into the scheme. If the primary The problem of evaluating MLM emphasis is compensation from recruiting, programs is further complicated by a wide rather than from the sale of products to end array of complex MLM payout formulas, or users, it is considered a pyramid scheme. compensation plans. The problem of How such primary emphasis is to be identifying emphasis on recruiting vs. retailing determined has until now been a formidable in a compensation plan, as well as consumer challenge for investigators. harm, can be greatly simplified by For some of the relevant terms used in understanding the four characteristics discussions about MLM, go to Appendix 2A. discussed below – commonalities which are generic to all MLMs, or product-based Persons investigating MLM must pyramid schemes. (There is also a fifth understand compensation plans and characteristic that appears in almost all MLMs Ch.2- 9 which amplifies the fourth characteristic.) For MLMs, including the 500 MLMs I have since explanations of various types of MLM analyzed. These were compared to compensation plans, go to Appendix 2B. characteristics of no-product pyramid schemes, as well as to legitimate businesses It is vital that we understand the to which MLM is often compared, such as commonalities and distin- direct sales, franchises, distributorships, etc. guishing features that separate (See Appendix 2D for details of this analysis.) MLM from all other forms of From this comparative analysis, a trained eye can see that when one focuses business activity. on the causes of the problems with MLMs, which are compensation plans with perverse reward features (enriching a few at the top at MLM compensation plans can get the expense of a huge downline who lose quite complex. Appendix 2C illustrates just money), certain characteristics, or “red flags,” a few examples out of hundreds of MLM become apparent. Four key characteristics compensation plans, showing the are both causative (causing high loss rates) complexity of only a portion of a typical and defining (clearly distinguishing pyramid MLM compensation plan. Many of the plans schemes from legitimate businesses). I’ll are far more extensive and complex than refer to these causative and defining these. This makes it difficult to compare characteristics as “CDCs.” plans from different MLMs. These widely The four characteristics (CDCs) of varying plans also illustrate the need for an recruitment-driven MLMs are causal, understanding of the commonalities and defining, and legally significant. The set distinguishing features that separate MLM from of four characteristics below were found to all other forms of business activity. be exclusive to recruitment-driven MLMs

What is the difference between (which included all MLMs in my sample of recruitment-driven MLMs and 500 programs). Based on careful analysis of (hypothetical) retail-focused MLMs? available data, MLM programs with all of these characteristics have a shocking loss Companies with all four of the following 37 characteristics of a product-based pyramid rate – approximately 99.7% of ALL scheme can be classified as recruitment- participants lose money (after subtracting driven MLMs, as differentiated from ALL expenses)! And if you eliminate TOPPs hypothetical retail-focused MLMs, which (top-of-the-pyramid promoters) from the would primarily reward those who sell calculation, the loss rate is closer to 99.9%. products. In reality, MLMs (with the possible This is not a legitimate business by any exception of some party plans) are reasonable measure. essentially closed systems, which sell In the light of these odds, typical products at retail primarily to program promises made by MLM promoters of participants and cooperating family lucrative incomes are misleading, except for a members – seldom to the general public. few at the top of the pyramid who got in early. These product purchases could be Again, it is important to recognize that – considered disguised or laundered  These four characteristics are causal investments in a product-based pyramid because they identify the cause of the scheme. TOPPs (top-of-the-pyramid harm or consumer losses. promoters), founders, and company  They are defining because they clearly executives are rewarded in commissions for separate MLMs, or product-based the sale of products to a revolving door of pyramid schemes, from all other forms of unwitting downline recruits. commercial activity.  And they are legally significant because How these defining characteristics they answer the question that law were derived. Early in my research, after enforcement has not answered in cases comparative analysis, I was able to identify a list of characteristics that are common to all 37 See Chapter 7: “MLMs Abysmal Numbers” Ch.2- 10

before; i.e., how the primary emphasis on income from recruiting (as opposed to 1. Each person recruited is selling direct to consumers at retail prices) empowered and incentivized to can be determined from the reward recruit other participants, who are system (compensation plan) – rather than likewise empowered and motivated to from complaints, which simply are too recruit still other participants, etc. – cumbersome and unreliable in this arena. Besides, as will be discussed in Chapter in endless chains of empowered and 9, victims of endless chains rarely file motivated recruiters recruiting complaints with law enforcement. recruiters – without regard to market saturation. It is the synergistic effects of these four When analyzing a program, prospects CDCs working together in an MLM that could ask: Is unlimited recruiting allowed, and cause the extraordinary loss rates are those who are recruited empowered and characteristic of these schemes. spurred on by incentives (such as overrides Interestingly, most of the laws that might from downline purchases, rank advancement, implicate MLMs as pyramid schemes are etc.) to recruit additional participants, etc. – so based on one or more behavioral effects of that the effect is unlimited recruiting of the scheme (such as whether or not sales empowered and motivated recruiters in an are made to non-participants) or behavior of endless chain of recruitment? participants, and not the essential causes of the problems; i.e., the underlying structure, This unlimited recruitment of endless or compensation plan. As explained already, chains of participants is the great underlying rewards drive behavior. flaw in MLM. In fact, all pyramid schemes, No wonder law enforcement has been so chain letters, and MLMs have this unlimited confused and inconsistent in this arena. recruitment characteristic in common. They Even so, using this analysis, law also assume virgin markets, which don’t exist enforcement agencies can work within for long – which means they either collapse or existing laws. Attempting to change the laws expand (“re-pyramid”38) into new markets. is risky, since the MLM lobby (Direct Selling Since MLM depends on unlimited Association) could then influence legislators recruitment of endless chains of participants, to pass deceptive “anti-pyramid” laws that it is fundamentally flawed, unfair, and are actually favorable to MLM, as they have deceptive. It is deceptive because prospects already done in several states. are sold on an income opportunity that is Twenty years of research and feedback primarily an opportunity for those placed at confirm this analysis, including a one-year the beginning of the endless chains of experiential test, direct observations of recruitment – usually those at or near the top numerous MLM opportunity meetings; of the pyramid of participants. New recruits communications with thousands of are being sold a ticket to a flight that has participants (and ex-participants and family already left the ground. members), executives from a variety of For important background information MLMs, and with consumers as MLM on the endless chain feature of MLMs, read prospects; consultations with top MLM the letters to FTC officials by Bruce Craig, experts and attorneys; the collection and former assistant to the Wisconsin Attorney processing of available data (including official General in Appendixes 2E and 2F. company reports); analysis of over 500 MLMs with all types of compensation plans; and surveys of consumers and tax professionals.

The four CDCs of recruitment-driven MLMs, or product-based pyramid schemes, that cause the harm and that clearly distinguish between MLM and legitimate direct selling 38 “Re-pyramid” will be explained in Chapter 3. Ch.2- 11

Exhibit 2a

CDC* (“Red Flag”) #1: Every MLM incentivizes unlimited recruitment of a network of endless chains of participants. This dependence on recruitment is not the case with legitimate direct selling, which focuses on sales to customers, not to the network of participants.

The endless chains of recruiters recruiting

recruiters – works on the same principle as illegal “pay to play” chain letters or classic, no- product pyramid schemes.

*NOTE: These CDCs (or “red flags”) are causative and defining characteristics of recruitment-driven MLMs, or product-based pyramid schemes. They are causative in that – taken together – they cause the extremely high loss rates suffered by participants, and they are defining in that they clearly define product-based pyramid schemes as differentiated from legitimate direct selling and other packaged business opportunities. All 500 MLMs I studied demonstrated this characteristic in their compensation plans. Ch.2- 12

MLM is also viral and predatory – as opposed to all those on the bottom of a rapidly expanding chains of recruitment from pyramid scheme actually losing money. A state to state and from country to country as more apt analogy for MLM as an income it targets and defrauds the most vulnerable in opportunity would be that of an iceberg, the population. But it is sufficiently deceptive instead of a pyramid. Those few who profit that even some people who should know from MLM stick out like an iceberg, with the better are victimized. vast majority under water, or in a losing These features should have been position, after subtracting expenses. sufficient grounds for the FTC to consider Had all forms of endless chain marketing MLMs as unfair and deceptive practices, and schemes been declared illegal (as happened in Wisconsin in 1970, but seldom enforced therefore illegal. However, that opportunity 41 was missed in the 1979 ruling that Amway since ), this confusion over definitions would was not a pyramid scheme, assuming certain be minimal. Based on DSA data on worldwide “retail rules” were followed. sales by MLMs (which represent losses to It is interesting to note that in the earlier 99% of participants) I estimate that since 1979, Koscot case39, the court noted, “The aggregate losses totaling hundreds of billions Commission has previously condemned so- of dollars by hundreds of millions of unwitting called “entrepreneurial chains” as possessing victims worldwide could have been prevented. an intolerable capacity to mislead.”40 This MLM in its present form would not have capacity has been demonstrated in literally existed, and you would not be reading this. thousands of MLMs (many now defunct) fashioned after the model of entrepreneurial The ill-fated Amway decision – and chains which the FTC has allowed following the “retail rules.” In 1979, FTC attorneys the 1979 Amway decision. Unfortunately, this were outfoxed and outgunned by Amway prophetic warning of an “intolerable capacity attorneys. FTC Chairman Robert Pitofsky to mislead” was set aside, and the deceptions ruled that Amway was “not a pyramid continued unabated. (See Chapter 8 for lists scheme,” assuming the implementation of its of at least 111 typical MLM misrepresentations.) “retail rules” that Amway claimed it would MLM promoters often argue that all voluntarily enforce. These rules can be organizations are organized as pyramids, summarized as follows: (1) distributors were with a few at the top and many at the to sell or consume 70% of the products they purchased each month (refined in later court bottom and with those at the top being paid 42 the most. If this were the only distinguishing cases to mean sales to non-participants ), characteristic of a pyramid scheme, they (2) they must be able to prove a sale to each would be right. But the endless chains of of ten customers each month, and (3) reasonable buy-back provisions would be recruitment of participants as primary 43 customers – with money to those at the top permitted. Though not enforced by the FTC coming from purchases (amounting to or by the MLMs, these retail rules have been losses) of those at the bottom – is far more used as a benchmark in other MLM cases. accurate and discriminating. The rules were merely given lip service. So the stacking of recruits into a pyramid In practice, the first two of these rules are of participants for the purposes of payout is unenforceable (in the present regulatory secondary to the chaining aspects. However, environment) and are generally ignored by it should be noted that in corporations and MLMs. The Amway decision opened the government organizations, even those at the floodgates for thousands of the most unfair, very bottom at least earn a minimum wage – deceptive, viral, and predatory MLMs ever

39 In re Koscot Interplanetary Inc., 86 F.T.C. 1106, 41 Tax Returns of the Top Amway Direct Distributors 1181 (1975), aff’d.,Turner F.T.C., 580 F. 2d 701 (D.C. in Wisconsin, Bruce Craig, op cit Cir. 1978) 42 Webster v. Omnitrition, IIB, filed in the Appeals 40 Holiday Magic, Inc., Docket No. 8834, slip op. pp. court for the U.S. District Court for the Northern 11-14 [84 F.T.C. 748 at pp. 1036-1039] (Oct. 15, District of California, March 4, 1996. Also statements 1974); Ger-Ro-Mar, Inc., Docket No. 8872, slip op. by FTC officials James Kohm and Debra Valentine – pp. 8-12 [84 F.T.C. 95, at pp. 145-149] (July 23, referred to later in this report. 1974), rev'd in part 518 F.2d 33 (2d Cir. 1975). 43 See 93 F.T.C. 618, 716-17 (1979). Ch.2- 13 devised. Tens of millions of consumers Third, MLMs engage in aggressive and recruited into MLMs worldwide will continue to unlimited recruitment campaigns and use pay heavy prices for that decision – unless the DSA to influence public opinion to FTC and/or state legislators and law accept and define their recruitment schemes enforcement officials muster the will to as legitimate direct selling opportunities. address the issue of widespread MLM abuse. And fourth, there is a revolving door of In spite of the confusion over definitions of newly recruited participants who are what constitutes a pyramid scheme, much can constantly replacing those who quit. Thus, in still be accomplished within the present legal MLM there is a continuous collapse of the framework. This chapter focuses on clarifying base of the pyramid, involving the churning of those definitions and on identifying the newly recruited participants. This allows those combination of features in the compensation at or near the top of the pyramid to maintain plan that cause the greatest harm. their positions and their high income levels. It is through actions like this, indicative Market collapse happens quickly. of continuous collapse, that MLMs, or MLM defenders argue that saturation never product-based pyramid schemes, can survive happens, which proves an MLM is not a longer without total collapse than no-product pyramid scheme. But total saturation is pyramid schemes. Losses from the absurd. Why would McDonald’s need continuous collapse of the pyramid are borne 100,000 fast food outlets in a city of 100,000 by the new recruits cycling through. people? One or two may be adequate. So Furthermore, because of the prolonged with MLM. Market saturation may be saturation and collapse, many more reached when a city has only five or ten participants are adversely affected in product- distributors, with new ones finding it more based schemes than in no-product schemes. and more difficult to recruit more participants. Strategies used by MLMs to compensate for market saturation and to avoid market Re-pyramiding to avoid market collapse will be discussed further in Chapter 3. saturation and collapse. When pyramid Are participants buyers or sellers? promoters introduced product purchases as Unlimited recruiting in MLMs also changes the means for financing their schemes (then the marketing nature of the system from one dubbed “multi-level marketing”), some found of a network of “distributors” to a network of ways to avoid ultimate collapse. First, MLM buyers. The normal distinction between recruiters used a hard-sell approach to focus buyers and sellers is blurred – even attention on the quality of the products, and evaporated. The sellers are the buyers, and away from endless chain recruiting. the buyers are the sellers – to themselves As a second strategy, major MLMs and their families. Also, we see the fallacy introduce new product lines or divisions, enter of the claim that MLM is removing the new demographic markets or countries, or “middle man” in their marketing. Actually, in change the name of the company and an MLM, middlemen may number in the introduce the package as a whole new thousands in multiplying downlines. company with a “different” product or service New MLM recruits buy products mainly emphasis – as Amway did when it morphed to qualify for profits from recruiting others, into “Quixtar” in the U.S., while keeping the rather than from any real need for the “Amway” name in overseas markets. Nu Skin products or from any expectation of profit shifted it’s recruiting to Asia to the point that from retailing. And as people tire of being 85% of its revenues came from Asia. And Nu solicited, the perceived opportunity to find Skin developed new product divisions, such as willing buyers eventually diminishes to a Interior Design Nutritionals (IDN), Big Planet trickle. Since the retail market is a phantom (internet services), and Pharmanex, and one, in order to increase the base of Photo-Max – through which it could cycle new recruiting prospects who will pay retail to recruits. This is a process I call “re-pyramiding;” “play the game,” we see promoters i.e., opening new markets in other countries introducing new product divisions or opening and/or by starting new product divisions and up new markets to recruit in other areas. repeating the cycle all over again. Ch.2- 14

Recruitment-driven MLMs engage in 3. Surveys of ex-distributors reveal that re-pyramiding to continue growing – and few continue buying the products after can become like Ponzi schemes. When quitting. They recall that little if any direct MLM promoters re-pyramid into other areas selling occurred outside of the network of to make it possible for the first investing distributors and their own families. (Surveys of participants to earn commissions from ex-distributors are more valid than those of purchases of new recruits, the MLM can be current distributors, who may have contracted said to have evolved from a pyramid to do a limited amount of selling to non- scheme into a type of Ponzi scheme – participants to keep their distributor license.) which is illegal in almost all jurisdictions. 4. We know from surveys conducted in Ponzi schemes are programs in which new areas of intense MLM activity that few sales investors are repaid, from the investments are made directly to consumers who are not of new investors.44 (The persons doing the in the network of participants.45 selling remain the same.) In MLM, without 5. Little if any direct selling continues in re-pyramiding, into new markets, collapse is an area two or three years after an MLM inevitable as market saturation makes future finishes its recruitment blitz through the area. prospects resistant to participation. 6. To counter dwindling sales due to a MLM proponents argue that drop-off in recruiting, the MLM engages in re- replacement of continual dropouts by pyramiding; i.e., recruiting in other areas or ongoing recruitment is like other direct sales shifting to new product divisions. MLM businesses. But this is a fallacy. Later promoters can then sell to new recruits. recruits never have the same opportunity as 6. Signs of reporting inconsistencies earlier entrants due to market saturation. can reveal a lack of direct sales. In the case of Nu Skin, sharp discrepancies appeared Why is recruiting emphasized over between U.S. revenues reported to the SEC retailing? Unlimited recruiting of recruiters, and those reported to the FTC and to combined with the other factors explained recruits in the amount of sales that were here, creates enormous leverage. Rewards occurring at retail prices. This was blatant for recruiting a large downline are so much evidence of misrepresentation.46 greater than for retailing products that 7. In my test of Nu Skin’s program, I saw participants see no point in spending time over 400 Nu Skin distributors over a one-year and effort retailing, except for token sales period, but I can recall only one who made a (often purchases in the names of relatives serious effort to sell very many of Nu Skin’s who become “counterfeit customers”) to expensive supplements directly to non- satisfy “retail rules.” Again, “you get the distributors. She sold to rich neighbors who behavior you reward.” The “primary were sympathetic to her desire to “succeed.” emphasis on income from recruiting” test of a pyramid scheme is thus satisfied. For an excellent analysis of the problems The following items summarize the resulting from the FTC’s allowing endless evidence that recruitment-driven MLMs do chain recruitment schemes (MLMs) to not engender any significant retail market: continue, read the letters written by Bruce 1. The compensation plan rewards the Craig, former Wisconsin Assistant AG, to FTC recruitment of a downline so well that there Chairman Robert Pitofski47 in Appendix 2F is little incentive to sell directly to consumers. and to FTC economist Dr. Peter J. Van der 2. An analyst can subtract all incentivized Nat48 in Appendix 2G. purchases by new distributors and their families from total revenues from that area on the company’s financial report. If the volume 45 “Survey of Tax Preparers”, by Jon M. Taylor, left over is minimal, direct selling is not the (posted in 2004 on website for mlm-thetruth.com) 46 major thrust of the company. REPORT OF VIOLATIONS of the FTC Order for Nu Skin to Stop Misrepresenting Earnings of Distributors, by Jon M. Taylor, filed with the FTC November 20, 44 Ponzi Schemes, Invaders from Mars, & More 2002 Since that time, Nu Skin has not reported retail Extraordinary Popular Delusions and the Madness of sales that they could not prove had occurred. Crowds, by Joseph Bulgatz, (New York: Harmony 47 Dated February 20, 2000 Books, 192), pages 11-45 48 Dated April 24, 2001 Ch.2- 15

Exhibit 2b

CDC* (“Red Flag”) #2: Advancement in a hierarchy of multiple levels of participants (“distributors,” ”associates,” etc.) is achieved by recruitment and/or by purchase amounts, rather than by appointment.

MLM is all about getting in early - or climbing to the top of the pyramid - where the big money is made – just like any other pyramid scheme..

*NOTE: These CDCs (or “red flags”) are causative and defining characteristics of recruitment-driven MLMs, or product-based pyramid schemes. They are causative in that – taken together – they cause the extremely high loss rates suffered by participants, and they are defining in that they clearly define product-based pyramid schemes as differentiated from legitimate direct selling and other packaged business opportunities. All 500 MLMs I studied demonstrated this characteristic in their compensation plans.

Ch.2- 16

2. Advancement in a hierarchy of subtraction of all costs from revenues to figure multiple levels of participants profits is ignored. Such purchases would be (“distributors,” ”associates,” etc.) is made from less expensive sources if serious achieved by recruitment and/or by comparison shopping were done. purchase amounts, rather than by Close examination reveals that both advancement and income are dependent appointment. primarily on downline recruiting and on Ask: Does a participating “distributor” “internal consumption” (sales to participants advance one’s position or rank (and in the scheme). If participants must recruit potential income) in a hierarchy of multiple and buy products to be successful, and if levels of participants by recruiting other the pay plan’s primary rewards are for “distributors” under him/her, who in turn building a downline, it should be considered advance by recruiting distributors under an illegal pyramid scheme. them, etc.? Or by buying products to qualify Exception – Selected distributors at certain levels in the compensation plan? given priority. Often during the startup of a In MLM, rank advancement in the new MLM, or when an MLM enters a new pyramid is determined not by appointment, country, selected distributors, or TOPPs but by time of entrance into the program, by (top-of-the-pyramid promoters), are recruiting success, and by volume of products assigned top positions arbitrarily by the purchased by one’s group. When persons are founders. Nepotism sometimes appears, recruited into such a program and then given such as when favored positions are incentives to buy products, they are being extended to family members of the “leveraged” for the profit of those above them. founders. This is unfair to those who come They may think they are advancing, when in in later, who must aggressively recruit and fact they are often being manipulated into buy products to have any hope of advancing buying more products and recruiting more to the top where the money is made. people to benefit those above them.

Are MLM “distributors” really distributors? When the pay plan rewards recruits far more for recruiting others than for retailing products or services, and when purchases are “incentivized,” or tied more to advancement in the scheme than to the sale of products and services to non-participants, it is a misnomer to refer to them as “distributors.” (Some MLMs use other terms for participants, such as “representatives,” “associates,” etc.) This is why I often place such terms as “distributors,” “associates,” “representatives,” etc., in quotation marks. It is more correct to refer to them as “investing participants.” Correctly viewed, an accumulation of such incentivized purchases over a period of time constitutes a substantial investment in a pyramid scheme. (See #3 below) Unfortunately, MLM participants are led to believe that purchases of goods and services are not part of the cost of doing business, so they may not subtract these purchases when figuring supposed “income.” Participants are typically not wise business managers so the customary Ch.2- 17

Exhibit 2c

CDC* (“Red Flag”) #3: “Pay to play” requirements are met by ongoing “incentivized purchases,” with participants the primary buyers.

MLM participants subscribe to minimum product purchases in order to "play the game" – to qualify for commissions and to gain or maintain advancement in the scheme

*NOTE: These CDCs (or “red flags”) are causative and defining characteristics of recruitment-driven MLMs, or product-based pyramid schemes. They are causative in that – taken together – they cause the extremely high loss rates suffered by participants, and they are defining in that they clearly define product-based pyramid schemes as differentiated from legitimate direct selling and other packaged business opportunities. All 500 MLMs I studied demonstrated this characteristic in their compensation plans. Ch.2- 18

3. “Pay to play” requirements are met by ongoing “incentivized purchases,” If participants must recruit and with participants the primary buyers. buy products to be successful, or if the pay plan’s primary rewards Ask: Are “distributors” who are recruited presented with significant “pay to play” are for building a downline, it options; i.e., are they encouraged to make should be considered an illegal initial or ongoing investments in pyramid scheme

“incentivized purchases” in order to take advantage of the “business opportunity,” How much is actually invested in the and to continue qualifying for advancement scheme? MLMs typically charge a nominal in – or overrides and bonuses from – the fee to be licensed as a distributor. This is MLM company? usually less than $100 to avoid raising the

What are “incentivized purchases?” – eyebrows of law enforcement officials – and or “pay-to play49 purchases” – or “pay for to escape subjecting the MLM program to your paycheck”? I coined the term more strict guidelines as a franchise, “incentivized purchases” to refer to the security, or “business opportunity.” practice of tying purchases of products from However, in the typical scenario, the an MLM company with requirements to enter fee for initial registration is merely the the “business opportunity” option, to qualify for beginning of the total MLM investment. One commissions, and to qualify for rank must add incentivized ongoing purchases, which may total hundreds, or even advancement in the hierarchy of “distributors” 52 – who are in effect merely participants making thousands of dollars a year. They pyramid scheme investments disguised (or constitute a substantial portion of the cost of laundered) as purchases. They are also participating in the “business opportunity.” called “pay to play” purchases. (See Appendix Whether they are used, sold, given away, or 2A for definitions of relevant terms.) stored, is irrelevant to the analysis. Incidentally, William Ackman in his attack Escalating incentives to continue on Herbalife50 used very descriptive term for purchasing products to qualify for higher this feature – “pay for your paycheck.” commissions rates and/or ever-higher levels in the hierarchy of participants often lead Percentage of revenues accounted for “distributors” to hyper-consume products or to by internal consumption – a key legal give away a lot of samples. Many fill their issue. In pyramid scheme cases, the garages with products they don’t need. The percentage of purchases accounted for by argument that they would have purchased the participants’ personal consumption – as products anyway, and that these purchases opposed to sales to non-participants – has should not be considered an expense of become a litmus test for determining if an doing business, does not hold water. Upon MLM is an illegal pyramid scheme. MLM quitting, most cancel product subscriptions. executives may attempt to excuse lack of evidence of retail sales by pointing to company rules that require sales to non- Webster v. Omnitrition,79 F.3d 776, 781 (9th Cir. 1996); participants as proof of such sales. However, United States v. Gold Unlimited, Inc., 177 F.3d 472, 480-81 (6th Cir. 1999); F.T.C. v. Equinox, Int’l. Corp., 1999 U.S. the existence of “rules” aimed at encouraging Dist. LEXIS 19866, *15 (D. Nev. Sept. 14, 1999); People v. retail sales and discouraging inventory Cooper, 166 Mich. App. 638, 651-52; 421 N.W.2d 177 (1987); Koscot Interplanetary, Inc. v. Draney, 90 Nev. 450, loading will not protect a company from being 530 P.2d 108 (1974); Section 5 of the FTC Act; M.C.L. an illegal pyramid scheme if not properly 750.372; N.R.S. 598.100, et, seq. incentivized and adequately enforced.51 52 The minimum 100 PV (personal volume) for Quixtar (Amway) participants was “roughly equal to $260/mo.” ($3,120 per year) . . . and “because Quixtar’s overpriced 49 products are not sellable to anyone except distributors who For this insight, I thank Kristine Lanning, former are buying to qualify for bonuses, Quixtar distributors’ assistant to the Attorney General for North Carolina. earnings are a direct function of how much product they and 50 December 20, 2012 Sohn conference for investors their downline consume. The more internal consumption and 51 In re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1181 the larger the downline, the higher the bonus.” (Complaint (1975), aff’d., Turner v. F.T.C., 580 F.2d 701 (D.C. Cir. and demand for jury trial, US Dist. Ct., Central District of 1978); In the Matter of Amway Corp., 93 F.T.C. 618 (1979); Calif., Western Div., Case No. CV 07-05194), § 97) Ch.2- 19

So when participants are expected to device for disguising or laundering pyramid make product investments to get into an scheme investments. MLM – and then to continue purchasing MLMs typically sell overpriced potions and products (by subscription), training, etc., in lotions touted to prevent or cure a wide range order to achieve rank advancement, they are of maladies. This could be compared to a paying pyramid investment fees to “play the bushel of apples selling for $20 a bushel. The game,” one of the earmarks of a product- seller paints blue stripes on them and sells based pyramid scheme.53 them for $80 – $60 more because of the If participants subtracted purchases “magical properties” attributed to the blue and the operating costs of recruiting from stripes – the old “snake oil” pitch. commissions, they would find a high Many MLM products are sold at a breakeven bar rarely exceeded by premium so that commissions can be paid revenues. In other words, almost all to many levels of distributors. If an MLM participants below the TOPPs lose money. product were sold for $20 more than a comparable one sold through other outlets, this $20 premium could be considered the Investing in the form of pyramid investment portion of the price, which incentivized and ongoing product would flow to the top of the hierarchy of purchases could be considered a participants in typical pyramid fashion. device for disguising or laundering pyramid scheme investments. Do MLM participants sell products at listed retail prices to non-participants? MLM promoters have convinced many Why are incentivized MLM product regulators that MLM distributors sell a purchases not widely recognized as significant amount of products to persons investments in a pyramid scheme? Most not participating in the scheme. In most MLMs offer lucrative incentives for recruiting MLMs, this is patently false. We know from an increasing number of “distributors” (or surveys conducted in areas where intense other term for participants) and for revenues MLM activity is occurring that few sales are from product sales. So many participants made directly to consumers who are not recruit “dummy distributors” from friends and connected to the recruitment scheme. As relatives and buy products in their names – or discussed earlier, in a randomized survey of 54 simply buy products for them as “counterfeit households in Utah County, Utah, where customers.” They believe this will qualify them many MLMs are located, we found four for “the really big bucks.” Few realize that they MLM distributors for every one non- have in effect paid a very large fee for participating customer. participation in a pyramid scheme. Through a It is generally motivated participants who variety of misrepresentations about the are induced into paying for overpriced “pills, “opportunity,” large sums of money may thus potions, and lotions” typically sold by MLMs. be extorted from them. Such an amount paid at the start into a no-product pyramid scheme would We know from surveys that few immediately arouse suspicions of its’ being sales are made directly to an illegal pyramid scheme. But since the consumers who are not connected money paid into an MLM is paid for to the recruitment scheme. It is legitimate products and over a period of time, most participants and investigators fail generally motivated participants to see it as an investment in a pyramid who are induced into paying for scheme. In reality, this means of investing in overpriced “pills, potions, and the form of incentivized and ongoing lotions” typically sold by MLMs. product purchases could be considered a

54 53 In FTC v. Amway (1979 – 142-145), Webster v. Omnitrition Randomized survey conducted in Utah County, (Discussion on “Pyramid”), and FTC v. Skybiz (29) Utah, by Consumer Awareness Institute, 2004 Ch.2- 20

A startling admission. We usually see not be true in an MLM, which depends for a “wink-wink, nod-nod” attitude of MLM much of its revenues on minimum purchases promoters on how they get participants to by participants who buy to qualify for purchase most of the products from the commissions and/or rank advancement. company. “Pay-to-play” or incentivized For a list of criteria to distinguish between purchases play a bigger role than most are MLM and legitimate direct selling, see Exhibit willing to admit. But occasionally the truth 2f: “Does Multi-level Marketing* Qualify as a leaks out. Consider this quote from Form of Direct Selling? – a 7-Point Checklist.” Advocare’s “Policy and Procedures” manual regarding its compensation plan: How recruitment-driven MLMs kill their own retail market. In many MLMs, You may choose any method you like purchases at inflated retail prices are to achieve Advisor status. These examples point out the practical reasons you always primarily made by new recruits as a form of want to track your volume if you think entry fee – after which they pay wholesale you’re close to qualifying Advisor status – for products. Recruiters at MLM opportunity and if necessary, cover the $500 Personal meetings often kill their own retail market. Volume with your own purchases.55 Why would anyone pay full retail price when there are plenty of “distributors” who would “. . . if necessary, cover the $500 gladly sell at wholesale prices to meet their Personal Volume with your own “pay to play” quota of purchases? purchases.” –Advocare P&P manual Most ex-distributors of MLMs I have interviewed have said they cancelled automatic bank draft payments for monthly MLM not recognized as legitimate product shipments or sharply reduced selling. Additional evidence that little actual purchases from the company following their direct selling takes place in MLM can be quitting an MLM. This supports the conclusion found on the business shelves of any that the retail market for the products is more bookstore. I searched the contents of books contrived than real. “Pay to play” purchases on salesmanship of major bookstores and usually cease upon termination. found no mention of MLM or multi-level or network marketing as an arena for What about the refund policy of professional salespersons. The only MLMs? Many MLMs have a 30-day or one- exceptions were when networking (not MLM) year return policy, allowing for a refund for was discussed, and only when a professional unused and unopened merchandise, minus a sales person mentioned a bad experience small re-stocking fee. While this sounds with MLM on his way to becoming a real acceptable to recruits and regulators, hundreds salesperson56. And even in the books that Zig of interviews with ex-distributors lead to the Ziglar (who has written on MLM57) has written conclusion that this offers little actual protection on salesmanship, he is careful not to include to participants. It is extremely rare for MLM MLM as a form of selling. Apparently, MLM is victims to recognize the fraud in an MLM only respectable to those doing it. without intensive de-programming by a When as a young man I sold knowledgeable consumer advocate. They encyclopedias to help pay my way through have been told by their upline that anyone can college, it was not a requirement that I buy a succeed and are conditioned to blame set for myself or to meet a certain quota in themselves – not the MLM program – for their order to qualify for commissions. And later, “failure.” And many have opened their product as an insurance agent, I was not required to packages to sample or share the contents, so buy the insurance I was selling. This would they don’t “qualify” for a refund. Or they may fail to qualify on other technicalities. 55 (Advocare) “Policies, Procedure, and the Compensation Plan” (Rev. 10/21/08), “Section II: The Compensation “Tools for success” – or just more Plan,” Chapter 4:”Advancing to Advisor,” p. 20. money down the drain.” Top distributors 56 The Sales Bible: The Ultimate Sales Resource, by may sell “tools” (books, audio/video training, Jefferey Gitomer (John Wiley & Sons, Inc., N.J., etc.) to aid recruits in “building their business.” 2003) 57 Ziglar, op cit Their message to participants is that if they Ch.2- 21 are not succeeding in selling products or recruiting a downline, it is because they are not doing it right – not because the program It was disclosed in a recent itself is inherently flawed. If they want to be California case involving Quixtar’s successful, they need the proper “tools.” (Amway’s) “top guns” that only 3.4% The sellers of these tools may make of sales were to non-participants! more money on them than on the sale of products to or through their downline. While not required “pay to play” items, some 4. Company payout (in commissions & upline promoters will not provide training bonuses) per sale for the total of all and other support to downline participants upline participants equals or exceeds who do not buy the tools. So these tools that for the person selling the product become in fact a necessary cost to “play the – resulting in inadequate incentive to game” – further reducing the likelihood that retail and excessive incentive to these hapless recruits will realize a profit. recruit. This is what is meant by a “top-

Incentivized purchases are typical of weighted” pay plan. a pyramid scheme. On the FTC web site is an article entitled “The Bottom Line about Ask: Would a “distributor” purchasing Multi-level Marketing Plans.”58 Under the products for resale receive less in total payout heading “Evaluating a Plan,” the following (in commissions, bonuses, etc.) from the advice is given: “Beware of plans that ask company as would the total of all upline new distributors to purchase expensive participants? In other words, does most of the products and marketing materials. These money paid to distributors go to those at the plans may be pyramids in disguise.” higher or lower levels in the pyramid of The FTC ruling that Amway was not a participants? pyramid scheme was conditioned on the While the previous three features are fairly assumption that its “retail rules” would be easy to identify, this one requires enforced. Yet it was disclosed in a recent understanding of alternative distribution California case involving Quixtar’s models and complex incentives in the MLM (Amway’s) “top guns” that only 3.4% of 59 pay plan. Group bonuses and other incentives sales were to non-participants! must be factored in to determine actual payout In summary, MLMs typically require per sale. Sometimes the bonuses come in the significant purchases in order to participate form of larger discounts or higher commissions in the financial rewards outlined in the per sale at higher levels. compensation plan. While the actual enrollment fee may be small, the cost to Why does this “top-weighted” qualify for commissions and rank feature of recruitment-driven MLMs advancement can be substantial. This is discourage retailing of products to end- one of the earmarks of a pyramid scheme, users? MLMs offer small rewards to front as opposed to legitimate direct selling.60 line “distributors” for selling products, which are usually overpriced to support the large network of participants. So to achieve significant income one must recruit a large downline from which to draw commissions from their combined purchases. This “top weighted” characteristic, more than any other, determines whether a 58 www.ftc.gov program is biased towards recruitment or 59 Notice of Errata re exhibits E, F and G to Affidavit of Billy towards retailing (direct selling to end users). Florence submitted with complaint, US Dist. Ct., Central It is also an important red flag signaling an District of Calif., Western Div., Case No. CV 07-05194), § 97) p. 13 illegal pyramid scheme in most jurisdictions 60 In FTC v. Amway (1979 – 142-145), Webster v. because it shows a primary emphasis on Omnitrition (Discussion on “Pyramid”), and FTC v. Skybiz compensation from recruitment rather than (29) Ch.2- 22 from sales to end users who are not “time freedom,” and the earnings of top participating in the scheme. distributors is posted – but with no mention of For a more complete discussion of why the abysmal odds of getting there. MLM compensation plans are so top- In other sales settings, it is not unusual weighted, read “My explanation for the for successful commissioned sales persons extremely unfair income distribution in MLM” to receive more income than their sales in Chapter 7. Note especially Exhibits 5a&b). managers. This is because the person doing the selling usually makes more in Why is this top-weighted feature one commissions per sale (often 20-40%) than of the main problems with MLMs? managers two or three management levels Compensation plans of recruitment-driven above him or her. But in recruitment-driven MLMs lead to extreme inequality in MLM programs, upline distributors several company payout to participants. There are a layers removed from the actual sale may few “winners” who profit at the expense of a receive as much or more in commissions multitude of “losers.” When plotted on an and bonuses per sale from the company as income distribution chart, the graph the person who actually sold the product. resembles a candlestick, with a handful on the The latter may only get a sales commission left receiving huge earnings, and a multitude of 5-15% from the company62 – not enough of participants to the right losing money. to make selling profitable, even if the For example, Nu Skin has published products were priced competitively. average income figures of its distributors, Since the total payout per sale is having been ordered by the FTC to cease its limited, when upline participants receive misrepresentations of distributor earnings. substantial income in overrides from down- Based on its own report entitled “2011 Nu Skin line purchases, this tightens any resale Enterprises, Inc. Distributor Compensation margin and limits the percentage of Summary,” on discussions with top executives commissions to any participants selling and high level ex-distributors, and on my one- products to actual customers. So the year experiential test of their system, I potential income of front line “distributors” is concluded the following: extremely limited, forcing him or her to At best, one out of about 3,000 distributors recruit a large downline in order to realize a profited; i.e., received more in commissions significant income from commissions on than they spent on products and minimum downline purchases. Powerful incentives are operating expenses. But of those few who at work to recruit a downline of hundreds, even profited, only a few netted anywhere near the thousands, of participants.63 average incomes that promoters at opportunity meetings stated were earned by “Blue Diamond” distributors. It is likely that less than one in 10,000 new recruits received the potential Blue Diamond incomes held out to This “top-weighted” characteristic them! All others just “didn’t try hard enough.” is an important red flag signaling Often these “losers” will invest an illegal pyramid scheme in most considerable amounts of time and money and jurisdictions because it shows a then quit, blaming themselves. But their primary emphasis on compensa- “failure” is due not so much to their lack of tion from recruitment rather than effort, as to an exploitive and unfair system, from sales to end users who are which dooms approximately 99.7% of all not participating in the scheme. participants61 (including dropouts) to losses – after subtracting “pay to play” purchases and minimal operating expenses. A 99% loss rate would not be so serious, except that in MLM 62 Again, read “My explanation for the extremely unfair opportunity meetings, the program is typically income distribution in MLM” in Chapter 7, noting touted as the path to financial freedom, or especially Exhibits 5a and 5b. 63 For examples of complex top-weighted compensation plans, see Appendix 2C. Nu Skin is 61 To see how this was calculated, see Chapter 7. one of the most top weighted of MLMs. Ch.2- 23

Exhibit 2d

CDC* (“Red Flag”) #4: Company payout (in commissions & bonuses) per sale for the total of all upline participants equals or exceeds that for the person selling the product – resulting in inadequate incentive to retail and excessive incentive to recruit. This is what is meant by a “top-weighted” pay plan.

MLM’s typically top-weighted compensation plans disproportionately reward founders and TOPPs (top-of-the-pyarmid promoters – at the expense of those at the bottom levels.

*NOTE: These CDCs (“red flags”) are causative and defining characteristics of recruitment-driven MLMs, or product-based pyramid schemes. They are causative in that – taken together – they cause the extremely high loss rates suffered by participants, and they are defining in that they clearly define product-based pyramid schemes as differentiated from legitimate direct selling and other packaged business opportunities. All 500 MLMs I studied demonstrated this characteristic in their compensation plans. Ch.2- 24

Can’t low commissions to front-line TOPPs to feverishly build their downlines; distributors be offset by retailing products i.e., to recruit a revolving door of new at marked up retail prices? MLM promoters recruits who buy products in order to claim “distributors” who buy MLM products at participate in the “opportunity.” wholesale prices can then sell them at a higher retail price, such as in conventional retail 5. In addition to the four CDCs above, outlets, which allow for a retail profit margin. nearly all MLMs also have a fifth MLM communicators then go to great lengths CDC, making it even more top- to assure regulators that they are legitimate weighted. The MLM company pays direct sales operations and that participants commissions and bonuses on more can make money buying wholesale and selling “distributor” levels than are products at retail prices. They also tout the unique qualities of their products to justify the functionally justified; i.e., five or more high prices they must charge to pay levels, which only further enriches commissions on huge pyramids of participants. those at the top of the pyramid. The problem is that suggested retail Ask: Does the company pay overrides prices for MLM products are generally too (commissions and bonuses) to distributors in a high to be competitive with other outlets. So hierarchy of more levels than are functionally MLM “distributors” purchase large quantities justified; i.e., five or more levels?” 64 for themselves and their families and/or sell For even the largest of conventional products at wholesale prices to downline distributor arrangements, the entire U.S. participants and others in order to meet can be covered by four supervisory levels in volume requirements for bonuses or discounts the sales hierarchy; e.g., branch managers, at different levels. Again, the payment of full district managers, regional managers, and retail listed price generally occurs with new national sales manager. More than that is recruits who are “buying into” the system. This superfluous and bloated, driving up prices is how they “pay to play” (the game). and making sales at a competitive retail How does this feature distinguish markup unrealistic and unprofitable. recruitment MLMs from (hypothetical) Why do five or more levels signal a retail-focused MLMs? This “top weighted” recruitment-driven MLM? There is seldom characteristic is primarily what would any functional justification for five or more separate recruitment-driven MLMs from levels in an MLM hierarchy of participants. “retail-focused MLMs” – if such were to exist. other than to encourage recruiting and the Retail-focused MLMs would make it possible illusion of very large potential incomes – for participants to make money from the sale which only a few enjoy. of products with only a small downline of Combined with other factors, this feature participants, or with none at all – by assigning hugely enriches those participants at the top the majority of commission payments to front- of the pyramid at the expense of those line distributors for actual sales, as is the case beneath them, 99% of whom lose money. in legitimate direct selling or retail settings. Such exorbitant incomes result from the However, out of over 500 MLM programs I reaping of huge overrides from the combined have analyzed, I did not find any that could product investments of as many as thousands clearly be classified as retail-focused MLMs. of downline participants, which increase Possible exceptions are the party plans that exponentially with each added level. It is a emphasize income from the sale of products at money transfer scheme – transferring money in-home parties, though they may allow for from those at the bottom to those at the top. recruitment of a downline. But even then, one must look at the compensation plan to see if the program is so top-weighted as to encourage recruitment and self-consumption over selling to the general public. In summary, this “top-weighting” of 64 For this insight, I am indebted to Douglas M. MLM compensation plans is what drives Brooks, a Boston attorney, who has for many years worked on cases related to franchises and MLMs. Ch.2- 25

Exhibit 2e

CDC* (“Red Flag”) #5: In addition to the four CDCs above, nearly all MLMs also have a fifth CDC, making it even more top- weighted. The MLM company pays commissions and bonuses on more “distributor” levels than are functionally justified; i.e., five or more levels, which only further enriches those at the top of the pyramid.

More than four levels in the compensation plan exponentially enriches those at the top with the addition of each additional level – at the expense of those who invest at the bottom. The primary customers are those in the downline, making the MLM merely a money transfer, or product-based pyramid scheme.

*NOTE: These CDCs (“red flags”) are causative and defining characteristics of recruitment-driven MLMs, or product-based pyramid schemes. They are causative in that – taken together – they cause the extremely high loss rates suffered by participants, and they are defining in that they clearly define product-based pyramid schemes as differentiated from legitimate direct selling and other packaged business opportunities. All 500 MLMs I studied demonstrated the prior four characteristics in their compensation plans, and most included this fifth characteristic. Those that did not make up for it by extra rewards paid to those at the top levels. Ch.2- 26

It should be noted that in the afore- mentioned 1979 FTC v. Amway ruling, the The FTC prosecution argued that as prosecution had argued that as the number the number of levels in an MLM of levels in an MLM compensation plan increased, so did the opportunity for fraud. It compensation plan increased, so is interesting that in 1979, Amway had ten did the opportunity for fraud (FTC payout levels. By 2008, the number of levels v. Amway). But no one at the FTC had increased to an astonishing 22 levels!65 noticed that the number of levels But no one at the FTC noticed this since that time has more than worsening of Amway’s highly leveraged doubled at Amway. compensation plan.

If each “distributor” were to buy enough Generally, but not always, this products each month to yield an override of characteristic of excessive payout levels $5 in commissions and bonuses to the is a key feature (other than products for original upline distributor, then with a five- sale) separating recruitment-driven level downline, the upline distributor gets MLMs from classic, no-product pyramid $19,525 per month, while with a six-level schemes. The latter typically pay on only downline the same distributor can get four or five levels before the person atop the $97,650 per month – five times as much as pyramid collects and moves on to start a for five levels. The incentive to recruit to get new pyramid. It also helps explain why the to the sixth level becomes enormous. loss rate for recruitment-driven MLMs is Of course, it seldom works out that way, but much higher than for classic, no-product this illustrates why recruiting is emphasized pyramid schemes. over selling products to persons outside the

How does extreme leverage result pyramid. An income of $97,650 is far more from excessive payout levels? MLM appealing to a Level 1 participant than $100 promoters refer to such residuals as that might be earned by selling the products “leverage” – large company payouts, at the full retail price (assuming $20 markup disproportionate to effort expended, to top- on products sold to each of five customers). level participants. The effects of leverage Compared to recruiting, selling can be illustrated in a downline of six levels products at full retail price becomes a waste of participants. For example, assume that a of time in such a system. The incentive to “distributor” recruits five “active distributors,” recruit to move up a level becomes very each of whom recruits five more, and so on great. Again, one can see that the legal through six levels of distributors. requirement of “primary emphasis” on We see the pyramid grow exponentially: income from recruiting fees (in the form of downline purchases) is satisfied. Level 1: 5 distributors In legitimate direct selling or retailing x $5 in commissions & bonuses = $25/month operations, management looks at what value Level 2: (5x5=) 25 + 5 = 30 total distributors each link in the distribution chain contributes x $5 ” ” ” ” = $150/month to a profitable operation. They are always on Level 3: (25x5=) 125 + 30 = 155 total the lookout to streamline operations, not to distributors x $5 ” ” ” ” = $775/month cut profits by adding more levels of sales

Level 4: (125x5=) 625 + 155 = 780 total management. Rational corporate behavior in distributors x$5 ” ” ” ” = $3,900/month this scenario would be to quickly jettison

Level 5: (625x5=) 3,125 + 780 = 3,905 total passive commission recipients in their distributors x $5 ” ” ” ” = $19,525/month distribution chains, not recruit more. But with a recruitment-driven MLM, the opposite is true – Level 6: (3,125x5=) 15,625 + 3,905 = the more levels, the better, thus exponentially 19,530 total distributors x $5 “ “ “ “ = $97,650/month! enriching those at the top, who recruit aggressively to maximize their gains. Also,

65 Quixtar Business Reference Guide, 2007, and company revenues are enhanced by Amway Business Reference Guide (or counterpart), recruitment more than by sales to end users. 1979, Ch.2- 27

Exploitive breakaway compensation 95% of them. These pay plans are clearly plans – legal or not? One category of recruitment-driven and top-weighted, compensation plans, the “breakaway” meaning they are driven by incentives to deserves mention, as it is so highly leveraged recruit, with company payout of that the losses of participants are staggering. commissions (after “skimming” by founders) In a breakaway system, the levels in going primarily to a select few “TOPPs” the hierarchy are made up, of “breakaway (top-of-the pyramid promoters) who are organizations” (or pyramids) – groups of often those who were positioned at or near participants who have met requirements to the beginning of the recruitment chain. “break away,” allowing a small commission Where data was available, I found loss override from all participants in the rates averaging about 99.7%.66 A list of the breakaway unit. So a hierarchy of six levels MLMs for which I have analyzed the is actually six levels of groups of compensation plans and which displayed at participants, which makes it a constellation least four of the five causative and defining of pyramids within a giant mega-pyramid – characteristics of recruitment-driven MLMs with most of the payout going to TOPPs. is found in Appendix 2E. The extreme loss rate results from each profitable top-level “distributor” being The same four CDC’s are found in all supported by a downline of many groups of classic, no-product pyramid schemes as participants (often totaling thousands), in all MLMs. It is important to recognize that almost all of them victims who lose money – the structural elements CDCs) of both no- after subtracting purchases and other product and product-based pyramid expenses. In my opinion, MLMs with schemes are identical. To ask if an MLM is breakaway compensation plans are the a pyramid scheme is like asking if a hybrid most extreme and exploitive type of pyramid vehicle is a car. It may have advanced scheme and therefore should be illegal. features, but it’s still a car. So with MLM, which is merely an elaborate form of a “Australian two-up,” and other pyramid scheme. schemes that limit the number of levels for payout, make up for it in other ways. The fact MLM is not legitimate direct selling. that an MLM compensation plan limits the Based on the above CDCs, of the 500 number of levels upon which any distributor can MLMs we analyzed, none qualified as be paid overrides from the company does not legitimate direct selling. (To clearly separate negate the “endless chain” feature of the MLM from legitimate direct selling, review scheme. For example, in “Australian two-up” again the 7-point checklist in Exhibit 2f.) I plans, new recruits must forfeit commissions for should also note that these four CDCs exist in the first two sales to an upline sponsor before none of the hundreds of alternative income qualifying for commissions. The mathematical options I have reviewed over many years of impossibility of later recruits enjoying the same teaching and researching in the field of financial benefit as earlier participants is income or business opportunities. apparent. It should be noted that 2-up recruits who fail to recruit two others become in effect Harmful effects of recruitment- the downline of someone above them. This driven MLMs could continue for several levels. MLM compensation plans with all of the characteristics discussed above inevitably These four CDC’s confirmed by lead to the following negative effects: industry-wide research 1. Loss rates are extremely high – far worse In 100% of the compensation plans of than for legitimate direct selling. See over 500 MLMs I have analyzed, I found at comparison in Exhibit 2g, which is based on least the first four of the five causal and data from Nu Skin’s reports – and similar to defining characteristics (CDCs) discussed those in other MLMs analyzed in Chapter 7. above, and the fifth CDC exists on over 66 Chapter 7, Exhibit 7d Ch.2- 28

from (unreported) direct selling of products, which is simply not the case.

3. Misrepresentations abound. Deception is essential for MLM to survive and grow. If the truth were told about the abysmal odds of success, only the numerically challenged would join. Some MLM promoters make For nearly all MLM participants, money exaggerate-ted product claims to draw in paid out exceeds money coming in. new recruits. I have concluded that success To those who understand the numbers, in a recruiting MLM requires one first to be this is the harm that is most objectionable – deceived, then to maintain a high level of especially in light of the MLM being presented self-deception, and finally to go about as a profitable income opportunity. deceiving others. Because of the extreme leverage in the Chapter 8 lists at least 111 typical compensation plan, the founders, early misrepresentations used in MLM entrants into the program, and a few TOPPs recruitment campaigns. With MLMs get huge gains – who are held up as dependent on so many falsehoods, it would examples for all to see. But for the vast not be an exaggeration to consider the majority of participants, actual profits are rare. income earned by MLM sponsors as “theft by When discussing average income of deception,” and certainly as ill-gotten gain.

MLM participants, it should be noted that 4. Recruitment-driven MLMs become there are three statistical measures used to somewhat like Ponzi schemes, with indicate “average” – the mean, median, and promoters moving from one location to mode. The most talked about is the another, as each area is increasingly arithmetic mean, or the aggregate income of perceived to be saturated. What happens is all divided by the number of participants – that the MLM grows rapidly until it reaches which is negative if all recruits are counted market saturation in a given area. All later and minimal expenses (including entrants are severely disadvantaged in their incentivized purchases) are subtracted. recruiting efforts and lose money. MLMs The median, or middle measure, for all sometimes get around this by starting new MLMs I have studied is zero or less. And product divisions or entering new geographic the mode, or most common measure, is regions to start new pyramids, a process I also zero or less. Also, if TOPPs – whose have labelled “re-pyramiding.” disproportionately large incomes skew the So investing participants recover their averages – are removed from the investments by recruiting in other areas – in calculation, the average will nearly always Ponzi fashion – to get new participants to be a significant minus figure. invest. If they don’t do this, they can lose their By any measure, MLM is a losing income stream and the rank they achieved. proposition. This explains why the DSA and Company officials cooperate – or the MLM spokespersons and statisticians do company may collapse, along with their jobs. everything they can to skew the numbers in their favor. A more detailed analysis of the 5. The distinction between seller and buyer abysmal statistics on average earnings will becomes confused and blurred. The seller be presented in Chapter 7. becomes the buyer, and the buyer becomes the seller – to themselves and their families. 2. Since the compensation and 6. When most of the buyers are marketing system is weighted towards participants, MLM is simply a money transfer recruitment, instead of retailing of products, scheme, transferring money from those at the MLMs are technically illegal in many bottom to those at the top – through the jurisdictions. This one effect is the basis of infrastructure of the MLM company. most statutes against pyramid schemes. MLM promoters often go to great lengths to make it appear that revenues of participants come Ch.2- 29

Exhibit 2f: Does MLM (multi-level or network marketing) qualify as a legitimate form of direct selling? — a 7-point checklist

Much confusion exists on whether or not MLM can direct sales company, including life insurance) – with qualify as direct selling. Since the MLM industry has much to prominent MLM programs, such as Amway and Nu Skin.

gain by being classed as direct selling, MLM promoters and CONCLUSION: The typical MLM company is no more the industry’s lobbying arm, the Direct Selling Association, a direct sales company than a pig is a horse. MLM work hard to convince legislators, regulators, and the public companies use highly leveraged compensation systems that they are direct selling companies. Since few officials (rewarding top distributors at the expense of a large have much experience in direct sales, they are often misled downline of recruits who invest in products to “play the on this key point. game” – almost all of whom lose money), its participants Based on several years of experience, observation are primarily recruiting to build downlines, not to sell and research related to both direct sales and MLM, I can products directly to end users. safely conclude that the typical MLM business model When was the last time you were approached by an constitutes what I call a “product-based pyramid Amway or Nu Skin “distributor” to buy products without scheme” and NOT a form of legitimate direct selling. some mention of the “business opportunity”? With They should be considered “recruitment-driven MLMs”; millions of “distributors” recruited over the last twenty i.e., MLMs that require aggressive recruiting of a large years, if they were primarily selling direct to customers, downline to earn a significant income. However, it is true you would expect by now to have been inundated with that selling – mostly in the form of recruiting – is involved requests to buy products from them – without being in building an MLM downline. asked to join up. No, the sellers are the buyers, and the Based on this analysis, below is a comparison of two buyers are the sellers – generally to themselves and their marketing models – direct sales, as represented by immediate families. traditional Fuller Brush sales persons (or any non-MLM

LEGIT. CHARACTERISTICS OF LEGITIMATE DIRECT SALES DIRECT RECRUITMENT-DRIVEN MLMs COMPANIES SALES (incl. that reward participants for recruiting large downlines – Amway, Nu insurance) Skin, Nikken, etc.– which is virtually all MLMs 1. The number of agents/sales persons recruited for a given area YES NO – MLMs use an endless chain of recruiters recruiting still is somewhat limited to prevent market saturation and resulting more recruiters, ad infinitum. And each participant must dissatisfaction of existing sales persons or agents. recruit others to make his/her investment profitable. 2. Advancement to various levels of sales management is by YES NO – Advancement in the sales hierarchy is achieved by appointment. recruiting a downline who purchase products 3. Little or no purchases are required to begin and to YES NO – Sizable initial and ongoing purchases are tied to qualification continue selling the program profitably. The company, rather to get commissions and/or to advance through higher distributor than the sales person, assumes the burden of financing and payout levels. Thus, many participants stock up on inventory. The stocking inventory. When I sold encyclopedias as a young man, burden of inventory cost is thereby transferred from the company it was not a requirement that I buy a set for myself or meet a to the distributor – who finds that the easiest way to sell the certain quota in order to qualify for commissions. And as an products is to sell the “opportunity.” Most actual buyers are insurance agent, I was not required to buy the insurance I was recruits. selling 4. A maximum of four levels of sales managers is sufficient– for YES NO – An MLM downline may include 6, 8, 10, or even an example: branch manager, district manager, regional manager, infinite number of levels of distributors – which, of course, is & national sales mgr. absurd. 5. Commissions per sale paid by the company to the person YES NO – A distributor several levels above the person selling the selling products and services to end users are typically greater product may get as much or more commission per sale from than the total override commissions for ALL those above the company as the person doing the selling. him/her in sales management. 6. The primary focus in compensation systems, at sales YES NO – Marking up and reselling products bought at high meetings, and in actual effort by sales persons is on selling wholesale prices is unrealistic. The primary focus is on products and services to legitimate customers, or “end users.” recruiting more participants, so persons are seldom approached to buy the products without considering the “business opportunity.” Top-level recruiters are often held up as examples for their huge pay checks. 7. Sales persons can make a reasonable income (in commissions YES NO – Commissions paid by the company for direct sales pale and bonuses) from selling the products or services – without in comparison with potential rewards for recruiting a recruiting a downline. downline. In MLMs, it is extremely rare for participants (except for those at or near the top of the pyramid), to report profits on their tax returns. Ch.2- 30

Harmful effects of MLM, continued – 10. A perverse risk-reward relationship develops with recruiting MLMs. In legitimate 7. Stockpiling of products is common, a businesses, the more time and money one fact seldom admitted by MLM participants. invests in the business, the more likely it is that Many wind up making excessive purchases in success will be achieved. But with recruiting order to advance up the hierarchy of MLMs (with the exception of the TOPPs), the participants, so they can reap large residual more one invests, the more one loses. incomes off the efforts of others – which The luckiest of MLM participants are those seldom happens. Most participants are left with who invest the least time and money. Of all unsold products, broken promises, and those approached, the most fortunate are unrealized dreams. Return privileges for usually those who refuse to join at all. refunds are not used as much as one would 11. Extreme leverage results, meaning the expect for the reasons mentioned above. majority of company payout goes to TOPPs. Cases of downline distributors receiving large commission checks are rare, but are held up as examples for all prospective recruits to see (without disclosing costs incurred). However, for the vast majority of MLM participants, actual profits are rare – and losses are the rule, not the exception. Again, study Exhibit 2g.

12. The program becomes a closed market system, in which products are sold primarily through (and to) a downline of participants (and sympathetic family members) and seldom to legitimate customers at retail prices. This alone should qualify it as an illegal pyramid scheme.

13. Personal losses can be substantial, Stockpiling is common in MLM including psychological, social, and spiritual harm67 – far outside of the norm for legitimate 8. The regulatory process – essential in a businesses. Some MLM participants lose more democracy to protect consumers – is than money. We often hear of marriages and compromised when pyramid fraud is allowed families broken up, credit cards maxed out,, by regulatory agencies. bankruptcies, long-term friendships ruined, Victims of all types of pyramid or chain selling religious and other groups stressed or broken schemes rarely file complaints, fearing up, even suicides – all from single-minded consequences from or to those they recruited dedication to am MLM program. In fact, the (often close relatives or friends) – and having more committed a person is to an MLM, the been taught that any failure is “their fault.” Lacking greater the likelihood that he/she will suffer at such complaints, law enforcement seldom acts least some of these consequences. against these scams. This complacency on the Also, disturbing tendencies to move away part of those responsible for consumer protection from ethical and charitable motivations to a more creates, in effect, a “license to steal.” materialistic and greedy persona often becomes

8. MLM observers have noticed cultish apparent from MLM participation. These personality changes help explain why some see and even compulsive behavior from MLM 68 participation. Some MLMs adopt cultist MLM as an unethical business model. patterns in recruitment and retention of members, becoming a rather closed society. Also, the devolution of “MLM junkies” has been observed, with traits of addiction similar to those with other addictions. 67 For examples, go to feedback in ch. 9 Appendix. 68 Jon M. Taylor, The Network Marketing Game. op cit. See also False Profits, by Robert FitzPatrick. (Herald Press: Charlotte, N.C., 1997). Ch.2- 31

Exhibit 2g: Legitimate direct selling vs. recruitment-driven MLMs

Legitimate direct selling Direct sales persons who sell directly to customers seldom lose money, since most supplies and training are provided by the company. And the sales persons do not have to buy the products in order to qualify for commissions. Most of the commissions are paid to the person doing the selling. With the growth of the Internet and discount stores, little direct selling is done any more.

Majority make money Few lose money ______

Recruitment-driven MLMs, or product-based pyramid schemes An extremely high loss rate explains MLM’s high attrition rates, churning of new recruits, and need to aggressively “re-pyramid” through new markets and/or with new products

00.3% make money in the typical MLM69 99.7% lose money in the typical MLM

Only a few of the participants in a typical It is very expensive to build a profitable MLM earn significant profits – after purchases MLM downline. Significant purchases are and operating expenses are subtracted. To required to qualify for and to maintain “pin correctly represent these persons would levels” (pay rank). And the cost of mounting a require a circle so small that it would be barely recruitment campaign effective enough to visible in this visual. “succeed” in an MLM can be very high. For these reasons, the dropout rate is also extremely high. In any MLM, the first ones into a given market have a huge advantage. Those coming in later are buying a ticket on a flight

69 that has already left the ground. This unsavory See Chapter 7. Calculations are based on reports of average income of participants for 50 MLM companies reputation has certainly been evident in that have released such data by 2013. See methodology surveys of consumers that I and others have and calculations in Chapter 7. done. I also found it interesting to do an

Ch.2- 32

Considering all the harmful effects of MLM, it The unsavory reputation of MLM among is easy to see why MLMs are far more harmful the general public in the U.S. Eighteen years of than classic, no-product pyramid schemes. They feedback from all over the world confirms what have a higher loss rate, cause far greater losses most consumer advocates have observed – in the aggregate, and affect far more victims. that MLM generally has an unfavorable They also have a much lower payout ratio for reputation among the general public. When I distributors, since most of the proceeds go to did an advanced Google search of the (exact) products and infrastructure, and some to the term “fraud,” with one or more of the terms founders. Conversely, in no-product pyramid “multi-level marketing,” “network marketing,” or schemes, all the money goes to the person at “MLM,” there were over 1 million results! the top, but the downline consists of only a few The typical answer by promoters of persons, who theoretically can move up to take specific MLMs to the unsavory reputation of their turn at the top. MLM is that the reputation is deserved by most See Exhibit 2h for a summary of some of MLMs, but not their MLM. Their MLM is the effects stemming from the CDCs (“red somehow different. This is another reason why flags”) of recruitment-driven MLMs, both defining and understanding the underlying individually and in combination. MLM model is important.

Exhibit 2h: Characteristics and effects of recruitment-driven MLMs, or product-based pyramid schemes

CHARACTERISTICS EFFECTS 1. Each person recruited is empowered & given Demonstrates primary income is from recruiting, especially with the incentives to recruit other participants, who are features of unlimited recruitment and such powerful incentives to empowered and motivated to recruit still other recruit – vs. meager profits from retailing over-priced products. Hyper participants, etc. – in endless chains of empowered growth inevitably leads to perceived saturation, which often is followed and motivated recruiters recruiting recruiters – by expanding (“re-pyramiding”) to other markets – or to introducing without regard to market saturation. new product divisions and cycling through the same markets. 2. Rank advancement in a hierarchy of multiple Demonstrates primary income is from recruiting, since that is the levels of “distributors” is achieved by only way to advance in the scheme and to realize major profits. In recruitment, rather than by appointment. virtually any MLM, 99% of recruits are doomed to financial loss. 3. “Pay to play” requirements (to qualify for Raises breakeven bar, assuring losses for 99% of participants. May commissions and/or for rank advancement) are technically place MLM in category of a franchise, security, business met by quotas of “incentivized purchases”. opportunity – or a de facto pyramid scheme. Encourages hyper- consumption of products by participants, who are the primary buyers. 4. Company payout per sale for the total of all Removes incentive to do direct selling, since recruiting is potentially upline participants equals or exceeds that for many times more profitable. the person selling the product 5. (typical, but optional) The company pays Demonstrates primary income is from recruiting. Enhances leverage commissions and bonuses on five or more for top participants who profit hugely, while assuring high loss rate for “distributor” levels – more than are functionally lower levels. Virtually eliminates retail option, due to high wholesale justified; i.e., more than needed to manage the prices (to pay commissions on many levels) that make direct sales sales function. with retail markup very difficult. Primary retail target is new recruits – which are making de facto pyramid investments. 1-5: Combining all (or at least the first four) of Results in high loss rates (99.7% average) – much higher than for the above characteristics no-product pyramid schemes (87.5% to 93.3%). Strong emphasis on recruiting as the primary source of income, satisfying most statutory definitions of a pyramid scheme. Demonstrates extreme leverage, necessitating deceptive income promises to succeed at recruitment. Ch.2- 33

Few would question the underlying flaws in allowed to sell competitors’ products along with chain letters of the past, where you pay five those of the particular MLM they signed with. dollars to everyone on a list, add your name at the  Are MLM promoters selling investment securities? bottom, and forward it to all your friends – and they They talk to prospects about the “residual income,” to their friends, ad infinitum. Most consumers see or “passive income” potential of signing up in their the flaws in this concept, so that it requires little MLM – as an investment that was not dependent so explaining. But when MLMs (built upon endless much on their own efforts as on the efforts of those in chains of recruitment) came along and introduced their downline. But they do not register as securities unique and exotic products with complicated pay with the state or federal securities agencies. plans, charismatic leaders, palatial home offices,  Are MLMs franchises? Though many promoters and donations to influential political candidates refer to their MLMs as “like a franchise,” as an “un- and charitable causes; promoters were able to franchise,” or even as a “personal franchise,” the dupe regulators, legislators, and many in the last thing MLM executives want is to have to media into believing they were legitimate. comply with franchise disclosure requirements, The underlying motivations that seem to drive including a franchise disclosure document that MLM development and recruitment are greed and could be hundreds of pages long with financial data, the desire for easy money, even at the expense of a background of founders, etc. The MLM industry multitude of victims. Though not articulated by spent $4 million lobbying for an exemption from the founders, they seem to understand that it is much Business Opportunity Rule so they would not be easier to facilitate a scheme that promotes product required to provide even a one-page document purchases by selling a bogus opportunity than by disclosing information to help prospects make a selling the products without the attached opportunity. wise decision about participation.  Are MLMs a form of gambling or a lottery? Some Considering all the harmful effects promoters present MLM as an opportunity for the chance of unlimited income: “You never of MLM, it is easy to see why MLMs know how much money you will make if you sign do far more harm than classic, no- up now,” or “You may get lucky and recruit product pyramid schemes. They someone in your downline who is a ‘business have a higher loss rate, cause far builder’ who will make you a lot of money,” etc. greater losses in the aggregate, and New MLMs will sell a “pre-launch” opportunity, affect far more victims. implying that one could profit handsomely by being one of the lucky first ones in.  Are MLMs a form of direct selling? Of course, MLM’s problem with legal identity the Direct Selling Association says it satisfies the criteria of person-to-person selling away MLM promoters and defenders have a from a fixed location, etc. The problem is that recurring problem whenever they have to the DSA does not specify what legitimate direct present MLM as a class of business activity. selling is not – endless chains of recruitment of This is because MLM is like a chameleon; it can participants as primary customers.71 – and often must – change colors to suit the  Are MLMs buyers’ clubs? Some MLM promoters situation. Consider the following examples: present their programs as ways to buy from your  Are MLM participants employees of the own business rather than from others – like a company? MLM executives often try to exercise buyers’ club. The problem is that products from the control of an employer, but don’t want to be MLMs are almost always far more expensive than classified as such because of the costs and those purchased from alternative outlets, so they legal liabilities. Yet, their contracts have been can’t qualify as discount buyers’ clubs. It might be challenged as exercising too much control for all right if an MLM was sold as a “pay more” participants to be considered independent buyers’ club, and not as a business opportunity. 70 contractors. For example, they may not be  Are MLMs business opportunities? If so, they may need to register as such with the applicable state 70 For a thorough discussion of bad legislation (IRC § 3582) pushed by lobbyists in 1982 to reclassify employees as http://www.armydiller.com/financial-scam/mlm.htm#dsalegislation independent contractors to those contractors’ detriment, go to 71 Again, See Exhibit 2f for a 7-point checklist for the following web site (“All you need to know about MLM) – determining if MLM is a form of legitimate direct selling Ch.2- 34

agencies, which may require disclosure of funds. This is what happened to cause the information they don’t want to disclose and other collapse of the Bernie Madoff scheme in 2008 requirements with which they would not want to when the financial markets imploded. comply. So while MLM promoters often refer to Classic, no-product pyramid schemes offer no their particular program as a “business product, merely the transfer of investors’ money opportunity” to prospects, they are careful to refer from those at the bottom to those at the top. In to it as “direct selling” to law enforcement officials. contrast, MLMs, or product-based pyramid  Are MLMs income opportunities? If they were, they schemes, deceive participants into thinking that should provide a good likelihood a person could they are legitimate businesses by offering earn a significant income from them. However, the consumable products. But few are sold outside the opposite is true. As carefully demonstrated in network of participants, so they wind up also being Chapter 7, almost all participants in MLMs – transfer schemes, at least indirectly – transferring approximately 99.7% of them (where data is money from product purchases of a continuing available), lose money. And if you eliminate TOPPs stream of new recruits to the company to pay for (top-of-the-pyramid-promoters) from the calculation, products, infrastructure costs, and distributors. the loss rate is about 99.99% for new recruits – with Usually less than half the money from purchases approximately zero chance of profiting. It would be of recruits is rebated back to the network of more honest to call MLMs money traps that lead distributors, with a disproportionate amount going to almost certain loss, except for those at the top to founders and TOPPs. of the pyramid. Since MLMs are dependent on the  And finally, are MLMs cleverly disguised recruitment of an endless chain of recruitment, pyramid schemes? If you are not already recruiters soon find their local market saturated convinced, re-read this chapter and read the rest and must recruit elsewhere. As will be discussed of the chapters in this book with an open mind in Chapter 3, this saturation of markets happens and decide for yourself. But I can attest that after rather quickly, so MLMs are extremely viral in analyzing the compensation plans of over 500 spreading like a fast-growing cancer from state to MLM schemes, I feel more comfortable than state and eventually to vulnerable foreign markets ever labeling them recruitment-driven MLMs, or to keep the chain of recruitment going. Both product-based pyramid schemes. Ponzi and pyramid schemes are similar in that timing of entry into the program is critical. In Ponzi schemes, the person who initiates the scheme What is the difference between Ponzi usually profits the most, failing to use the investors’ schemes and (no-product or money to fulfill his promises to them and instead product-based) pyramid schemes? chooses to pay them out of funds received from future investors. In pyramid schemes, the timing of Both pyramid schemes (whether or not entry affects rank position in the pyramid (and product-based) and Ponzi schemes72 are money resultant level of pay) of participants, and each transfer schemes, meaning that they involve a person recruited is incentivized to recruit others in transfer of money between participants, rather an endless chain of recruitment. than offering either legitimate investments or the Unlike Ponzi schemes and no-product production or sale of actual goods or services to pyramid schemes, some of the more successful those outside of the participants themselves. In the MLMs are able to continue almost indefinitely, case of Ponzi schemes, new investors are not only by expanding to other markets (often recruited to provide revenues, but little real overseas), but by introducing new “product investment occurs. Instead, earlier investors are divisions” or name brands and starting the whole paid dividends or “profits” from the investments of recruitment process all over again. And after new investors. Of course, since the supply of new enough years have gone by, a new generation investors is limited, eventually the scheme of prospects can be targeted under a new name collapses when new investors cannot be found, or or focus, as Amway has done with Quixtar and the demand for refunds of original investment Nu Skin has done with several product divisions. principal by earlier investors exceeds available Again, this is a process I call “re-pyramiding.”

72 The history of pyramid and Ponzi schemes will be discussed in Chapter 10. Ch.2- 35

Are all MLMs pyramid schemes? As will be explained in Chapter 10, the structural difference between pyramid schemes As the following chapters will demonstrate, and MLMs – aside from the existence of products MLMs are merely product-based pyramid for sale – may represent a distinction without a schemes disguised as “direct selling difference. (The only substantive difference is that companies.” But even when confronted with one accepts cash – and the other payments for overwhelming evidence of this, MLM defenders – products (usually over time) as investments in the especially the Direct Selling Association – will scheme.] Definitions and terms designating likely protest: “Wait a minute. You’re not pyramid schemes used in state statutes are suggesting that all MLMs are (illegal) pyramid compiled in Appendix 2H. One can see from schemes, are you?” reviewing these that it is no wonder there is so As if all of the foregoing were not sufficient much confusion over terminology. to answer that question, an appropriate response would be – Emphasis on “internal consumption” in labeling MLMs “pyramid schemes.” In recent If it looks like a duck, MLM cases, efforts have been made to determine walks like a duck, the percentage of sales that were made to swims like a duck, participants versus non-participants. The former and quacks like a duck, are considered internal to the system, or “internal then it’s probably a duck! consumption.” The latter are “external sales.” Unless it can be proven that the majority of sales were to end users outside the network, it may be considered a pyramid scheme. However, this data Are all MLMs pyramid is not easy to obtain, as the companies are loathe schemes? to seek or to disclose such information. As

If it looks like a duck, explained in this chapter, this emphasis can more walks like a duck, readily be discovered by analysis of the compensation plan. swims like a duck, and quacks like a duck, The question of whether or not a given MLM then it’s probably a duck! is a pyramid scheme has become a red herring to mislead anyone investigating the company. Defining what is a pyramid scheme has become so In fact, as will be shown in later chapters, obfuscated by the MLM industry that it thwarts efforts MLM is the most harmful of the two classes of to prosecute cases against MLMs. But one thing is pyramid schemes (no-product and product- certain – MLM is an unfair and deceptive practice – based), by any measure – loss rates, aggregate making it illegal under Section 5 of the FTC Act, and losses, total number of victims, low payout based on statutes in many states. percentage, and degree of leverage enjoyed by TOPPs (the degree to which they profit from the A more descriptive term for MLMs, purchases of those beneath them). or product-based pyramid schemes: Definitions and terms for pyramid “pancake schemes” schemes vary among the states. Those who expect to find uniform definitions of pyramid I owe it to a man whose loved one’s life was schemes across jurisdictions will be turned upside down by MLM addiction for this disappointed. Statutory definitions of what is and insight. Others have calculated that in “doubling” what is not a pyramid scheme vary from state to 33 times with a simple binary MLM progression, state, and many show lack of recognition of the you exceed the population of the earth. In plotting fundamental flaws in all endless chain the positions on a graph, this man found that the recruitment programs, including MLMs. This is downline organization looks more like a flat line or not surprising, as many attorneys, legislators, pancake with a bump in the middle than a academicians, and so-called experts are not triangular-shaped pyramid. To see this flat line clear on these issues. characteristic of MLM, see Appendix 2I. Ch.2- 36

Of course, if you have more than a doubling startup company entrepreneurs. Often the role of recruits at each level, the line flattens out even and requirements or the compensation plan are more quickly. For example, with Nu Skin a person widely misunderstood. Therefore on this page must be an “Executive” with five active distributors we’ll expose some misconceptions: beneath him or her to qualify for “breakaway” commissions or for rank advancement. While a Misconception #1: The purpose of the compensation plan is to compensate distributors. “Blue Diamond” may only be paid on six levels, the mathematical progression of endless chain Reality: The purpose of the compensation plan is recruitment continues. The progression (with the to motivate behaviors that will grow your company. line of victims getting longer at teach level) Here is another example of the unfairness of proceeds as follows: MLM. Newly recruited distributors are misled to 1x5 =5 believe that the compensation plan is designed X5= 25 to benefit them, when in fact, it benefits TOPPs X5= 125 (top-of-the-pyramid promoters), founders, and X5= 3,125 (a very long flat line of victims) the sponsoring MLM company. X5= 15,625 X5= 78,125 Then skip to misconception #7: X5= 390,625 X5= 1,953,125, or 1.9 million victims Misconception #7: I can buy an off-the-shelf plan for now and change it later. (A line of that many persons standing next to each other could be 800 miles long!) Reality: The plan you launch with will have By only the 15th level, the progression enormous impact on your early success. Some approximates the population of the entire earth! refinements will be possible later, but a major In contrast, with a classic 1-2-4-8 pyramid change can destroy your business. scheme, the progression matures at the fourth [NOTE: This latter reality explains why – once level, with the person at the top cashing in from established, compensation plans are not altered, the investments of those at the bottom. There are except for minor modifications.] no product or infrastructure costs to recoup, so all the money goes to the person at the top. So one Some MLM “players” game the system. person wins at the expense of 14 who lose their investment – as opposed to a massive “flat line” Some “players” regularly “game the MLM scheme in which thousands in a downline system.” They are extremely successful MLM lose money to enrich a few at the top. recruiters who are continually on the lookout for The point I am making is that the “flat line” new MLMs. Because of their reputation for downline is another way of illustrating that MLM is aggressive recruiting, they are given entry far more damaging than classic 1-2-4-8 no-product positions at or near the top of a pyramid of schemes by any measure – loss rate, aggregate distributors yet to be developed. They may bring losses, and number of victims. hundreds of downline distributors with them from another MLM. This practice – called “cross recruiting” – has led to lawsuits. Some even Compensation plans designed to work more than one MLM at a time. benefit the company and TOPPs, not These players often choose to work fast- downline participants paying binary compensation plans in which they can be earning tens of thousands of dollars a A recent statement73 by a leading designer week before they move their downline to the of compensation plans reveals the real next deal. This often happens when a new motivation behind the plans: market is opened up in another country or when A critical component of your new MLM or a new product division is introduced. We have party plan company is the compensation plan. learned of a top “player’s” position determined This is one of their earliest concerns for many by nepotism, by a telephone call, or even by a toss of the dice. This is not fair to others in the MLM, but as this chapter illustrates, MLM is 73 “A Winning Compensation Plan – like agose laying fundamentally an unfair and deceptive practice. golden eggs”: The Sheffield Group– www.sheffieldnet.com Ch.2- 37

levels of sales management – branch, division, What would a “good MLM” look like? regional, and national sales managers. Thus, if MLM is a legitimate direct sales program, it Many have asked if it is possible to have a should be capped at a maximum of (preferably) fair and equitable “retail-focused MLM” program. three levels of individual participants. (More than In other words, what would a “good MLM” look that serves only to enrich founders and TOPPs at like? Considering the inherent flaws in MLM as a the expense of their downlines). And by limiting business model, the established precedents, the number of levels on which commissions are and the motivations that drive the industry, one paid, prices could be more competitive – and might wonder if such an MLM is possible. Some distributors could succeed from retailing the insist that a “good MLM” is an oxymoron. products, not just from recruiting and selling to However, for anyone willing to try, here are their downlines at inflated prices. Not having to some consumer protections that should mitigate pay on so many levels would make competitive some of the harm done by endless chain pricing possible, although MLM may never recruitment schemes. Assuming honest compete with discount outlets. If the pay plan execution, they could help to assure an MLM were limited to three levels, retail sales prices would be both legal and ethical. could be much lower. 1. Commissions or bonuses would be paid 6. Ideally, no commission payments would be only for sales to non-participants – not for paid in perpetuity, except for sales by those on the “internal consumption” (sales to participants). first level (“front line”) in one’s downline of This would minimize losses from buying what is participants. For example, downline commissions not needed and would put the emphasis might be paid for one or two years to give time for squarely on selling to legitimate customers, as the upline to profit from training recruits until they opposed to recruiting a downline and are competent. This would minimize the incentivizing them to buy and stockpile mathematical absurdity of a program that expands products.74 endlessly not only in space (area-by-area market 2. An MLM could reward selling of products saturation), but also in time, and it would limit the more than recruiting by paying at least half of motivation to build a downline for “residual the total company payout to “front line income,” or the dream of sitting back and profiting distributors” actually selling products to end use forever from the efforts of others. consumers; i.e., persons not in the network of 7. Breakaway compensation plans – participants. So if a company’s total payout to essentially pyramids within mega-pyramids – participants was 50% of total revenues, would be banned, and other complex plans commissions (not retail markup) paid by the (matrix, binary, etc.), would be replaced with company to frontline distributors would be at simpler unilevel plans. This would help to limit least 25%. The other 25% would be split among the obfuscation that hides misrepresentations the upline. This could make retailing to non- and makes comparisons difficult. The irony of participants profitable. And distributors wouldn’t this is that such an MLM compensation plan be so eager to recruit, especially persons in their would be fashioned after classic no-product own area who could compete with them. pyramid schemes – which are illegal, though not 3. “Pay to play,” or incentivized purchase usually as harmful as MLMs. requirements would be minimal or non-existent. 8. The MLM would disclose average NET Participants would be eligible for commissions payout to ALL participants at all levels in the pay and/or bonuses without having to satisfy a plan, meaning money paid by the company to minimum quota. They should not lose their participants, less money paid in to the company status if they have a bad month and fail to meet by these same participants, including purchases, a monthly quota. This could minimize losses. training, and sales “tools.” 4. The number of levels in the payout 9. In reports of average income of structure would be no more than are functionally participants, ALL participants who joined would be justified. Even sales programs of major included in these averages, not just those who are corporations can cover the country with four “active.” Attrition rates and total refunds (“buybacks”) as a percentage of total revenues

74 See Koscot and Omnitrition cases in Chapter 10. Ch.2- 38 would also be disclosed. Such transparency would definition of multi-level marketing as a business discourage many typical MLM misrepresentations. model, It applies to over 500 MLMs I have 10. Prospects would have to be told that analyzed – and is much closer to the truth than market saturation could inevitably occur, leading those cited earlier. to a diminishing opportunity for new recruits. Such protections would remove the underlying Multi-level marketing (MLM) is a “easy money” motivation (“residual income,” purported income opportunity, in which “time freedom,” etc.) and the complex maze of products are sold by recruitment of persons deceptions, upon which MLM is dependent. who are incentivized to buy products and to 11. Any major legal actions against the recruit others in endless chains of company would be disclosed, whether or not participants, who must buy products to resolved successfully. qualify for commissions and to advance 12. And finally, a list of at least five names upward through multiple levels in company- drawn randomly from the total population of sponsored pyramids of participants. participants in a given region who had been with Further – With unlimited recruitment, the company for at least a year would be MLM assumes both infinite and virgin provided with telephone numbers as references, markets, neither of which exists in the real whether or not they are still active. world. MLM is therefore inherently flawed, unfair and deceptive. It can also be extremely I have tried in vain to visualize an MLM viral and predatory. program with such consumer protections Prospects are typically lured into MLM succeeding. The driving force of huge incomes with exaggerated product and income for TOPPs would be absent, and founders may claims. Rewards are stacked in favor of find it more difficult to skim from revenues. In those at or near the top of the pyramid, who fact, I have run these suggestions by several are often the first ones to join. Since persons who were interested in starting a “good approximately 99% of participants lose MLM,” but they each decided on a more money, most of them eventually drop out, to standard MLM compensation plan – probably be replaced by a continual stream of new because no one would make obscene profits recruits, who are likewise destined for loss with such strict protections against abuse. and disappointment.

Conclusions A testable hypothesis for the

An accurate, research-based, and legitimacy of MLM consumer-friendly definition of multi-level marketing. Based on 20 years’ consumer If the legitimacy of MLM were approached advocacy and research on this topic, I can scientifically, the scientific method of proposing articulate what I believe to be an accurate a testable hypothesis could be applied, at least definition. It incorporates the four causal and in the examination of effects of MLM on the defining factors of a recruitment-driven MLM company and on its participants. discussed above. I am confident this definition is Some regulators made decisions on the the most useful for analytical purposes, as it holds theory (and may have been convinced by MLM true for all 500 MLMs I have analyzed. promoters) that if MLMs were pyramid schemes, Unlike other definitions cited earlier, this they would be destined for ultimate collapse. definition recognizes the inherent flaws of any However, as discussed above, Amway MLM, or product-based pyramid scheme; viz., defenders used this argument in claiming that an endless chain of recruitment and a pay plan Amway had already been operating for many that is recruitment-driven, top-weighted, and years without coming even close to saturation financed primarily by incentivized purchases of and collapse. It is obvious the prosecutors did the participants. Also, it clearly separates MLM not understand the difference between total from all other income activities, which definitions saturation and market saturation, which will be articulated by others have not accomplished. explained in Chapter 3. MLM promoters have So below is what I believe to be the only found ways to overcome market saturation and real-world, consumer friendly, research-based to transfer losses to a revolving door of new Ch.2- 39 recruits, so that the company can continue to primarily for those at the top of the pyramid of thrive. These will also be explained in Chapter 3. participants, which are often those who enrolled at Because MLM is presented as an income or near the beginning of the chain of recruitment in opportunity, and income claims are what is most any specific market. And given the costs of often challenged by critics, the bogus income participation, it would be rare for new participants claims issue is a better place to start. Given to realize profits above expenses – meaning the available data, the most relevant strategy for vast majority lose money. And accordingly, attrition testing MLM as a business model would be to for MLM participation would be high. take a broad sample of MLM companies and This hypothesis will be tested in upcoming analyze their compensation plans and resulting chapters. In fact, in Chapter 7 I show that MLMs average income figures for participants. So a are the most harmful of the two classes of pyramid testable hypothesis might be framed like this: schemes (product and no-product), by any Assuming MLM’s unlimited recruitment of measure – loss rates, aggregate losses, payout endless chains of participants, average income ratios, and number of victims. So read on. data for participants in a broad sample of MLMs will show that participation in MLM is profitable

Ch.2- 40

Appendix 2A

Definitions of Relevant Terms

Compensation plan – the method of point that recruiting becomes unprofitable. Promoters compensating participants in a program, which can of an MLM program must then find other areas or be very elaborate in recruitment-driven MLMs. Often create other product divisions in which to recruit. ignored by regulatory officials, it is the position of this Market saturation is reached far sooner than actual author that analysis of compensation plans is saturation, a point often overlooked when MLM essential in identifying the programs likely to cause apologists defend their programs by saying that the greatest consumer losses. See above for types of saturation has never actually happened, and that MLM compensation plans. replacement is an ongoing process like many other businesses. Also called “de facto saturation” De facto (market) saturation – an area where recruiting opportunities are perceived to have Multi-level marketing (MLM), as defined by the diminished to the point that recruiting becomes Federal Trade Commission is “any marketing unprofitable. (Same as “market saturation.”) program in which participants pay money to the program promoter in return for which the participants Direct selling. This is a term that MLM obtain the right to – companies, with help from the Direct Selling 1. recruit additional participants, or to have Association, have worked hard to adopt for their additional participants placed by the promoter or any business model. According to them direct selling is other person into the program participant’s downline, marketing and selling products, direct to consumers tree, cooperative, income center, or other similar away from a fixed retail location. However, what the program grouping; DSA/MLM lobby fails to recognize is what legitimate 2. sell goods or services; and direct selling is not – an endless chain of recruitment 3. receive payment or other compensation; of participants as primary customers. provided that: (a) the payments received by each program Downline – all of the MLM distributors who are participant are derived primarily from retail sales of recruited under a given distributor and from whom goods or services, and not from recruiting additional are generated overrides on product sales participants nor having additional participants placed into the program participant’s downline, tree, Incentivized (or “pay to play”) purchases – cooperative, income center, or other similar program the practice of tying purchases of products from an grouping, and MLM company with requirements to enter the (b) the marketing program has instituted and “business opportunity” option and to advance in the enforces rules to ensure that it is not a plan in which hierarchy of “distributors” – who are in effect merely participants earn profits primarily by the recruiting of participants making pyramid scheme investments additional participants rather than retail sales.” 36 disguised (or laundered) as purchases. As this book will make clear, this definition has some problems with it, most notably: Leverage – a concept often used by MLM (1) Until this analysis, it has never been made promoters to convey the idea that by drawing income clear how it was to be determined that payments to from a large downline of distributors, a person can participants came primarily from the retail sales of leverage his/her time and investment in the scheme goods or services and not from recruiting of by drawing on the time and resources of their additional participants. Hopefully, after reading this downline. A related concept is “residual income,” a book, the question can be answered. form of passive income often received by authors, (2) the fact that the institution of “rules” [in (b) artists, insurance agents, and others who have made above], is insufficient to correct the problems with a contribution and thereafter get royalties from work product-based pyramid schemes. The compensation performed earlier. The ideal presented is that a plans must be addressed, along the lines of this successful MLM recruiter can work hard for a period analysis, if the problems with MLM are to be of time and never have to work again, thanks to corrected. his/her downline. The following definition, (explained in this Market saturation – an area where recruiting chapter) is the only one based on extensive opportunities are perceived to have diminished to the independent research: Ch.2- 41

that pay much greater rewards for recruiting than for Multi-level marketing (MLM) is a purported direct sales to end users, they cannot sustain income opportunity, in which products are sold by themselves from direct sales only. So when recruiting recruitment of persons who are incentivized to buy leads to saturation in a given market, they must products and to recruit others in endless chains of recruit elsewhere. They thus eventually become like participants, who must buy products to qualify for Ponzi schemes, seeking new investing participants commissions and to advance upward through elsewhere (in the form of incentivized product multiple levels in company-sponsored pyramids of purchases) to pay off earlier investors. participants. Further – With unlimited recruitment, MLM Product-based pyramid scheme (recruitment- assumes both infinite and virgin markets, neither of driven MLMs) – a pyramid scheme that in most which exists in the real world. MLM is therefore respects resembles a no-product pyramid scheme, inherently flawed, unfair and deceptive. It can also be except that products are purchased by distributors, extremely viral and predatory. ostensibly for resale, but actually for qualification or Prospects are typically lured into MLM with advancement in the scheme. Such product purchases, exaggerated product and income claims. Rewards often combined with other incentives, qualify distributors are stacked in favor of those at or near the top of the for commissions and advancement in ascending levels pyramid, who are often the first ones to join. Since in the distributor hierarchy. Such payments could be approximately 99% of participants lose money, most considered investments in a pyramid scheme laundered of them eventually drop out, to be replaced by a through product purchases. continual stream of new recruits, who are likewise destined for loss and disappointment. Pyramid scheme – According to the FTC, these are plans which “concentrate on the commissions you Network marketing – a term devised by MLM could earn just for recruiting new distributors” and which companies to get around the implications of “multi- “generally ignore the marketing and selling of products level marketing” – which sounds too much like a and services.”75 The latter feature, of course, ignores chain distribution or pyramid form of marketing. the realities of product-based pyramid schemes, which this paper demonstrates do more aggregate damage to No-product pyramid scheme – a blatant consumers than no-product schemes. The FTC has pyramid scheme that is easy to detect because no also described the essential features of an illegal products are offered, merely a participation fee or pyramid scheme as follows: “investment.” Chain letters work on the same Such schemes are characterized by the principle. A continuous chain of “participants” or payment by participants of money to the company in “investors” is recruited, in which each pays a fee to return for which they receive (1) the right to sell a participate and receives money by recruiting others product and (2) the right to receive in return for into the program. recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate “Pay to Play” – a requirement common to all users. . . As is apparent, the presence of this second chain letters, no-product pyramid schemes, and element, recruitment with rewards unrelated to product-based pyramid schemes, in which an product sales, is nothing more than an elaborate investment – either in monies or in products chain letter device in which individuals who pay a purchased – is required in order to “play the game,” valuable consideration with the expectation of i.e., participate in and/or advance in the scheme. This recouping it to some degree via recruitment are need not be a substantial up-front fee to enroll in the bound to be disappointed.76 MLM, but can be in the form of ongoing (usually Recent court decisions have emphasized the monthly) volume purchase requirements for bonuses, need for the majority of sales to be to non- advancement to “pin levels,” etc. These could be participants for an MLM program to avoid being viewed as disguised or laundered investments in a classified as a pyramid scheme. product-based pyramid scheme. See “incentivized Unfortunately, the issue of whether or not a purchases.” given MLM is a pyramid scheme has become a red herring to deflect attention away from its being Ponzi scheme (in the final evolution of a determined to be an unfair and deceptive act or recruitment-driven MLM) – named after Charles practice, which makes it clearly in violation of Section Ponzi, an Italian-born swindler who cheated over 5 of the FTC Act – and of many state statutes. 30,000 investors of over $15 million in 1919-1920. Since that time, a Ponzi scheme refers to any 75 FTC Consumer Alert, December 1996 investment swindle in which some early investors are 76 In re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1180 paid off with money put up by later ones. Since (1975), gaff’s mem, sub nom. Turner v. FTC 580 F .2d 701 recruitment-driven MLMs use compensation plans (D.C. Cir. 1978). Ch.2- 42

Recruitment-driven MLM (product-based pyramid schemes) – an MLM with a compensation plan that rewards primarily distributors who recruit huge downlines, and is therefore a product-based pyramid scheme. My research shows this applies to virtually all MLMs, or at least the 500 I have studied.

(hypothetical) Retail-focused MLM – an MLM which uses a compensation plan in which company A research-based definition of multi- remuneration to distributors is generous for front-line level marketing: distributors who actually sell the products to consumers, but which does not allow huge and Multi-level marketing (MLM) is a disproportionate fortunes to be made by upline purported income opportunity, in distributors. Such companies may exist in theory, but I have not found any. which products are sold by recruitment of persons who are Saturation – the occurrence of reduced interest incentivized to buy products and to in an MLM as more and more people are recruited recruit others in endless chains of into the scheme. Note that although total saturation of participants, who must buy products a market may never be reached, saturation is to qualify for commissions and to perceived as a problem by new prospects as the percentage of prospects dwindles due to the advance upward through multiple perception of diminished opportunity. De facto or levels in company-sponsored market saturation is the result. pyramids of participants.

Scheme - “a plan or program of action, Further – With unlimited especially a crafty or secret one; . . . a systematic or recruitment, MLM assumes both organized . . . design.”77 infinite and virgin markets, neither of

Time freedom – another term bandied about by which exists in the real world. MLM is MLM promoters to appeal to those who want to be therefore inherently flawed, unfair relieved from the requirement of having to spend their and deceptive. It can also be precious time to earn a living. They can live off the extremely viral and predatory. labor of others. Prospects are typically lured into

Unfair or deceptive act or practice – the very MLM with exaggerated product and type of business activities that FTC was established income claims. Rewards are stacked to protect against.78 MLM is the epitome of such in favor of those at or near the top of practices. Unfortunately, FTC officials have become the pyramid, who are often the first sidetracked to determining whether or not an MLM is ones to join. Since approximately 99% a pyramid scheme, using a definition that has been of participants lose money, most of obfuscated to the point that MLM proponents are able to fend off efforts to stop such practices. them eventually drop out, to be Upline – the direct line of distributors who are replaced by a continual stream of new above a given distributor in the MLM distributor recruits, who are likewise destined hierarchy or pyramid scheme and who receive for loss and disappointment. overrides from sales or purchases. In a recruitment- driven MLM, top upline participants receive most of the payout in commissions and bonuses from the company and are the only ones to profit significantly.

77 Merriam Webster’s Collegiate Dictionary, Tenth Edition, 1993

78 Section 5 of the FTC Act. Ch.2- 43

Appendix 2B

Explanations of Compensation Plans

MLM promoters frequently argue that Stairstep/breakaway – A “distributor” while they know of problems in their ascends a staircase of groups of participants industry, they have solved the problems with escalating incentives to recruit more with their new brand of MLM compensation people to profit from more and more “pay to plan, which is supposedly more fair, honest, play” purchases. Commissions from one’s generous, etc., than all the others. personal group are replaced with overrides for Why are compensation plans so volume of qualifying breakaway groups important to MLM promoters? Because they (“organizations”) of “distributors.” Extremely are at the heart of what MLM is about. As high leverage rewards hugely those at the top one promoter proudly stated in a meeting I at the expense of a multitude of downline attended, “Our compensation plan IS our distributors who invest in “pay to play” product.” purchases – their loss, but their upline’s gain. Here are the basic MLM compensation Each breakaway is a separate plan options: organization tied to one person who draws

Unilevel – There is no limit to the overrides from the entire breakaway number of distributors that can be recruited organization, which may be one of many. It is on the first level (who “retail” products to important to recognize that six levels in a end users). However, there is usually a limit breakaway are not six levels of distributors, on the number of levels deep that can but of whole breakaway organizations of qualify for commissions or overrides. It people. could be considered a “flat pyramid” and is Though breakaway plans are found in probably the most fair of the compensation some of the most popular MLMs, those who plans – though few would get rich. It is also understand breakaway plans agree that the structure typically used by no-product they are the most exploitive and extreme of pyramid schemes of the past. all the pyramid schemes ever devised – and therefore have the greatest leverage and Binary – Binary plans promote the highest loss rates. The author recruiting in a downline of two legs of characterizes breakaways as “mega- distributors (left and right “profit centers”), pyramids” comprised of many nested “poly- with incentives to maintain matching sales pyramids.” volume between the two legs, since commissions are based on the lesser Creative new plans. Though these are producing leg. Commissions are paid only the basic compensation plans that have been on “matching volume,” and this can sharply used by MLM companies in the past, it should limit company payout. Seldom are high be noted that new forms of compensation are volume producers matched in the same leg being developed by a never-ending supply of of the downline. Binary plans could be MLM schemers. These include a trinary plan, considered “split pyramids.” modifications of matrix and binary plans, and creative combinations of the above. Often, Matrix – A limit is placed on the number promoters of new MLMs claim they have of distributors wide in the first and succeeding come up with a revolutionary compensation levels and on the number of levels deep. plan that is superior to all others. However, I Additional recruits “spill over” into the next have found that the four (and usually five) level. Growth is limited (for example, 4x12=48 causative and defining factors (“red flags”) total downline). Can be played like a lottery – discussed in this paper can be found in all lazy participants can win. Matrix plans could multi-level compensation plans. be viewed as “block pyramids.” Ch.2- 44

Appendix 2C

Sample MLM Compensation Plans

What follows are examples of compensation plans for three MLM companies with names starting with the letter Z. You can nearly always view the company’s compensation plan by doing an advanced Google search with the name of the company on one line and “compensation plan” on the other. Note the creative nomenclature for these plans. This is typical in the MLM industry. In fact, analyses of “proprietary density” of MLM compensation plans reveals the use of many proprietary words unique to the specific MLMs – which is not typical in legitimate direct selling programs. All of this suggests a tendency on the part of founders and promoters of MLM programs to obfuscate the nature of their programs to prospects.79

79 For more on the myriad deceptions used to deceive prospects, see Chapter 8. Ch.2- 45

ZamZuu Compensation

Windsock

Team Compensation Plan

In today’s world, it’s all about staying fresh in the marketplace. That’s why we’re proud to announce a brand new opportunity. Pre-launch will begin on January 15, 2010, and with it will be an exciting new way to make money that you’ll find distinctly familiar. Here’s how it works! Resources Getting Started as an Associate:

Everyone has to start somewhere. And in our marketing business, one does so by registering for the Associate Referral Program. For every referral that purchases an E-Commerce Business Solution, the Associate will receive $25. That’s it! All Associates work with their Power Team Leaders on providing referrals and receive a check every time one makes a purchase. For Flight The Rep Opportunity: crews All Associates who have referred at least three sales to their Power Team Leader will be given the option to continue as a Rep. (They may continue as an Associate if they choose.) As long as these sales, or any three personal sales, remain active, you will be qualified to override. Misc Should you elect to become a Rep, you’ll start working toward completing your 1st Team. As a Rep, you will earn: The 50% Match on all personally sponsored Associates and Reps.*- A $25 Direct Sale commission for every personal sale. Plus for every month you maintain six active personal sales, you’ll receive a $50 monthly bonus! *Must be qualified to override.

Fast Start Bonus:

If an Associate elects to become a Rep, they have 14 days from the time the third sale is made by their Power Team Leader to make six personal sales. In addition to earning $25 for each sale, they are paid a $1,000 Bonus! If they do this in the first two weeks, that’s a minimum of $1,150! A Rep’s 1st Team is considered complete when: A total of six team sales with at least three being personally made by you. All items are subject to tax where applicable.

Getting to your Power Team:

Once your 1st Team is complete, the very next Associate you personally register starts your Power Team. Now, you’re at the top pay level of the company. Your Power Team will include the 1stTeam of every Associate Ch.2- 46

and Rep in your Power Team through infinity. In addition to earning the 50%Match on all personal Associates and Reps and a $25 Direct Sale commission on new sales, you’ll also earn…

 $25 Power Team commission on all personal sales, Associate referred sales, and sales made by all Reps in your Power Team.  $2 Residual commission of the monthly Web site hosting fee on all active sites in your Power Team.  Right to earn $250 Leadership and $5,000 Bonuses.

The Power Team Bonuses:

Once you have started your Power Team and are qualified to override, there are many bonuses that you can earn! And the best part? There are no time limits! So, get to work because you may earn them as quickly and as often as you wish. They are limitless. Once you qualify for a bonus, you must keep all sales active until that bonus is paid.

Leadership Bonuses:

Every Power Team sale of $249.95 equals one sale toward a Leadership Bonus. For every three sales, you’ll earn $250!* YTB Travel opportunity sales ($499.90) will count as two sales toward the Leadership Bonus only. $5,000 Bonus:

Once you have 50 active Power Team sales, you will earn a $5,000 Bonus! Grow to 100 active Power Team sales, and you’ll earn another $5,000 Bonus! Once you reach 100 active Power Team sales, those sales will lock in. (This is separate from the Leadership Bonus.)All items are subject to tax where applicable.

Power Team Generations:

A Power Team Generation will start when one of your Power Team Reps starts their own Power Team. Their Power Team is considered 1st Generation to you. When a Rep in your 1st Generation starts their Power Team, that Power Team is 2nd Generation to you. This continues for six generations. Commissions on Power Team Generations are as follows:

 1st Generation: $15 for every 1st Generation sale plus $2 Residual commission of the monthly Website hosting fee on all active sites in your 1st Generation.  2nd Generation: $10 for every 2nd Generation sale plus $2 Residual commission of the monthly Web site hosting fee on all active sites in your 2nd Generation.  3rd Generation: $5 for every 3rd Generation sale plus $2 Residual commission of the monthly Website hosting fee on all active sites in your 3rd Generation.  4th, 5th and 6th Generation: $2.50 for every 4th, 5th and 6th Generation sale plus $1 Residual commission of the monthly Web site hosting fee on all active sites in your 4th, 5th or 6th Generation. Ch.2- 47

Quick Definitions:

Referral Fee ($25): A Referral Fee is paid to an Associate when a referral given to their Power Team Leader purchases a site.

Direct Sale Commission ($25): A Direct Sale Commission is paid to a Rep when one makes a personal sale. This commission is paid whether the Rep is in his or her 1st Team or Power Team.

Power Team Commission ($25): A Power Team commission is paid to a Rep when a sale is made in their Power Team either by the Rep or one of his or her Power Team Reps.

Qualified to Override:

Being qualified to override allows you to earn a 50% commission match, overrides and bonuses on your Power Team, Power Team Generation commissions, and Director compensation. In order to qualify to override, you must have three active personal sales. You must maintain three active personal sales to continue to qualify to override.

50% Match:

As long as you qualify to override, you will earn a 50% commission match on all of your personally sponsored Reps and Associates. If one of your personally sponsored Reps earns a $25Direct Sale commission, you earn $12.50. It’s the same for all marketing commissions. (Please note: There will not be a match paid on bonuses or the 50% Match.)

Ch.2- 48

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Ch.2- 50

Ch.2- 51

Appendix 2D

Comparative Analysis of Direct Sales and other Legitimate Distribution Models with No-Product Pyramid Schemes (NPS) and Recruitment-driven MLMs*, or Product-based Pyramid Schemes (PPS)

Analysis by Jon M. Taylor, MBA, Ph.D., President, Consumer Awareness Institute, and Advisor, Pyramid Scheme Alert

What this analysis reveals How these distinctions were derived

The table which follows shows that clear Fortunately, I was able to draw from an distinctions can be made between classic (1-2-4-8, extremely broad background in home businesses to etc.) no-product pyramid schemes, product-based make these comparisons, having had direct MLMs (multi-level marketing) programs*, and all experience or performed consultation services in forms of legitimate businesses to which the latter almost all forms of business to which MLMs are are often compared. MLM programs are often often compared. In addition, I spent a full year in an referred to as “network marketing” (also “consumer intensive one-year test of a leading MLM as a full- direct marketing,” etc.) and can be separated into fledged distributor, carefully noting everything that two categories: went on. I then conducted interviews with hundreds 1. Recruitment-driven MLMs use of present and former participants in a variety of compensation systems that are so heavily weighted MLMs before arriving at the conclusion that most towards the top of the hierarchy of participants that MLMs are in fact cleverly disguised pyramid it is necessary for participants to recruit schemes. aggressively to realize any significant profits. These I knew enough from my direct experience to are highly leveraged programs, enriching a few at know that the major problems with MLMs resulted the top of a pyramid of participants at the expense from the compensation systems, or pay plans, of of the efforts and purchases of a multitude of the various MLM companies. Decades ago, downline distributors – whose contributions are psychologists learned that “you get the behavior “leveraged” for the benefit of those above them. In you reward.” Nowhere is this more evident than in recruitment-driven MLMs, most of the payout in multi-level marketing. commissions and bonuses from the MLM go to top Combining the research and experience of distributors and very little can be gained from efforts myself and others, I itemized what characteristics in to sell products directly to consumers. Properly MLM and in no-product pyramid schemes are unique understood, such MLMs are illegal pyramid schemes. to them and clearly differentiate them from other types The vast majority of MLMs I have studied fall into this of business activity. Then I broke these down into category. those which were implicit within the compensation 2. Hypothetical retail-focused MLMs pay the bulk plan – which seemed to cause most of the problems – of their commissions to the person selling the products and those that could be considered merely effects or services to end use consumers. In a retail MLM, growing out of the reward system. Items numbered 1 there is enough incentive to sell directly to customers to 6 could be considered causal, while items that it is not necessary to recruit a large downline to numbered 7 to 17 could be considered effects. realize significant profits. In over 500 MLMs to 2012, I Number 6 applies to no-product pyramid schemes could find no examples of true retail-focused MLMs. and is replaced by number 4 for product-based pyramid schemes.

Ch.2- 52

Other useful findings: no-product schemes by any measure – loss rate, aggregate losses, number of victims, etc. What I found was strikingly clear. Five characteristics*** (especially the first four) clearly The chart that follows is color-coded to help differentiated the recruitment-driven MLMs, or discern the differences between characteristics of product-based pyramid schemes from the rest. the various business models. Defining and causal These factors were both defining and causal – characteristics of - defining the differences, as well as identifying the No-product pyramid schemes are marked in causes of the problems. No-product pyramid medium gray. schemes have always been more easily Recruitment-driven MLMs are dark gray. recognized, both by law enforcement and by Retail-focused MLMs (if such were to exist) are consumers. What this analysis shows is that traits light gray. can be singled out both to clarify differences and to Significant effects that are not causal are predict high loss rates. marked in very light gray, the most important of which are listed first, as numbers 7 to 10. These same five “red flags” could have legal significance in court cases. In most jurisdictions, a * a.k.a. multi-level marketing, network key element is considered in defining pyramid marketing, consumer direct marketing, etc. schemes – the payment of money by the company Recruitment-driven MLMs can be distinguished in return for the right to recruit other participants into from retail-focused MLMs, in which the company the scheme. If the primary emphasis is pays generously for retailing products without compensation from recruiting, rather than from the recruiting large downlines. For retail-focused MLMs, sale of products to end users, it is considered a #5 (and preferably #4 as well) would be answered pyramid scheme. How such primary emphasis is to with a “NO.” be determined has until now been a formidable ** “Incentivized purchases” are purchases of challenge for investigators. Hopefully, this challenge goods and services from the MLM company that will be met with this analysis and my more complete are tied to qualification to participate in analysis entitled “THE 5 RED FLAGS: Five Causal commissions or to advance through ascending and Defining Characteristics of Product-Based Pyramid levels in the distributor hierarchy. If they constitute a Schemes” *** required cost of participating in the “business In the spring of 1999, I mailed my conclusions to opportunity,” then whether they are used, sold, the presidents of 60 of the most prominent MLM given away, or stored is irrelevant – they should be companies and gave them a form to provide data to considered a cost of doing business. “prove me wrong.” At least five of them attempted to do so, but none were able or willing to do so. So I *** NOTE: In 2003, I settled on the 5 CDCs (or “5 was left with the necessity of validating my red flags”) for analytical purposes. However, analysis of conclusions using other resources. With the help of over 500 MLMs has led me to reduce the number to associates, careful research into public documents, four, since #4 occasionally does not apply. [#4 and #5 and a lot of communications with key informants, I were later reversed in subsequent reports so that the was finally able to locate the average incomes and first four could be easily identified as universal and #5 percentages of “distributors’ at various payout as applied to most, but not all, of them.] However, when levels at 37 (by 2012) “recruitment-driven MLM” the number of levels in the pay plan has been limited to companies. What I found was startling – far worse four or less, this has been compensated for by extreme than expected. After eliminating typical deceptions jumps in income at the top levels. All are top-weighted, in their reporting, the loss rate for the recruitment- though increasing the number of levels can greatly driven MLMs for which I was able to find average enhance the effect. earnings data was approximately 99.7%. And if you eliminate TOPPs (top-of-the-pyramid-promoters) from the calculation, the loss rate is closer to 99.9% for new recruits. That means that as few as one in 1,000 new recruits earn a profit – and only a tiny percentage of those earn the huge “residual income” promised them. No-product pyramid schemes, which are illegal because of the guarantee that the all of those on the bottom layers will lose money, have far better odds than that! Recent data shows that product-based pyramid schemes are far worse than Ch.2- 53

-

DEFINING AND CAUSAL driven driven

CHARACTERISTICS in the compensation ship

-

Direct Direct

-

system that identify harmful pyramid product COMMENTS – and PROBLEMS

-

schemes. The features on this page resulting from these characteristics

or or

both define a pyramid scheme and - when applied to pyramid schemes

cause the harm (extreme loss rate). (NPS and PPS)

Franchises Distributor sales agency Insurance sales business Recruiting Legitimate selling (no NPS schemes) PPS recruitment MLMs (hypo MLMs Retail thetical) 1. RECRUITING OF PARTICIPANTS IS NO NO NO NO NO YES YES YES Income is dependent on downline recruiting, UNLIMITED IN AN ENDLESS CHAIN OF with the assumption of an unlimited market. EMPOWERED AND MOTIVATED RE- Perceived or de facto saturation results in CRUITERS RECRUITING RECRUITERS. Is diminishing opportunity and guaranteed unlimited recruiting allowed, and are those who losses for participants at bottom levels. If all are recruited empowered and spurred on by pyramid schemes were defined as illegal incentives (overrides, advancement, etc.) to (and the laws were enforced) based on this recruit additional recruiters, who are also one characteristic, we would not have the empowered and motivated to recruit still more proliferation of schemes we see today. recruiters, etc. – so that the effect is an endless chain of recruiters recruiting recruiters? 2. ADVANCEMENT IN A HIERARCHY OF NO NO NO NO NO YES YES YES If a participant must recruit to advance to MULTIPLE LEVELS OF “DISTRIBUTORS” IS more profitable payout levels in the scheme, ACHIEVED BY RECRUITMENT, RATHER and if a program’s emphasis is on building a THAN BY APPOINTMENT. downline, it as a de facto pyramid scheme, Does a participant advance in position (and whether or not it has been declared illegal potential income) in a hierarchy of multiple levels by authorities. Also, for PPS’s, quality of of “distributors,” by recruiting other distributors under products often becomes questionable when him/her, who in turn advance by recruiting other advancement and monetary incentives are distributors under them, etc.? tied to recruitment. 3. “PAY TO PLAY” REQUIREMENTS ARE NO NO NO NO NO YES YES YES Such cost of participation assures huge SATISFIED BY ONGOING “INCENTIVIZED – only gains for top-level participants, but PURCHASES**.” Are new “distributors” given initial guarantees losses for those who fail to “pay to play” options? That is, are they invest- ascend to higher levels in the hierarchy of encouraged to make sizable investments in ment participants. The amount of initial investment “incentivized purchases” (purchases tied to for PPS’s may be small, but total purchases qualification for commissions or advancement in over time can be very significant for those the scheme**) in order to take advantage of the seeking promised rewards, such as “business opportunity,” and later to continue advancement to higher “pin levels” or bonus qualifying for advancement and payments from categories. the company? 4.TOP WEIGHTED PAY PLAN – COMPANY NO NO NO NO NO YES YES NO This results in extreme inequality in payout PAYOUT PER SALE FOR EACH UPLINE to distributors and a high loss rate. Only a PARTICIPANT EQUALS OR EXCEEDS THAT few participants at the top of the pyramid get FOR THE PERSON SELLING THE PRODUCT, enough in commissions from sales to a large CREATING INADEQUATE INCENTIVE TO downline to achieve a significant income. RETAIL AND EXCESSIVE INCENTIVE TO Conversely, those on lower levels seldom RECRUIT – AND AN EXTREME CONCENTRATION get enough payment from the MLM to cover OF INCOME AT THE TOP. Would a “distributor” their expenses, including purchases from purchasing products “for resale” receive the company. Thus the emphasis is on about the same total payout (in commissions, recruiting, not retailing or direct selling. If bonuses, etc.) from the MLM company as distributors on the front line receive over half participants several levels above who had of an MLM company’s payout, the MLM nothing to do with the sale? Those at the top would have more of a retail emphasis. of the hierarchy then profit hugely. NOTE: the program is still top-weighted if the total payout for all upline distributors exceeds that for the front-line person selling the product. 5. COMPANY PAYS COMMISSIONS AND/OR NO NO NO NO NO NO More than 4 levels in an MLM means huge BONUSES TO MORE THAN FIVE LEVELS OF – not payouts to top level participants, which “DISTRIBUTORS.” Does the company pay usually come from overrides on purchases of a commissions and bonuses to distributors in a large downline. This more than 4-level

hierarchy of more levels than are functionally compensates for the small payout per sale –

limit f f not, #5 is justified; i.e., more than five levels?” Even in I vs. NPS’s, where the top person gets it all. best

major corporations, the entire world – Paying bonuses on more than five levels in marketplace can be covered in five levels of an MLM enriches those at the top at the sales management – branch, district, regional, expense of those at the bottom.

national, and international sales managers.

Usually extreme more 6. ALL THE MONEY GOES TO THE TOP. NO NO NO NO NO YES NO NO With NPS’s, only participants at the top of the Would participants who recruit other pyramid get paid. Those at the bottom levels will participants into the scheme receive nothing always be waiting to advance to the highest level until advancing to the top level in the hierarchy? to get paid. Approximately 90% end up losers NOTE: This applies to NPS only – PPSs when the pyramid collapses or is shut down. (MLMs) are still top-weighted without all the money going to one person at the top, but more money goes to the upline than to the front-line person selling the product.

Ch.2- 54

-

DEFINING AND CAUSAL -

CHARACTERISTICS in the

compensation system that identify ship

-

harmful pyramid schemes. The product COMMENTS – and PROBLEMS

-

features on this page both define a resulting from these characteristics

or recruitment or

pyramid scheme and cause the harm - when applied to pyramid schemes

(extreme loss rate). (NPS and PPS)

Franchises Distributor sales agency Insurance sales business Recruiting Direct Legitimate selling (no NPS schemes) PPS MLMs driven (hypo MLMs Retail thetical) 7. Emphasis is on payments for the rights to NO NO NO NO NO YES YES NO This EFFECT results from the system of recruit as the primary source of income, rewards in the compensation system. rather than the sale of products and Though not a CAUSE of the harm done services by pyramid schemes, it is a key criterion in federal and state laws against pyramid schemes. 8. Loss rate is so dismal enough to NO NO NO NO NO YES YES NO Loss rates for recent NPS’s have ranged disqualify them as legitimate businesses. It from 87.5% to 93.3%. For PPS’s or is rare for participants to report a net profit recruitment-driven MLMs the loss rates are to the IRS. about 99.9%. One can do better with a single roll of the dice in a game of craps in Las Vegas. 9. Misrepresentation and deceptive sales NO NO NO NO NO YES YES NO Misrepresentation causes harm to practices are commonplace, as they are consumers who invest on the basis of essential for any pyramid scheme to survive incorrect information. To be successful in a and grow. If the truth were told about the PPS or NPS, one must first be deceived, abysmal odds of “success,” few would join then maintain a high degree of self- the program, and it would soon collapse. deception, and finally go about deceiving others. 10. New pyramidal organizations are set up NO NO NO NO NO YES YES NO The more durable MLM companies avoid in other areas (or with new product divisions collapse by initiating new pyramids, which they for PPS’s) to maintain downline networks label “growth opportunities.” They then until the pyramid collapses or the scheme is become like Ponzi schemes, moving to new stopped by legal action. By having to recruit areas or starting new divisions to get new new participants to repay earlier investors, recruits to buy products so that earlier NPS’s and PPS’s evolve into Ponzi investors can profit. schemes. 11. The distinction between buyer and seller NO NO NO NO NO YES YES NO This creates confusion and a low level of becomes blurred. With multi-level schemes, trust in the minds of consumers – and the seller, buyer, and recruiter (and his/her contaminates the marketplace for legitimate immediate family) may be the same entity. enterprises. 12. The program displays a pattern of rapid NO NO NO NO NO YES YES NO This pattern is common to all pyramid growth, then a leveling off in sales, followed schemes due to empowerment and by a precipitous decline in volume, unless incentives given to each recruit to recruit aggressive re-pyramiding occurs. other recruiters, as in #1 (above) 13. Duplication of one’s efforts and NO NO NO NO NO YES YES YES Recruits are taught that this process can investment is encouraged in order to build lead to great leverage for one’s time and one’s downline. investment – but not that they are only fattening the checks of their upline. 14. Continuous replacement of “losers” is NO NO Some- NO Some- YES YES NO Replacement also helps to maintain a supplied by continual recruiting of new times times pyramid scheme by creating a “body shop” participants. of new victims to replace an inordinate percentage of dropouts. 15. Demand for the products is distributor- NO NO NO Some- Some- NO NO YES The need for and quality of products driven, not market-driven. times times becomes secondary to participation in the scheme. “Pay to play” purchases become disguised (or laundered) pyramid investments. Some MLMs are notorious for hyper-consumption of products, filling garages, etc. 16. Promises are made of quick return on NO NO NO NO NO YES YES NO Pyramidal income appeals induce distributor investment, huge residual (“permanent”) investments, which ultimately become income, time freedom, and other easy losses for the vast majority of participants— money appeals. especially for PPS’s. 17. Addiction to pyramid scheme appeals NO NO NO NO NO YES YES NO “MLM junkies” have been observed cycling can be seen in some participants. through one MLM after another, losing money each time. It is likely that these same people would fall for NPS’s.

For more information, go to www.mlm-thetruth.com. © 2012, 2003 Jon M. Taylor

Ch.2- 55

Appendix 2E: List of MLMs for which compensation plans have been evaluated by Jon M. Taylor, MBA, Ph.D.

As of July 9, 2014, a MLMs evaluated: Avon – recently revised total of over 520 MLMs have Awareness Life been evaluated by Dr. Taylor 3000 BC (usually by request). When 124 Online B at least the first four of the 1Cellnet Baby Crazy five causal and defining 4Life International Bamboo Park factors80, or "red flags," 4 the Good Life ►Beach Body identified by Dr. Taylor are 5Linx BeautiControl Cosmetics found in an MLM, it can be Bel'Air A Bellamore considered a recruitment- A. L. Williams (now Primerica) Better Universe driven MLM, or product- Acai Plus Beyond Freedom Evolution based pyramid scheme – Achievers Unlimited bHIPGlobal and certainly an unfair and ACN Big Planet deceptive practice (UDAP). Adcalls Boceutica Such compensation plans Advantage Marketing Systems Biogen have been found to result in Advantage Neutraceuticals Biometrics loss rates of 99.1% to ►Advocare Bioperformance 99.9%. When you eliminate Affordable Energy BioPro TOPPs (top-of-the-pyramid Agel BioSolace (India) promoters) from calcula- AIM BodHD tions of average incomes, Alivemax Bodywise the chances of new recruits All-star Entrepreneur Bookwise Books profiting is approximately AlpineV Boresha Int’l ZERO! Altairia Brain Garden In addition to those listed Amazon Herb Business in Motion below, Dr. Taylor also Ambit Energy analyzed numerous MLM American Longevity C programs that are now American Marketing Cajun Country defunct, that were shut down Systems (AMS) Celebrating Home by authorities, or that did not American Petroleum Cell Tech Promotions (APP) Cell Wireless provide sufficient detail in their ►Ameriplan USA Ceres Living compensation plans to do a Amerisciences Champion Communications complete evaluation. This was Amigo Health Cie Aura true of many party plans. Amkey Citizenre Those MLMs with the Amsoil Cleur symbol ► by them have ► Amway-Quixtar Coastal Vacations furnished average income Annasa Cognigen statistics (See Appendix 7) Apeus Conklin Approval Warehouse Cookie Lee Jewelry NOTE: Since each person is ► Arbonne cPRIME encouraged to do their own 5- Ardyss International CR Health & Beauty Systems step “do-it-yourself evaluation” Ariix Creative Memories on our web site, we will not be Ascend Technologies Customer Advantage responsible for the decision Ascential Bioscience ►Cyberwize any reader chooses to make Asea about participation. At Home America D Ava Anderson Non-toxic Daisy Blue Avalla (Nutrimetrics) DCHL - Digital Crown Aviance Holdings Ltd. 80 See Chapter 2 Ch.2- 56

De Marle at Home Flexcom H Destiny 2000 FM Group World Hand of Heaven Direct from Vatican City For You HBW Insurance & Financial Discount Home Shoppers Club Foru Int’l Health 4 Wealth (now Global Income Partners) Forever Green Healthy Coffee USA Do Terra Earth Essence Forever Int'l ►Herbalife Dove Chocolate Discoveries Forever Living Heritage Health Products Drink ACT Formor Int'l Heritage Makers DSX Forte Builder Home Tec Dubli ►FHTM (Fortune Hi-tech Hsin Ten Enterprise USA DXN Marketing) – shut down (HTE USA) Dynapharm ►Free Life International Dynasty of Diamonds Freedom Rocks I Fruda Vida International iBuzzPro E Frutaigo IGlobalPro Easy Daily Cash Fuel Freedom International ►Ignite/Stream of Energy E-bio (India) Fuller Brush Igonet Ebiz.com Fun Unlimited ►Immunotec ►Ecoquest (now Vollara) Independence Energy eCosway G Alliance eFoods Global Gano Excel ►iNet Global eFusion (acai) GBG Infinity Downline (“infinity”?) Eiro GDI – Global InnerLight Elite Marketing Alliance Gano Life Inspired Living Elur Domain International Integris Global Emerald Essentials Gem Lifestyle IDN – later Big Planet, Emerald Passport (Profit Gemcap Pharmanex (all Nu Skin) Masters) Genesis Global Network Inspired Living App Empire Dreams Genesis Pure Int’l Galleries, Inc. (IGI) ►Empower Network Genewize Life Sciences ►Isagenix Enagic Global Equity Lending (was ►It Works Enfinitia Global Equity ending) ITV Ventures Eniva Gold Marketing Global Health Trax IV-7 Direct Enliven Global Income Partners iZigg Mobile Marketing EnvisionCC Global Information Network Envy Organics Globalinx J Epic Network Global Resorts Network Jafra Escape International Global Travel Trends Javita Coffee Essante (PRT Travel) JD Premium Essensa Naturale Global Wealth Trade Jeunesse Global Essentially Yours GNLD Jewelry by Park Lane Evolution International GOG (India) Jillian Chase Evolv Health GoHFT Juice Plus (NSA) Excel Telecom’s (defunct) Gold Canyon Jus Int’l eXfuse Gold Mine International Jusuru Int’l Extreme Research Golden Neo-life Diamite EZ Wealth by Design GoldQuest K Ez-Biz Goldshield Elite Kaching Kaching Good Life International Kaire F Goyin Kangivity Global Feeder Matrix Great Life International Kanosis Fern Green Organics Karemore FFSI Green World Kilante Coffee FGXpress GVO Team Elite Kleeneze (UK) First Financial Security K-Link First Fitness International Klob International First Source Marketing Alliance Ch.2- 57

Kyani My Harvest America Orovo L My Leisure Business Our World Network Learning Global USA My Travel & Cash Oxyfresh Leaving Prints My Video Talk Legacy for Life My4Life P Legacy Max My7Diamonds Palmary Legal Shield (was Prepaid Legal) Pampered Chef Lexxus N Paperly Lia Sophia NAA – Nat’l Agents Alliance Passion Parties Liberty International Narc that Car Passport LLC Liberty League Int’l (LLI) National Lending Corp. Petromagic Life Force Int’l (2-up) Native American Nutritionals Pharmanex LifeMax Natural Air Products PhotoMax Life Plus Nature's Own Pink Papaya ►Life TEAM Nature's Sunshine Plexus Pink Lifestyle Intra Supplements Nerium PM International AG ►Life Vantage Network MarketingVT Polaris Global (was Liberty Life without Debt NeuCopia League Int’l) Lifestyles USA NeutroGenesis Power Mall LifeWave New Face of Wealth Power2Marketing Lightyear Alliance New Quest International Premier Designs Limu New Vision USA Prepaid Legal Live the Source Neways Prepaid Living Livinity NextFit Primerica Financial Services Longevity Network Nexx Private Quarters Loving Works NHT Global ProActiv (Empower) LR Health & Beauty Systems ►Nikken Protandim (Life Vantage) ►Lyonness Noevir Prixdale Ventures North American Power Pur3 M Norwex Pure NRG Maakoa Nouveau Cosmeceuticals Pureworks Mandura Nouveau Riche University Purse Party ►Mannatech NSA (Juice Plus) Market America Nucerity Q Mary Kay Cosmetics NuLegacy Rx card Qing Mei Matol Botanical NuMed Qing Mei (cards) Mavericks (World Health Card) ►Numis Network Qivana Max International ►NuSkin QL Exchange Maxxis 2000 Nussentials Qnet (was GoldQuest) MB Social Nutrie Questnet MCA (Motor Club of America) Nutronix Quixtar (now Amway again) Me2Everyone Nuvante ►Melaleuca R Menage International O Rain Nutrition Metabolife Ohana Health RBC Life Sciences ML International Olivana Refer Life MMOGULS Omegatrends Regeneca Momentis Ominex ►Reliv ►Momentum Plus Omnitrition Rend Ltd. ►Mona Vie One24 Resorts 360 Vacation Plan Monarch Health Sciences OneX Retire Quickly (FFSI) Morinda Online Exchange Rev Up Daily Moxxor OnPoint Direct Ripplin MPB Today One Viz RMP Infotech Multi-pure ►Orenda Int’l ►Rodan & FIelds – Victoria ►MXI-Xocai ►Organo Gold SkinCare Ch.2- 58

Royal Body Care Team Everest VM Direct (Helloworld) Royale Business Club Team LIfe Changes Vollara (was Ecoquest) (Nutraburst) Votre Vu S Team National Sahara of India Pariwar Team Vinh University W Salu International Telex Free (Common Sense Waiora Savings Highway Communications) ►Wake Up Now Scent-sations That Free Thing Watkins SDL (New Zealand) Seminars The Limu Company Wazzub Seacret Direct The Profit Masters Wazzub ►Sendoutcards.com The Right Solution Wealth Masters International Sene Gence International The Traveling Vineyard Wealth Pools International Sensaria The Trump Network WIN (Wellness Int’l Network) Serenigy ►Thirty One Gifts Winalite Sevea Thoughts Transpired Woosh Seven Point 2 Tianshi World Financial Group SFI – Strong Future Int’l Tiens Biotech Group World Group Securities Shaklee TMII - Transcend Marketing World Leadership Group Share the Wealth International World Lending Group (recently Shopping Sherlock Tom Danley's Tape of the World Lending Group) Sibu Month World Marketing Alliance Silpada Designs Tomboy Tools (WMA) Silver Cache Top Line Creations ►World Ventures Simplexity Traverus Travel Wowgreen Simply You Trevo WoWie Sisel International Trilogy Wynlife Healthcare Skinny Body Care Trinity Communications Slender Now Trio Global Company X Solavei Triunity International ►Xango Soteria/ It Works Marketing Trivani Xeeklar Southern Living at HOME Trivita XELR8 Sozo ►Tupperware Xerveo – “20 million positions SpeakAsiaOnline.com TVC Matrix open” (Is that all?) Sportron TVI Express Ximo Spring Wellness Ubifone Xocai Stampin' Up! UltraStore Xooma Stanley Home Products/ Unicity XOWii Fuller Brush UniLife Health Care (India) Xplocial Stem Tech Health Sciences Univera Life Sciences Xtra Plan STIFORP Upper Crust Living Xyngular Stimulife Uprize Xzotto Success Life ►USANA Health Sciences Success University Y ►Sunrider V Yagooft Supralife V Mobile Technologies Yipiz Sweet Living (Philippines) Yoli Swiss Just Vaxa Int’l ►YOR Health ►Symmetry ►Vemma ►Young Living Essential Oils Synergy Worldwide ►Viridian Youngevity Syntec Nutraceuticals ►Visalus Health Sciences ►Your Travel Biz (YTB) Syntek Global Vision for Life Vision Travel Z T Vitagenesis Zamu ►Tahitian Noni Int’l Vitamark ►Zamzuu Take Shape for Life (Medifast) Viva Life Science Zeek Rewards Talk Fusion Viviane Zermat International Ch.2- 59

Zhunrize Zija Zilergy Zinzino Zivana Zoivi Zoom Mobile Zorpia Zrii Zu-B Zulian Zurvita Zeek Rewards Zeekler Zyngular Ch.2- 60

Appendix 2F Petition from Bruce Craig, former assistant to the Wisconsin Attorney General, addressed to FTC Chairman Robert Pitofsky ______February 25, 2000 Robert Pitofsky, Chairman, Federal Trade Commission 600 Pennsylvania Avenue, N.W. Washington, D.C. 20580

Re: Petition for compliance analysis or enforcement review regarding In re Amway, 93 FTC 618 (1979), Docket 9023

Dear Chairman Pitofsky:

I served as an Assistant Attorney General for the State of Wisconsin for 30 years, until retirement in 1997. During this period I litigated a significant number of pyramid cases - including extensive litigation against Amway1 in the early 1980s and cases against Koscot Interplanetary, Bestline, and Holiday Magic in the early 1970s. These actions were pursued with the direct co-operation of Commission staff. My most recent pyramid case, against Fortune In Motion, was successfully concluded in 1997. I recite this history only in the hope that it will lend credence to what follows. I direct this letter to you because you drafted the Commission's Amway opinion in 1979. The opinion appears to hold that (a) "a pyramid distribution scheme should now be condemned even without the demonstration of its economic consequences. The Commission has studied the effects of such 'entrepreneurial chains' and seen the damage they do and a per se rule should be used." [ALJ finding at par 107] and (b) that Amway would have been one of those "chains" but for the existence, and enforcement, of the "buy back rule", the "70% rule" and the "10 customer" rule [93 F.T.C. 618, 716-17 (1979)].2 These exculpatory rules have now become boilerplate in the hundreds of pyramid offerings that have surfaced since 1979. In my 1997 case, Fortune In Motion sought dismissal because it had incorporated the "Amway" rules into its marketing plan.3 In Webster v. Omnitrition, 79F.3d 776, 782-84 (9th Cir, 1996), the 9th Circuit reversed summary judgment in favor of the defendant, granted by the district court on the basis it used the "Amway" rules. The court, at p. 782, held "Our review of the record does not reveal sufficient evidence as a matter of law that Omnitrition's rules actually work." Since investments in pyramid type offerings have resulted in billions of dollars in losses over the years, I believe it critical that the Commission, initially, determines whether in fact Amway currently enforces its rules to the extent that they produce the results the Commission anticipated in its decision. The Commission may also want to consider, on a going forward basis, whether it is good policy to declare a practice per se illegal and then permit operation if certain exculpatory "rules" are incorporated in to the business plan. The attractive, but illegal, aspects of a pyramid proposal will continue to permeate a promoter's offering and recruiting efforts notwithstanding the theoretical dampening effect of the "rules." The economic motivation of a company utilizing a pyramid concept is in direct conflict with the exculpatory "rules" it promulgates. Ch.2- 61

There also exists the question, from an enforcement standpoint, whether these exculpatory factors can be effectively evaluated in time to prevent losses to the consuming public. When a pyramid, or "multi-level", company begins business operations there is no direct evidence if its "rules" are enforced or not. The time period between startup and detection is all some pyramids need. Fortune In Motion obtained over $4 million from Wisconsin residents during its short life and before we commenced litigation. The "buy back" rule was of no value since the company left the state and returned to its home offices in Canada. Does the enforcement agency bear the burden of proving that the "rules" are not enforced or is it an affirmative defense on the part of the pyramid company? Are all "multi-level" companies presumed to be pyramids until they prove their rules are effective in the manner contemplated by the Commission? The contacts I have had with Amway, and other, distributors over the years indicates that the "rules" upon which the Commission based its decision are given, at best, token recognition and are not broadly implemented or enforced. I have attached some unedited Amway distributor statements to simply give a flavor of their views on these issues. One such statement comes from a high level "Emerald" distributor. Determining the actual practices of Amway and its distributors in this respect would seem to be uniquely within the domain of the Commission. To this end, I will be asking some ex-distributor organizations to contact their members for comment to the Commission on this point, pro or con. I decided to submit this petition for enforcement review because it seems that most distributors, after failing in what they thought was a valid business enterprise, are not motivated to complain or seek redress. They have, in many instances, been conditioned to believe that any failure was their fault. Many such distributors have lost life savings, stable jobs and their marriages. After having spent most of my career dealing with these companies from an enforcement standpoint, and witnessing the damage first-hand, I feel some obligation to these victims to make this effort on their behalf . As indicated in Omnitrition, previously cited, and my Fortune In Motion case, the FTC Amway decision has created a good deal of uncertainty in respect to private and public legal efforts to deal with the abuses of pyramid plans. This will only increase with the onset of marketing over the Internet and the Globalization of this type of proposal. I urge the Commission to make initial inquiry of Amway on the question of enforcement and enforceability of its rules. Documentation of compliance with the Commission's decision, and of the beneficial effects it anticipated, should be readily available from Amway and its distributors. I also urge the Commission to re-evaluate, in general, the efficacy of its "rules" in preventing the abuses it has documented in connection with pyramid marketing. The premise of "multi-level vs. pyramid" marketing may well represent a distinction without a difference. If I can be of further assistance in any efforts of the Commission, or in clarifying matters stated herein, please feel free to contact me. I appreciate your taking the time to review this matter.

Sincerely,

Bruce A. Craig – Assistant to the Attorney General (Department of Justice), State of Wisconsin (Retired). State Bar No. 1009068, of Counsel, Lawton & Cates, S.C.

Ch.2- 62

1 This litigation was based on income misrepresentations. Documented evidence, from tax returns, disclosed that Wisconsin Amway Direct Distributors (the top 1%) had annual net incomes of minus $900. 2 Some language in the opinion, pp.716, 717, refers to the absence of inventory loading, "the purchase of a large amount of nonreturnable inventory" and the fact that an entry level Amway distributor makes no investment. However qualifying for the Direct distributor position does require mandatory monthly purchases, whether returnable or not depending on effective enforcement of the "buy-back" and other rules. The existence of the entry level distributor is not relevant to a pyramid analysis, the pyramid begins when the new distributor seeks to become a Direct. See Omnitrition par. 79 F.3d 776,782. 3 Wisconsin's pyramid rule, Ch. ATCP 122, Wis. Adm. Code does not contain the exculpatory "rules". It has been upheld by the Wisconsin Supreme Court.

Ch.2- 63

Appendix 2G

Letter to Dr. Peter Vander Nat, chief economist for the Federal Trade Commission ______April 24, 2001 To: Peter J. Vander Nat, Ph.D. Federal Trade Commission

From: Bruce A. Craig, Assistant Attorney General, Wisconsin, (Retired)

RE: PYRAMID ANALYSIS

I have reviewed your declaration in the Equinox case. I would like to submit an alternative analysis of pyramids. Although many of the elements and concerns referenced in your declaration mirror mine, I believe our point of departure differs.

BACKGROUND

I have litigated against pyramids since the late 1960s. The significant economic losses they engendered raised the concerns of our office over and above standard fraudulent business offerings that relied on misstated earnings potentials and related deceptions. Wisconsin has a relatively unique regulatory status within the Department of Agriculture, Trade and Consumer Protection – whereby rules having the force and effect of law can be promulgated at the administrative level. One of those rules is ATCP 122, which can be found at the end of this memorandum. After extended public hearings, ATCP 122 declared illegal “chain distributor schemes.” The rule has withstood challenges in the Wisconsin Supreme Court and in Federal Court . Most recently, the rule was upheld, in 1997, by the Wisconsin Court of Appeals in State v. Fortune In Motion. Perhaps of greater relevance to you is the fact that the then (c. 1972) Chairman of the Marketing Department of the Wisconsin School of Business, Howard Westing (now retired) was our primary witness in State v. H. M. Distributors and State v. Holiday Magic, the first significant legal challenges to ATCP 122. Professor Westing’s testimony was forthcoming only after we spent several weeks discussing the elements of ATCP 122 and the pyramids it regulated. His initial reticence was based upon a natural inclination not to challenge what was then a novel means of marketing. Perhaps my interest at the time was based upon my undergraduate degree in marketing from Northwestern University and the stimulation provided by my mentor Stuart H. Britt. The substance of Professor Westing’s testimony was that pyramids provided a form of “foreseeability” that enabled them to succeed notwithstanding non-competitive products, overlapping marketing areas and saturated markets. In this context “foreseeability” was the element that let every new applicant see not only how he could recruit for profit but also that all those he recruited could similarly recruit, ad infinitum. In other words, there was no barrier within the terms of the pyramid plan to continued recruiting. In essence, a pyramid is an endless chain in the guise of a business offering. This provides considerable leverage to pyramids because they could appeal to business success stories rather than the clearly gambling elements of a chain letter or lottery. Also they had the advantage of appearing, at first glance, as businesses to regulators and legislators – thus a foothold that has lasted until today. Ch.2- 64

Perhaps Wisconsin was fortunate in having a pyramid type endless chain reviewed, in 1907, by the Wisconsin Supreme Court in Twentieth Century Co. v. Quilling 130 Wis. 318, 319-20, 110 N.W. 174 (1907), the scheme involved the right to sell a “pole and thill coupling” to others:

It was further agreed that each person to whom a sale was made should have the same right as the defendant to sell exclusive territorial rights in other counties, and the purchasers from him still the same rights, and so on without limits. We are unable to regard such a project as a legitimate business enterprise . . . . it will infallibly leave a greater or less crown of dupes at the end with no opportunity to recoup their losses because the bubble has at last burst. It contemplates an endless chain of purchasers, or, rather a series of constantly multiplying endless chains, with nothing but fading rainbows as the reward of those who are unfortunate enough to become purchasers the moment before the collapse of the scheme.

What Twentieth Century did was focus Wisconsin’s efforts towards the endless characteristics of a pyramid. This was reflected in ATCP 122.

ANALYSIS

The controlling element of every pyramid I have examined is that reflected in ATCP 122: ATCP 122.02 Definition. (1) “Chain distributor scheme” is a sales device whereby a person, upon a condition that the person make an investment, is granted a license or right to recruit for profit one or more additional persons who also are granted such license or right upon condition of making an investment and may further perpetuate the chain of persons who are granted such license or right upon such condition. A limitation as to the number of persons who may participate, or the presence of additional conditions affecting eligibility for the above license or right to recruit or the receipt of profits therefrom, does not change the identity of the scheme as a chain distributor scheme. (emphasis supplied)

Once product sales and lower level introductory positions are stripped from the plan, the skeleton remaining is one where the recruit, for an investment (usually in the form of a minimum purchase or minimum monthly purchases), earns the right to recruit others in the same manner he was recruited. The elements presented by this scenario are as follows: 1. The rules by which the pyramid operates are initiated, administered and enforced by the sponsoring company. 2. The recruit seeking to participate in the pyramidal elements of the offering must make a purchase or series of purchases i.e. an “investment”. Usually this is a purchase from a recruiter who obtains his product from the sponsoring company at a discount from the amount paid by the recruit. 3. The required purchase generates profit to the recruiter and the sponsoring company from whom the product is purchased. 4. At the time the recruit makes his purchase investment he is fully aware that once reaching the distributive position for which the investment is made, he will be able to recruit others and profit in the manner described in Nos. 1,2, and 3 above. 5. Furthermore, the recruit realizes that his chances for recruiting others in a manner which will generate to him the profits above discussed are significantly enhanced by his ability to offer, pursuant to the plan of the sponsoring company, those recruits the same right (or in terms of ATCP 122 – “such license”) as he obtained with his investment. 6. All future recruits within this narrative will have the identical rights as those of the first recruit, including the ability to offer to their recruits such rights, ad infinitum. Ch.2- 65

7. The plan does not diminish the right to recruit, upon investment, at any time along the chain (such as regional managers recruiting district managers who in turn recruit sales agents). If it did, the element of “foreseeability” would deter the first recruit from joining, since his recruits would not enjoy the same recruiting rights as he does, and thus be much less likely to join. 8. It is the “endless” element of these proposals that distinguishes pyramids from other business offerings that do not contain that element.

DISCUSSION

A pyramid is much like a lottery, its mechanism is what makes it illegal – because the mechanism has no limit in its implementation. Many chain schemes are classified as lotteries, see for instance sec. 945.12 of the Wisconsin Statutes:

945.12 Endless sales chains. Whoever sets up, promotes or aids in the promotion of a plan by which motor vehicles are sold to a person for a consideration and upon the further consideration that the purchaser agrees to secure one or more persons to participate in the plan by respectively making a similar purchase and in turn agreeing to secure one or more persons likewise to join in said plan, each purchaser being given the right to secure money, credits, goods or something of value, depending upon the number of persons joining in the plan, shall be held to have set up and promoted a lottery and shall be punished as provided inhttp://folio.legis.state.wi.us/cgi-bin/om_isapi.dll?clientID= 78254&infobase=stats.nfo&jump=945.02&softpage=Document - JUMPDEST_945.02 s. 945.02. The further prosecution of any such plan may be enjoined.

This analysis goes directly to the element of the plan that makes it a pyramid. Take away the right to offer future recruits the same rights to profit and recruiting held by the recruiter and the plan fails – or must exist on other legal or illegal marketing elements. The FTC in the Amway decision appeared to recognize this critical factor, and then ignored it by concluding that retail sales and buy back provisions in the plan somehow changed it into a legal enterprise. A lottery is not made legal by adding requirements to participation or requiring acts, which would, in theory, mitigate the impact of the lottery. An illegal lottery is rendered legal by eliminating one of the elements of prize, chance and consideration. A pyramid is rendered legal by eliminating either the investment or the unbridled right to pass on recruiting rights identical to those held by the recruiter. In the case of a pyramid, neither of these elements is critical to a bona fide business. While requirements of bona fide retail sales and buy backs would undoubtedly mitigate the impact of a pyramid, they would also destroy the pyramid if truly enforced – just as the theatre referenced in footnote 3 would go broke if it truly let any meaningful number of persons participate in its lottery without buying a ticket to the movie. As previously discussed in my petition to the Chairman of the Commission, from an enforcement standpoint, it would be impossible to monitor the efficacy of a retail sales or buy back rule at the time a pyramid started up and likely impossible to validate at the time when the pyramid collapsed and the company disappears. The other scenario, much more dangerous, is that the company continues in business and has the economic and political resources to deter the Commission from even determining whether the retail sales and buy back rules are in fact enforced. It is for these reasons that I contend that the only way to prevent a pyramid from operation is to prohibit it, like a lottery, and require the company to eliminate one of the pyramidal elements before operating. In theory, a buy back rule could result in the conclusion that no “investment” was made since the money could be returned if requested. If this were the case, it would be the legal obligation of the defendant to prove that the buyback is readily and universally Ch.2- 66 available to the extent that no “investment” was made. Here, it would be the legal burden of the defendant, not the government, to prove the plan was not a pyramid.

CONCLUSION

I have no doubt that you are fully aware of the damage that a pyramid can cause. My recollection is that pyramids virtually destroyed the government infrastructure of Romania and areas of Russia. They clearly have taken billions from the thousands of participants over the years, not to speak of the diversion of funds from legitimate business enterprises. I recognize the difficulty the Commission has in undoing the Amway decision. However, if there was ever a time to reverse this trend it has to be now. I strongly urge you to focus your marketing and economic talents toward the “foreseeability” element referenced by Professor Westing and less towards traditional marketing analysis of products and markets. As I previously indicated, I believe the MLM – Pyramid distinction to be illusory. Proof of emphasis on retail sales and other distinctions that may mask the “investment” element neither go to the heart of the pyramid analysis nor escape the enforcement problems discussed above concerning the retail sales and buy back rule. I wish I had copies of Prof. Westing’s testimony, but it was 30 years ago. If you would like other information or documentation I would be pleased to supply it. I sincerely ask for your comments on this memorandum, including areas where you think my legal or marketing analysis is flawed. I am not working on commission in respect to these matters. I ask that this document, sent by e-mail, be currently treated as confidential, or at least not published, until we have had a further chance to discuss it. Be advised that I am sending copies of this correspondence to Prof. Keep, Ms. Perkins, and Taylor and Fitzpatrick. Attached to the e-mail is a copy of the Fortune In Motion opinion. Please note ATCP 122 set forth below.

Thank you for your time and consideration.

Bruce Craig

NOTE: In the Wisconsin law Chain Distributor Schemes are considered an unfair trade practice (The FTC should take note.):

ATCP 122.01 Unfair trade practice. The promotional use of a chain distributor scheme in connection with the solicitation of business investments from members of the public is an unfair trade practice under s. 100.20, Stats. When so used the scheme serves as a lure to improvident and un-economical investment. Many small investors lack commercial expertise and anticipate unrealistic profits through use of the chance to further perpetuate a chain of distributors, without regard to actual market conditions affecting further distribution and sale of the property purchased by them or its market acceptance by final users or consumers. Substantial economic losses to participating distributors have occurred and will inevitably occur by reason of their reliance on perpetuation of the chain distributor scheme as a source of profit. (emphasis by author)

Ch.2- 67

Appendix 2H

Definitions of – or related to – illegal pyramid schemes in state statutes

[Notes by JMT: Most of the states fail to specify the California endless chain of recruitment in pyramid schemes, An “endless chain” means any scheme for the disposal which would help to separate them from legitimate or distribution of property whereby a participant pays a recruiting businesses. Also, in several states where a valuable consideration for the chance to receive chain selling or recruitment program is exempt from compensation for introducing one or more additional being classified as a pyramid scheme if sales are made persons into participation in the scheme or for the to anyone (not just to non-participants), or where chance to receive compensation when a person buyback provisions are offered, the Direct selling introduced by the participant introduces a new Association has likely influenced the legislation – participant. Compensation, as used in this section, does especially if modifications were recent. Except where not mean or include payment based upon sales made to otherwise noted, the text for each state is a direct quote persons who are not participants in the scheme and who of that state’s definition. For a compilation of MLM laws are not purchasing in order to participate in the scheme. in the 50 states, go to the web site for The Advocate (Cal. Penal § 327) Group at – www.theadvocategroup.net .] Colorado Alabama “Pyramid promotional scheme” means any As used herein, “pyramid sales structure” includes any program utilizing a pyramid or chain process by which a plan or operation for the sale or distribution of goods, participant in the program gives a valuable consideration services, or other property wherein a person for in excess of fifty dollars for the opportunity or right to consideration acquires the opportunity to receive a receive compensation or other things of value in return pecuniary benefit, which is based primarily upon the for inducing other persons to become participants for the inducement of additional persons by that person, and purpose of gaining new participants in the program. others, regardless of number, to participate in the same (Colo. Rev. Stat. Ann. § 6-1-102) plan or opera-tion, and is not primarily contingent on the volume or quantity of goods, services, or other property Connecticut sold or distributed. [Ala. § Code 8-19-15 (19)] The advertisement for sale, lease or rent, or the actual sale, lease or rental of any merchandise, Alaska service or rights or privileges at a price or with a “Chain distributor scheme” means a sales device rebate or payment or other consideration to the whereby a person, upon condition that the person make purchaser which is contingent upon the procurement an investment is granted a license or right to solicit or of prospective customers procured by the purchaser, recruit for profit one or more additional persons who are or the procurement of sales, leases or rentals of also granted a license or right upon condition of making merchandise, services, rights or privileges, to other an investment and may further perpetuate the chain of persons procured by the purchaser, is declared to be persons who are granted a license or right upon the an unlawful practice rendering any obligation incurred condition of investment. [Alaska Consumer Protection by the buyer in connection therewith, completely void Act. AS § 45.50.561 (See definitions a.3)] and a nullity. The rights and obligations of any contract relating to such contingent price, rebate or payment shall Arizona be interdependent and inseverable from the rights and “Pyramid promotional scheme” means any plan or obligations relating to the sale, lease or rental. (Conn. operation by which a participant gives consideration for Gen. Stat. Ann. 42-105) the opportunity to receive compensation which is derived Also – from State v. Bull Inv. Group, Inc. (1974) 351 primarily from any person’s introduction of other persons A.2d 879, 32 Conn.Supp. 279:] Pyramid fraud law into participation in the plan or operation rather than from prohibits sale of rights or privileges where payment the sale of goods, services or intangible property by the made or consideration given to purchaser is participant or other persons introduced into the plan or contingent on his procurement of prospective operation. (Ariz. Rev. Stat. § 44-1731. Modified 3-5-2010) customers; since both vertical and horizontal pyramiding involve rebate or payment to purchaser Arkansas which is contingent upon procurement of prospective A pyramiding device shall mean any scheme whereby customers procured by purchase, both forms of a participant pays valuable consider-ation for the pyramiding are prohibited by this section. chance to receive compensation primarily from introducing one (1) or more additional persons into Delaware participation in the scheme or for the chance to "Pyramid or chain distribution scheme" means a sales receive compensation when a person introduced by device whereby a person, upon a condition that the the participant introduces a new participant. (Ark. person part with money, property or any other thing of Code Ann. § 4-88-109) value, is granted a franchise license, distributorship or other right which person may further perpetuate the

Ch.2- 68 pyramid or chain of persons who are granted such participants or by participants to others. (Idaho Code franchise, license, distributorship or right upon such Ann. § 18-3101) condition. (Del. Code Ann. § 2561) Illinois Florida The term “pyramid sales scheme” includes any plan A "pyramid sales scheme," which is any sales or or operation whereby a person in exchange for money marketing plan or operation whereby a person pays a or other thing of value acquires the opportunity to consideration of any kind, or makes an investment of any receive a benefit or thing of value, which is primarily kind, in excess of $100 and acquires the opportunity to based upon the inducement of additional persons, by receive a benefit or thing of value which is not primarily himself or others, regardless of number, to participate contingent on the volume or quantity of goods, services or in the same plan or operation and is not primarily other property sold in bona fide sales to consumers, and contingent on the volume or quantity of goods, which is related to the inducement of additional persons, services, or other property sold or distributed or to be by himself or herself or others, regardless of number, to sold or distributed to persons for purposes of resale to participate in the same sales or marketing plan or consumers. (815 Illinois Comp. Stat. 505/1) operation, is hereby declared to be a lottery, and whoever shall participate in any such lottery by becoming a Indiana member of or affiliating with, any such group or “Pyramid promotional scheme” means any program organization or who shall solicit any person for utilizing a pyramid or chain process by which a membership or affiliation in any such group or organization participant in the program gives a valuable consideration commits a misdemeanor of the first degree, punishable as exceeding one hundred dollars ($100) for the opportunity provided in s. 775.082 or s. 775.083. For purposes of this or right to receive compensation or other things of value subsection, the term "consideration" and the term in return for inducing other persons to become "investment" do not include the purchase of goods or participants for the purpose of gaining new participants in services furnished at cost for use in making sales, but not the program. (Ind. Code Ann. 24-5-0.5-2) for resale, or time and effort spent in the pursuit of sales or recruiting activities. (Fla. Stat. Ann. § 849.091) Iowa The advertisement for sale, lease or rent, or the actual \Georgia sale, lease or rental of any merchandise at a price or "Pyramid promotional scheme" means any plan or with a rebate or payment or other consideration to the operation in which a participant gives consideration purchaser which is contingent upon the procurement of for the right to receive compensation that is derived prospective customers provided by the purchaser, or primarily from the recruitment of other persons as the procurement of sales, leases or rentals to persons participants into the plan or operation rather than from suggested by the purchaser, is declared to be an the sale of goods, services, or intangible property to unlawful practice rendering any obligation incurred by participants or by participants to others. (Georgia the buyer in onnection therewith, completely void and a Code § 16-12-38 (8) nullity. The rights and obligations of any contract relating to such contingent price, rebate or payment Hawaii shall be interdependent and inseverable from the rights A person engages in an unfair method of competition and and obligations relating to the sale, lease or rental. an unfair or deceptive act or practice within the meaning of (Iowa Code Ann. 714.16) section 480-2 when, in the conduct of any trade or commerce, the person contrives, prepares, sets up, Kansas proposes, or operates any endless chain scheme. As “Pyramid promotional scheme” means any plan or used in this section, an endless chain scheme means any operation by which a participant gives consideration scheme for the disposal or distribution of property whereby for the opportunity to receive compensation which is a participant pays a valuable consideration for the chance derived primarily from any person’s introduction of to receive compensation for introducing one or more other persons into participation in the plan or additional persons into participation in the scheme, or for operation rather than from the sale of goods, services the chance to receive compensation when a person or intangible property by the participant or other introduced by the participant introduces a new persons introduced into the plan or operation. (Kan. participant. Compensation, as used in this section, does Stat. Ann. § 21-3762) not mean or include payments based upon sales made to persons who are not participants in the scheme and who Kentucky are not purchasing in order to participate in the scheme. [L “Pyramid distribution plan” means any plan, program, 1970, c 28, §1; gen ch 1985] (Hawaii Rev. Stat. § 480-3.3) device, scheme, or other process by which a participant gives consideration for the opportunity to Idaho receive compensation or things of value in return for “Pyramid promotional scheme” means any plan or inducing other persons to become participants in the operation in which a participant gives consideration program. Ky. Rev. Stat. Ann. § 361) for the right to receive compensation that is derived primarily from the recruitment of other persons as Louisiana participants in the plan or operation rather than from “Pyramid promotional scheme” means any plan or the sales of goods, services or intangible property to operation by which a participant gives consideration for

Ch.2- 69 the opportunity to receive compensation which is derived marketing program wherein the financial gains to the primarily from the person’s introduction of other persons participants are primarily dependent upon the continued, into a plan or operation rather than from the sale of goods, successive recruitment of other participants and where services, or intangible property by the participant or other retail sales are not required as a condition precedent to persons introduced into the plan or operation. (La. Rev. realization of such financial gains; (2) offer to pay, pay or Stat. Ann. § 361) authorize the payment of any finder's fee, bonus, refund, override, commission, cross-commission, dividend or Maine other consideration to any participants in a multi-level The organization of any multi-level distributor-ship marketing program solely for the solicitation or arrangement, pyramid club or other group, organized or recruitment of other participants therein; (3) offer to pay, brought together under any plan or device whereby fees pay or authorize the payment of any finder's fee, bonus, or dues or anything of material value to be paid or given refund, override, commission, cross-commission, by members thereof are to be paid or given to any other dividend or other consideration to any participants in a member thereof who has been required to pay or give multi-level marketing program in connection with the sale anything of material value for the right to receive such of any product or service unless such participant sums, with the exception of payments based exclusively performs a bona fide and essential supervisory, on sales of goods or services to persons who are not distributive, selling or soliciting function in the sale or participants in the plan and who are not purchasing in delivery of such product or services to the ultimate order to participate in the plan, which plan or device consumer; or (4) offer to pay, pay or authorize the includes any provision for the increase in such payment of any finder's fee, bonus, refund, override, membership through a chain process of new members commission, cross-commission, dividend or other securing other new members and thereby advancing consideration to any participant where payment thereof themselves in the group to a position where such is or would be dependent on the element of chance members in turn receive fees, dues or things of material dominating over the skill or judgment of such participant, value from other members, is declared to be a lottery, and or where no amount of judgment or skill exercised by the whoever shall organize or participate in any such lottery by participant has any appreciable effect upon any finder's organizing or inducing membership in any such group or fee, bonus, refund, override, commission, cross- organization shall be guilty of a misdemeanor, and upon commission, dividend or other consideration which the conviction thereof shall be punished by a fine of not more participant may receive, or where the participant is than $5,000 or by imprisonment for not more than 11 without that degree of control over the operation of such months, or by both. (Me. Rev. Stat. Ann. Title 17, § 2305) plan as to enable him substantially to affect the amount of finder's fee, bonus, refund, override, commission, Maryland cross-commission, dividend or other consideration which “Pyramid promotional scheme” means any plan or he may receive or be entitled to receive. operation by which a participant gives consideration (e) Multi-level distribution companies shall not for the opportunity to receive compensation to be represent, directly or indirectly, that participants in a derived primarily from any person’s introductions of multi-level marketing program will earn or receive any other persons into participation in the plan or stated gross or net amount, or represent in any operation rather than from the sale of goods, services, manner, the past earnings of participants; provided, or other intangible property by the participant or other however, that a written or verbal description of the persons introduced into the plan or operation. [Md. manner in which the marketing plan operates shall Title 8: 4: 8-404 § (a) (5)] not, standing alone, constitute a representation of earnings, past or future. Multi-level distribution Massachusetts companies shall not represent, directly or indirectly, [Note by JMT: While the applicable that additional distributors or sales personnel are easy Massachusetts statute does not define pyramid to secure or retain, or that all or substantially all schemes as such, it defines multi-level marketing and participants will succeed. (Mass. § 93:69) has some unique and very salient restrictions regarding MLM, particularly Ch. 93:69 (a), (d), and (e)] Michigan Section 69. (a) As used in this section the term A pyramid or chain promotion is any plan or scheme "multi-level distribution company" shall mean any or device by which (a) a participant gives a valuable person, firm, corporation or other business entity which consideration for the opportunity to receive distributes for a valuable consideration, goods or compensation or things of value in return for inducing services through independent agents, contractors or other persons to become participants in the program distributors, at different levels, wherein participants in the or (b) a participant is to receive compensation when a marketing program may recruit other participants, and person introduced by the participant introduces one or wherein commissions, cross-commissions, bonuses, more additional persons into participation in the plan, refunds, discounts, dividends or other considerations in each of whom receives the same or similar right, the marketing program are or may be paid as a result of privilege, license, chance, or opportunity. (Mich. the sale of such goods and services or the recruitment, Comp. Laws Ann. § 445.1528) actions or performances of additional participants. (d) No multi-level distribution company or participant in Minnesota its marketing program shall: (1) operate or, directly or It shall be illegal for any seller or lessor to operate or indirectly, participate in the operation of any multi-level attempt to operate any plans or operations for the

Ch.2- 70 disposal or distribution of property or franchise or both currently marketable if the goods have been consumed whereby a participant gives or agrees to give a valuable or the services rendered or if the goods or services are consideration for the chance to receive something of seasonal, discontinued, or special promotional items. value for inducing one or more additional persons to give Sales plan or operation promotional materials, sales a valuable consideration in order to participate in the aids, and sales kits are subject to the provisions of this plan or operation, or for the chance to receive something subsection (6)(b)(v) if they are a required purchase for of value when a person induced by the participant the participant or if the participant has received or may induces a new participant to give such valuable receive a financial benefit from their purchase. (Mont. consideration including such plans known as chain Code Ann. § 30-10-324) referrals, pyramid sales, or multilevel sales distributorships. (Minn. Stat. Ann. § 325F.69) Nebraska Chain distributor scheme also known as pyramid Mississippi sales shall mean a sales device whereby a person, The term “pyramid sales scheme” includes any plan or upon a condition that he or she make an investment, operation for the sale or distribution of goods, services, is granted a license or right to recruit for profit one or or other property wherein a person for a consideration more additional persons who also are granted such acquires the opportunity to receive a pecuniary benefit, license or right upon condition of making an which is not primarily contingent on the volume or investment and may further perpetuate the chain of quantity of goods, services, or other property sold or persons who are granted such license or right upon distributed to be sold or distributed to persons for such condition. (Neb. Rev. Stat. § 87-301) purposes of resale to consumers, and is based upon the inducement of additional persons, by himself or others, Nevada regardless of number, to participate in the same plan or A “pyramid promotional scheme” means any program operation. (Miss. Code Ann. § 75-24-51) or plan for the disposal or distribution of property and merchandise or property or merchandise by which a Missouri participant gives or pays a valuable consideration for The term “pyramid sales scheme” includes any plan or the opportunity or chance to receive any compensation operation for the sale or distribution of goods, services or or thing of value in return for procuring or obtaining one other property wherein a person for a consideration or more additional persons to participate in the acquires the opportunity to receive a pecuniary benefit, program, or for the opportunity to receive which is not primarily contingent on the volume or compensation of any kind when a person introduced to quantity of goods, services, or other property sold or the program or plan by the participant procures or distributed or to be sold or distributed to persons for obtains a new participant in such a program. (Nev. purposes of resale to consumers, and is based upon the Rev. Stat. Ann. § 598.100) inducement of additional persons, by himself or herself or others, regardless of number, to participate in the New Hampshire same plan or operation. (Mo. Ann. Stat. § 407.400) “Chain distributor scheme” means a sales device whereby a person, upon condition that he make an Montana investment, is granted a license or right to solicit or (a)”Pyramid promotional scheme” means a sales plan recruit for profit or economic gain one or more or operation in which a participant gives consideration additional persons who are also granted such license for the opportunity to receive compensation derived or right upon condition of making an investment and primarily from obtaining the participation of other may further perpetuate the chain of persons who are persons in the sales plan or operation rather than granted such license or right upon such condition. from the sale of goods or services by the participant (N.H. Rev. Stat. Ann. § 358-B:1) or the other persons induced to participate in the sales plan or operation by the participant. New Jersey (b) A pyramid promotional scheme includes a Ponzi [Note by JMT: New Jersey was the only state for scheme, in which a person makes payments to which I could not find anything resembling a statute investors from money obtained from later investors, defining or restricting pyramid or chain selling rather than from any profits or other income of any schemes, but I found this excerpt from an informative underlying or purported underlying business venture. article by Eric Witiw in the Law Review of Seton Hall (c) A pyramid promotional scheme does not include a University School of Law:] sales plan or operation that: (i) subject to the provisions of subsection (6)(b)(v) Who would not like to make a 700% return on an (v) (A) provides for, upon the request of a participant investment in a relatively short period of time? deciding to terminate participation in the sales plan or Although this offer is obviously too good to be true, operation, the repurchase, at not less than 90% of the over the last sixty years countless people have fallen amount paid by the participant, of any currently victim to this allure. In fact, fraudulent pyramid marketable goods or services sold to the participant investment schemes recur regularly. To address this within 12 months of the request that have not been problem, New Jersey's Legislature considered a bill resold or consumed by the participant; and which would have prohibited pyramid scams, but (B) if disclosed to the participant at the time of purchase, ultimately declined to enact any new legislation. provides that goods or services are not considered Although the state may bring civil actions against a

Ch.2- 71 promoter under the Consumer Fraud Act and the North Dakota Uniform Securities Law and criminally prosecute “Pyramid promotional scheme” means any plan or under the theft statute and the Uniform Securities operation by which a participant gives consideration Law, case law, including the appellate division for the opportunity to receive compensation which is decision State of New Jersey v. Frederica Bey and derived primarily from any person’s introduction of the New Jersey Supreme Court decision State v. other persons into participation in the plan or DeLuzio, raises the question of whether New Jersey, operation rather than from the sale of goods, services, like Delaware and Michigan, should adopt legislation or intangible property by the participant or other prohibiting pyramid promotion scams. persons introduced into the plan or operation. (N.D. Cent. Code § 51-16.1-01) The defendant, in Bey, was acquitted of theft by deception. On appeal, the New Jersey Superior Ohio Court, Appellate Division, overturned the defendant's “Pyramid sales plan or program” means any scheme, conviction for promoting an illegal lottery after whether or not for the disposal or distribution of property, concluding that pyramid schemes do not fall within the whereby a person pays a consideration for the chance or statute which prohibits illegal lotteries. This decision, opportunity to receive compensation, regardless of however, is more significant for the fact that it reveals whether he also receives other tights or property, under a conflict in two lines of cases: one construing either of the following circumstances: (1) For introducing pyramid investments as merchandise under the one or more persons into participation in the plan or Consumer Fraud Act and the other holding pyramid program; (2) When another participant has introduced a investments as securities under the Uniform person into participation in the plan or program. (Ohio Securities Law. Rev. Code Ann. § 1333.91) (Article on New Jersey Law: “Selling The Right to Sell the Same Right to Sell: Applying the Consumer Fraud Oklahoma Act, the Uniform Securities Law and the Criminal “Pyramid promotional scheme” means any plan or Code to Pyramid Schemes” 1996, 26 Seton Hall L. operation by which a participant gives consideration Rev. 1635) for the opportunity to receive compensation which is derived primarily from the person’s introduction of New Mexico other persons into the plan or operation rather than “pyramid promotional scheme” means any plan or from the sale of goods, services or intangible property operation by which a participant gives consideration by the participant or other persons introduced into the for the opportunity to receive compensation which is plan or operation. (Okla. Rev. Stat. § 21-1071) derived primarily from any person’s introduction of other persons into participation in the plan or Oregon operation rather than from the sale of goods, services “Pyramid club” means a sales device whereby a person, or intangible property by the participant or other upon condition that the person make an investment, is persons introduced into the plan or operation. (N. M. granted a license or right to solicit or recruit for economic Stat. § 57-13-2) gain one or more additional persons who are also granted such license or right upon condition of making New York an investment and who may further perpetuate the chain As used herein a “chain distributor scheme” is a of persons who are granted such license or right upon sales device whereby a person, upon condition that such condition. “Pyramid club” also includes any such he make an investment, is granted a license or right sales device which does not involve the sale or to solicit or recruit for profit or economic gain one or distribution of any real estate, goods, or services, more additional persons who are also granted such including but not limited to a chain letter scheme. (Or. license or right upon condition of making an Rev. Stat. Ann. § 646.609) investment and may further perpetuate the chain of persons who are granted such license or right upon Pennsylvania such condition. . . It does not include sales The terms “Chain-Letter Plan” or “Pyramid Club” demonstration equipment and materials furnished mean any scheme for the disposal or distribution of at cost for use in making sales and not for resale. (N. property, services or anything of value whereby a Y. Gen. Bus. Law § 359-fff) participant pays valuable consideration, in whole or in part, for an opportunity to receive compensation for North Carolina introducing or attempting to introduce one or more “Pyramid distribution plan” means any program utilizing a additional persons to participate in the scheme or for pyramid or chain process by which a participant gives a the opportunity to receive compensation when a valuable consideration for the opportunity to receive person introduced by the participant introduces a new compensation or things of value in return for inducing participant. (73 Pa. Stat. Ann. § 201-2) other persons to become participants in the program; and "Compensation" does not mean payment based on sales South Carolina of goods or services to persons who are not participants in Any contract or agreement between an individual and any the scheme, and who are not purchasing in order to pyramid club, or other group organized or brought participate in the scheme. [N. C. Gen. Stat. Ann. § 14- together under any plan or device whereby fees or dues 291.2 (b)] or anything of material value to be paid or given by

Ch.2- 72 members thereof are to be paid or given to any other deception and trickery to get it passed, with the member thereof, which plan or device includes any support of Utah’s Attorney General, whose main provision for the increase in such membership through a political donors were MLM companies. Similar tactics chain process of new members securing other new have been used by the DSA in other states.] members and thereby advancing themselves in the group to a position where such members in turn receive fees, (2) "Consideration" does not include payment for dues or things of material value from other members, is sales demonstration equipment and materials hereby declared to be an unfair trade practice pursuant to furnished at cost for use in making sales and not for § 39-5-20 (a) of the South Carolina Unfair Trade Practices resale, or time or effort spent in selling or recruiting Act of 1971. activities.

South Dakota (4) "Pyramid scheme" means any sales device or plan “Pyramid promotional scheme” defined. For the under which a person gives consideration to another purposes of 37-33-1 to 37-33-11, inclusive, the term, person in exchange for compensation or the right to pyramid promotional scheme, means any plan or receive compensation which is derived primarily from the operation by which a person gives consideration for introduction of other persons into the sales device or the opportunity to receive compensation that is plan rather than from the sale of goods, services, or derived primarily from the introduction of other other property. (Utah Code § 76-6a-2) persons into the plan or operation rather than from the sale and consumption of goods, services, or Vermont intangible property by a participant or other persons “Chain distributor scheme” is a sales device whereby introduced into the plan or operation. The term a person, upon a condition that he make an includes any plan or operation under which the investment, is granted a license or right to solicit or number of persons who may participate is limited recruit for profit or economic gain one or more either expressly or by the application of conditions additional persons who also are granted such license affecting the eligibility of a person to receive or right upon condition of making an investment and compensation under the plan or operation, or any may further perpetuate the chain of persons who are plan or operation under which a person, on giving any granted such license or right upon such condition. consideration, obtains any goods, services, or ((06-031-002 Vt. Code R. §CF 101) intangible property in addition to the right to receive Virginia compensation. (S. D. Cod. Laws § 37-33-1) “Pyramid promotional scheme” means any plan or operation by which a person gives consideration for Tennessee the opportunity to receive compensation a majority of A “pyramid distributorship” means any sales plan or which is derived from the introduction of other operation for the sale or distribution of goods, persons into the plan or operation rather than from the services or other property wherein a person for a sale or consumption of goods, services, or intangible consideration acquires the opportunity to receive a property by a participant or other persons introduced pecuniary benefit, which is not primarily contingent on into the plan or operation. (Va. Code Ann. § 18-2.239) the volume or quantity of goods, services or other property sold or delivered to consumers, and is based Washington upon the inducement of additional persons, by such “Pyramid schemes” means any plan or operation in person or others, regardless of number, to participate which a person gives consideration for the right or in the same plan or operation. (Tenn. Code Ann. § opportunity to receive compensation that is derived 47-18-104) primarily from the recruitment of other persons as participants in the plan or operation, rather than from Texas the bona fide sale of goods, services, or intangible “Pyramid promotional scheme” means a plan or property to a person or by persons to others. (Wash. operation by which a person gives consideration for Rev. Code Ann. § 19.275.020) the opportunity to receive compensation that is derived primarily from a person’s introduction of other West Virginia persons to participate in the plan or operation rather “Pyramid promotional scheme” shall mean the than from the sale of a product by a person introduced organization of any chain letter club, pyramid club, or into the plan or operation. (Texas Bus. & Com. Code other group organized or brought together under any Ann. § 17.461) plan or device whereby fees or dues or anything of material value to be paid or given by members thereof Utah are to be paid or given to any other member thereof, (b) "Compensation" does not include payment based which plan or device includes any provision for the on the sale of goods or services to anyone purchasing increase in such membership through a chain process of the goods or services for actual personal use or any members securing other new members and thereby consumption. advancing themselves in the group to a position where . . such members in turn receive fees, dues or things of [Note by JMT: I personally testified against the SB182 material value from other members. amendment to the statute in 2006 which allowed for compensation for personal use. The DSA used

73

Appendix 2I

MLM programs can be considered flat line or pancake schemes

MLM programs are shaped more like a flat-line with a bump in the middle than like a triangle or pyramid. MLMs are far worse than no-product pyramid schemes by any measure – loss rates suffered by participants, aggregate losses, and numbers of victims. A classic 1-2-4-8 no-product pyramid scheme, which does look something like a pyramid:

O

O O

O O O O

O O O O O O O O

______

Binary MLM programs – displayed in 6-point type. The next line would be longer than a page. O OO OOOO OOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO

Binary MLM programs – displayed in 2-point type – which looks more like a line with a bump in the middle: The next line would be two pages long. O OO OOOO OOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO OOOOOOOOOOOOOOOO

______

Nu Skin’s highly leveraged breakaway compensation plan – an even flatter line:

Each distributor must have 5 Executives under him/her to qualify for breakaway commissions – and for rank advancement. The top person is a Blue Diamond – who receives over half of the commissions paid to a mega-pyramid of participants. By the 16th level, the number of distributors exceeds the adult population of the earth!

Using 6-point type. The next line would exeed the width of the page.

O OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO

Using 4-point type: it looks more like a flat line – or a pancake – than a pyramid. The next line would be about five pages long, and it would definitely look like a flat line – with a bump in the middle. Ch.2- 74

O OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO OOOOO

A MODEL STATUTE AGAINST “CHAIN DISTRIBUTOR SCHEMES”

In the Wisconsin law Chain Distributor Schemes are considered an unfair trade practice (The FTC should take note.):

ATCP 122.01 Unfair trade practice. The promotional use of a chain distributor scheme in connection with the solicitation of business investments from members of the public is an unfair

trade practice under s. 100.20, Stats. When so used the scheme serves as a lure to improvident and un-economical investment. Many small investors lack commercial expertise and anticipate

unrealistic profits through use of the chance to further perpetuate a chain of distributors, without regard to actual market conditions affecting further distribution and sale of the property purchased by them or its market

acceptance by final users or consumers. Substantial economic losses to participating distributors have occurred and will inevitably occur by reason of their reliance on

perpetuation of the chain distributor scheme as a source of profit.