A new bill is being circulated that, passed as is, would legalize illegal pyramids. It is H.R. 5230: https://www.congress.gov/114/bills/hr5230/BILLS-114hr5230ih.pdf
The DSA is behind it, and probably wrote it: https://morningconsult.com/opinions/clear-definition-pyramid-schemes-will-prevent-fraud-protect-consumers/
Here’s a related video Amway released: https://www.youtube.com/watch?v=yFnluRO5u3w&feature=youtu.be and notice how they discuss lots of issues, but do NOT address the root cause of an illegal pyramid scam, little to no retail sales to external, non-distributor/IBO customers. Keep in mind it was the landmark 1979 Amway court decision that cited the 10 customer/month/distributor rule was a key element that resulted in the court finding Amway was not an illegal pyramid. Of course, Amway didn’t address the ATS (Amway Tool Scam), which dwarfs the Amway profit for the upper level distributors. All in all, the Amway video is pure, evil, and disgusting propaganda.
Here’s a distributor-produced video from a few months earlier: https://www.youtube.com/watch?v=H3U5zQNFAkg, which addresses the pyramid scheme issue with very similar, incomplete reasons given for why Amway is not an illegal pyramid. There’s a lot of other nonsense in the rest of that hour-long video as well.
My improved version can be viewed here: HR5230
I highly encourage you to forward the Direct Selling Caucus your complaints, here’s the members: http://www.dsa.org/advocacy/caucus
Here’s a summary of what is wrong with most MLMs, and why my version is worded as it is, and pokes so many holes in the bill it makes Swiss cheese look like a plate of steel:
The Fallacy of MLM
Introduction – Illegal Pyramids and RICO Fraud
This document provides a high-level discussion of MLMs, most of which are illegal pyramids – and many are also RICO frauds. A detailed discussion would result in literally hundreds of pages and several hours, if not days, of verbal discussion. The discussion below is the result of a root cause analysis, so while it is relative simple, it is not simplistic. The author was an active Amway IBO (Independent Business Owner, formerly known as a distributor) for 12 years, a “spy” IBO for another 4 years, as well as conducting in-depth research/analysis regarding Amway and other MLM illegal pyramid/RICO fraud scams, inclusive of the 4 year “spy” period, since 2005. As a technical, engineering degreed individual with significant analytical skills, as well as being trained in the practice of root cause analysis, there are fundamental, foundational reasons why MLM:
- Is almost always an illegal pyramid and often a RICO fraud as well;
- Why MLM products/services are almost always overpriced; and
- Why the lack of retail sales to non-distributors is critical to proving an MLM is an illegal pyramid.
But first let’s discuss what makes an MLM an illegal pyramid and a RICO fraud. An illegal pyramid exists when the majority of profits for the MLM corporation and/or distributors (the common legacy name for the independent contractors, also known as members, IBOs, associates, affiliates, brand representatives, etc.) do not come retail sales to non-distributor customers. A customer is defined as someone who does not participate in the MLM compensation plan. Examples of other profit sources include, but are not limited to:
- Signup and renewal fees;
- Internal consumption; and
- Most significantly, when present, tool scams. Tool scams exist when the high level distributors and/or sometimes the MLM company sells training/motivation materials and make massive, secret profit, often several times more than the profit coming from the promoted and above-table MLM products/services profit. Examples of individual tool scam sources include, but are not limited to, various meetings, books, CDs, DVDs, MP3 recordings, website access, and voice mail. Because of the secretive nature of tool scam profits, this is also RICO fraud, and is particularly significant because the high level distributor lifestyles are how prospects are attracted, and how lower level distributors stay in the MLM longer. In fact, many high-level distributor MLM businesses shrink significantly, but their lifestyle (large mansions, airplanes, yachts, luxury cars, etc.) continue to be supported by the tool scam profits.
Most MLMs claim the distributors do not make any profit from the singular act of signing up a new distributor; and therefore the MLM cannot be an illegal pyramid, but this is only one sign of an illegal pyramid, not the only/exclusive indication. Unfortunately, most MLM critics do not make this distinction between distributors making money from the initial signup fee and ongoing internal purchases, and the result is the MLM industry takes advantage of this oversight. The good news is the FTC does recognize this fact. The signup fee is usually described as covering the MLM company administrative costs, is usually kept below $500, the level at which federal law considers the business to be a franchise, which would trigger more disclosures and unveil the MLM as a scam. This is not to say that sign-up costs are less than $500, as product purchases above this level may not be required, but are highly encouraged, providing a loophole for the MLM to scam people without being subjected to the franchise disclosures. Of course, an upline profit is made when the new distributor buys the highly encouraged initial and ongoing MLM product/services, as well as the upline tool purchases, which are separate from the signup process.
What is Value?
Since MLM products/services are usually 2-3 times more expensive than comparable items at major chain stores, such as Walmart and Target, it is important to define the concept of value. Price is not the only determinant of value. The definition of value includes the:
- Price – assumes similar the amount of the MLM product are being compared to similar store-bought products, and taking concentration into account;
- Quality – this can be a very subjective factor, as described below; and
- Convenience – for example, the product being delivered to the residence, and this usually results in added cost for shipping/handling, adding to the already inflated price.
These 3 factors are often difficult to quantify, as the claimed concentration may not result in similar results compared to a store-bought product, quality is often in the eye of the beholder, such as the quality/effectiveness placed on vitamins by different individuals or the quality of a given makeup, or the value placed on the extra shipping cost, which would be unacceptable to a very frugal/poor person compared to a wealthy/time-limited individual. However, in all cases the free market must make these value decisions, as opposed to the regulators or the court/legal system, both of whom would be overwhelmed by trying to insert themselves into this issue. The subjective/squishy concept of value is another important aspect of how MLMs obscure the illegal pyramid.
Keep in mind the “majority” of profits coming from external customers criteria is a very low bar, and could easily be moved half-way to the nearly 100% non-MLM companies obtain from external customers, or 75%. Consider how many non-MLM companies could survive if 75%, or even 50% of the profits came from people not working for the company. The actual number of MLMs having more than single digit percentage profit coming from retail sales to non-distributors is nearly zero, whereas a non-MLM business of any type, whether the business is a large department store, a convenience store, a cobbler, a service business, such as a legal firm, accounting firm, or any other type of business, online or offline, would fail if virtually 100% of the profit did not come from people not compensated by the business. Most MLMs would fail the 50%, let alone the 75% retail sales to non-distributors criteria, and by a healthy margin, as most MLM retail sale to non-distributors account for low single digit percent portion of profits. An analogy would be a track and field hurdle race, where the non-MLM companies have to run over 3’ hurdles, whereas MLMs have to clear a 3” hurdles, where the hurdle height is proportional to the percentage of retail sales necessary for a non-MLM business to survive, or in the case of an MLM, to be considered a legitimate, free market demand based entity. All successful non-MLM companies easily clear the 3’ hurdle of nearly 100% coming from non-compensated customers, whereas most MLMs trip over the 3” hurdle of 50% retail sales criteria, an obvious sign something is wrong, but what specifically IS wrong with this picture?
Why MLM Products Are So Expensive
Before answering that question, let’s discuss why most MLM products are priced 2-3 times more than similar store-bought products. Considering the 3 main parts of what makes up the total MLM product price, production cost, MLM company profit, and distributor bonuses (retail sales markup is considered superfluous, as the MLM product is already overpriced at distributor cost, so few products are actually sold at full retail markup, therefore retail markup is ignored for the purposes of this document), each portion is inflated, which lead to higher prices and here’s why:
- Production Cost – Includes all costs of production, including the land/facility mortgage, lease, rent, initial, ongoing, and replacement production equipment, utilities, insurance, hourly and salary employee income costs, etc. Since the typical quantity of products is much lower than a major brand, the cost per item is higher, as the above are sunk costs that do not increase proportionally with the production quantity. Outsourcing production to others is similarly expensive, as the outsourced company must also make a profit and must tool up to support production of a limited quantity for the MLM;
- MLM company profit – There is no issue with a company making a reasonable profit in a capitalist framework, but for every penny of company profit, an extra penny must be charged to whoever is buying the product; and
- Distributor bonuses – These must be kept relatively high to compete with other MLMs, and are typically 30-70% of the “wholesale” distributor product cost.
When added together, and not even considering shipping or retail markup costs to make more profit from non-distributor customers, the MLM product price results in being 2-3 times, and often more, than a comparable free market product. To overcome the obvious objections to buying an expensive product, the MLM often touts “miracle cures, special processes and/or ingredients that result in superior product results, etc.,” but the reality is the product does not perform much differently than a comparable store-bought product, is not worth the extraordinary extra cost even if it does perform marginally better, and often performs worse, as evidenced by various consumer oriented organizations that perform head-to-head comparisons for these products.
The expensive products also explain why many startup MLMs pay high level distributors millions of dollars and bring with them much of their downline, from existing MLMs to create an initial “critical mass” of product demand. This is done to keep the new MLM losses as low as possible, for a short of period of time as possible, and keep the overpriced product price as low as possible. As many high level distributors are often disenchanted with their existing MLM because they have developed conflict with the MLM executives over their lack of retail sales, tool scams, and other issues, finding candidates who want a “fresh start” is a relatively easy task for the new MLM.
Why Is Having All/Mostly Internal Sales An Illegal Pyramid?
This is a key question, as the DSA’s position and recent proposed federal legislation makes an MLM having all/mostly internal sales legitimate MLM, even though several court cases, namely the 1979 Amway decision and more recent Vemma decision, require significant retail sales for an MLM to not be an illegal pyramid. Also keep in mind significant retail sales are not the only measure of an MLM being legal, as the above mentioned signup/renewal fees and/or tool scams could be present instead. A succinct explanation of why significant retail sales are required can be found in the recent BurnLounge decision, where the lower court judge, upheld by the higher court, described an MLM distributor has a “conjoined opportunity” or additional incentive that is not present for a non-distributor customer. A customer merely exchanges money for the product, and assuming the product is sold at distributor cost, little to no retail profit is earned. As the nature of business is to make profit, this is obviously not a good situation. However, a distributor has another, conjoined incentive (actually, as set of incentives) to buy the product. The major incentive/opportunity is the hope of future wealth. Other incentives/opportunities include, and are a mix of positive and negative incentives:
- Learning the benefits of using the product in order to create belief in the product, or at least pretend the benefit exists, and provide the opportunity to describe these benefits to others, usually the downline distributors; and
- Setting an example of being loyal to the product, in order to encourage the same behavior in the downline, and obtain upline assistance.
Both of which are logical, yet create a distorted view of true demand for the MLM products, in addition to the hope of future wealth incentive/opportunity. Distributors not displaying the above loyal behavior are typically ignored by the upline, as are distributors not buying into the tool scam system, and almost always wither on the vine, resulting in almost exclusively loyal distributors participating over the longer time period.
All of the above MLM product/service issues are subject to the interpretation of the FTC’s Section 5 federal law prohibiting “unfair and deceptive” business practices, and a proposed federal law, HR5230, would make these practices legal, thus weakening the FTC’s ability to shut down these types of fraudulent businesses. The proposed federal law does not even mention tool scams. After all, the bill proponents argue, if the distributors are buying the products, there is market demand, so why get all the angst over retail sales to non-distributors?
Here’s why: Consider a typical $200/month worth of MLM products, the promoted/expected/required level of self-consumption. Assuming a conservative 2 times more expensive than a comparable store-bought MLM product, let’s split the behavior into 2 parts, which, when added together, results in the same $200/month behavior. Since most MLMs have little to no retail sales to non-distributors, for the purpose of this illustration, we’ll assume no retail sales are made, and further address minimal retail sales, tool scams, and shipping costs later:
Part 1 – The distributor pays $100/month to the upline, with the expectation the upline will pay back to the distributor a “loyalty bonus” of $10/month and split the remaining $90/month among the upline, and the distributor must also perform Part 2 in order to receive the $10/month.
Part 2 – The distributor goes to a nearby Walmart, Target, or other nearby store, and buys $100/month of product similar to what the MLM offers.
Part 2 is merely buying product that a person uses, even if the person must buy products they were not previously using, such as vitamins. Since many people do buy vitamins, this is not considered a major concern. Part 1 is a pure illegal pyramid, with money being exchanged with no benefit other than a small “payback.” Thus, the original $200/month in MLM product purchases is merely a product-camouflaged illegal pyramid. The goal for the new distributor is to sponsor others, so they can keep a larger percentage, and from the multiple contributors, to the $100/month illegal pyramid payments, in order to make a 5/6/7 figure per year profit. And here’s the real kicker – even IF the MLM products were priced at or even below the retail store prices, the products couldn’t be sold if the quality was poor. This means retail sales, not pricing, is the real sign of whether the MLM is an illegal pyramid or not.
Most MLMs have at least some non-distributor retail sales, although these are usually what are known as sympathy sales. These are sales to close relatives and friends who initially want to support their close relative/friend’s business, if for no other reason to not damage their relationship, hardly a case for free market demand. While these sympathy sales are technically retail sales to non-distributors, they are usually negligible, as the prospective customer cannot afford the products over the longer term, relationship or no relationship.
To increase the appearance of retail sales, distributors are often taught to cheat, here’s a couple of methods used, although there are probably other methods as well:
- Manipulate the computer to make a self-consumption purchase look like a retail sale; and
- Use a nearby friend/relative’s credit card and address to buy the products, the distributor then brings a personal check/cash when they pick up the products for their own use. In this way, the sale also appears to be a retail sale, a criteria often used as a requirement in order to earn the bonus, often paid on a weekly or monthly basis.
The computer manipulation and ship-to-another-address techniques are clearly fraud, and should be investigated when an MLM claims to have more than single digit percentage retail sales.
Tool scams further encourage internal consumption, as customers buy products, not the tools. As the tools are the vast majority of profit for MLMs having tool scams, it makes much more sense for the upper level distributors to tell their downline distributors to use their limited time to obtain new distributors as opposed to customers.
There are 3 major concepts described above, namely:
- The definition of an illegal pyramid, where the majority of profit is not from retail sales to non-distributors;
- Why MLM products/services are expensive, which leads to little to no retail sales to non-distributors, especially in the presence of tool scams; and
- Why significant retail sales to non-distributors are needed to demonstrate the MLM is not an illegal pyramid.
Here’s a deconstruction of the proposed bill, first with the offending statement, then with the specific issue(s) the statement includes:
8 (a) IN GENERAL.—It shall be unlawful for any per-