14 August 2013

Around the Pyramids -- Background Section

I write this Note upon two collections of separate, but also substantially-related events:

  1. Chewie and I have both received solicitations from several people now over various "home business" or "make money fast" proposals
  2. After talking to several people who have also raised concerns, it became clear to us that some effort in terms of research and discourse is needed, even though neither of us are lawyers, financial advisors, or business gurus 

We know the economy is bad and a lot of people are either out of work or struggling to make ends meet. It seems with each passing day that each dollar buys less and less. Consequently, many people turn to multi-level marketing in hopes of earning money.

Multi-level programs have been around for a while; some of the most common ones include Tupperware, Pampered Chef, Amway, Amsoil, Herbalife, and some that sell (ahem) marital-aids. But there have also been some larger schemes that have also made the news and/or popular-culture--two examples include Charles Ponzi's investment schemes in the 1920s and later, questionable investments made by Bernie Madoff.

Thus in the common mind, there is apprehension that results from such activities. This in mind, let us start with a couple of definitions:

To start, consider Black's Law Dictionary (9th Edition) and their definition of a "pyramid scheme" as
a property-distribution scheme in which a participant pays for the chance to receive compensation for introducing new persons to the scheme, as well as for when those new persons themselves introduce participants. Pyramid schemes are illegal in most states. Also termed endless-chain scheme; chain-referral scheme; multilevel-distribution program; pyramid distribution plan. Cf. Ponzi Scheme.  

As these types of things are regulated more locally, the precise public definitions tend to vary by state. As an example, let's consider what Wisconsin has to say on the matter:

"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. 
(Wis. Adm. Code, ATCP 122.02 (1)) 

A few states specifically define multi-level marketing, an example is Georgia, which states:

(6) "Multilevel distribution company" means any person, firm, corporation, or other business entity which sells, distributes, or supplies for a valuable consideration goods or services through independent agents, contractors, or distributors at different levels wherein such participants may recruit other participants and wherein commissions, cross-commissions, bonuses, refunds, discounts, dividends, or other considerations in the program are or may be paid as a result of the sale of such goods or services or the recruitment, actions, or performances of additional participants. The term shall not include licensed insurance agents, insurance agencies, licensed real estate brokers, licensed real estate agents, licensed real estate agencies, licensed securities dealers, licensed limited securities dealers, licensed securities salesmen, or licensed limited securities salesmen. Any multilevel distribution company which operates in any of the forms precluded by paragraphs (1) through (4) of subsection (a) of Code Section 10-1-411 shall be considered an unlawful pyramid club under Code Section 16-12-38." (OCGA 10-1-410)

Between these definitions, it is also worth noting that not all multi-level plans are inherently illegal. Many do so by selling legitimate goods and thus derive most of their profits through legal sales of these goods to end-user consumers, with recruitment as down-side distributors being a side-track. Others are regulated elsewhere by the government as financial institutions (such as banks, securities brokerage, S&L associations), public utilities, or as insurers.

Thus, as the site MLMLaw put it:
"Essentially, if a marketing plan compensates participants for sales by their ""enrollees," "recruits," and/or their downline enrollees and recruits, that plan is multilevel. If a program compensates participants, directly or indirectly, merely for the introduction or enrollment of other participants into the program, it is a pyramid."

The FTC has even said:
"More importantly, MLM's actually sell their product to members of the general public, without requiring these consumers to pay anything extra or to join the MLM system. MLM's may pay commissions to a long string of distributors, but these commission are paid for real retail sales, not for new recruits." 

Even the Courts have tended to agree, as noted in United States v. Gold Unlimited, Inc., 177 F.3d 472 (6th Circuit, 1999), in which the jury instructions at the trial were:
"A pyramid scheme is any plan, program, device, scheme, or other process characterized by the payment by participants of money to the company in return for which they receive the right to sell a product and the right to receive in return for recruiting other participants into the program rewards which are unrelated to the sale of the product to ultimate users." 

Thus, it appears that two of the keys lies in these constructions:

  • the plan's actual purpose: is it to sell tangible products to non-participating members of the public (end-users), or is the selling merely a sideshow or camouflage to adding paying participants/enrollees/distributors into the scheme? 
  • for what reason is compensation (e.g. commissions) paid out--are they strictly on the basis of selling products to end-users or for recruiting people into the program? 

To us, these seem to be fair and reasonable criteria by which to judge a plan in terms of minimising the risks of potential problems.

Go to Fundamental Problems

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