Multi-Level Marketing or Illegal Pyramid Scheme?

Multi-Level Marketing or Illegal Pyramid Scheme?

CONSUMER ALERT  

Bill  Schuette
ATTORNEY GENERAL 

The Attorney General provides Consumer Alerts to inform the public of unfair, misleading, or deceptive business practices, and to provide information and guidance on other issues of concern.  Consumer Alerts are not legal advice, legal authority, or a binding legal opinion from the Department of Attorney General.

Multi-Level Marketing or Illegal Pyramid Scheme?
What is the Difference?

«Multi-level» or «network» marketing is a form of business that uses independent representatives to sell products or services to family, friends, and acquaintances.  A representative earns commissions from retail sales he or she makes, and also from retail sales made by other people that he or she recruits.  Examples of well-known multi-level marketing companies include Amway and Mary Kay Cosmetics.

Some companies call themselves multi-level marketing when they are really operating pyramid schemes that violate Michigan’s Pyramid Promotion Act.  Even when a multi-level plan does not violate Michigan’s Pyramid Promotion Act, the marketing of the plan may violate Michigan’s Consumer Protection Act, if the acts, methods, or practices are unfair, unconscionable, or deceptive.

It is understandable that consumers often have difficulty telling the difference between an illegal pyramid scheme and a legitimate multi-level marketing opportunity.   Governmental regulators and the industry continue to debate where the legal lines are drawn.  Multi-level marketing is a lawful and legitimate business method that uses a network of independent representatives to sell consumer products.  Compensation must primarily be based on the sale of products and services to the ultimate consumer.

Pyramid schemes claim to be in the business of selling products to consumers in order to look like a multi-level marketing company.  However, little or no effort is made to actually market the product.  Instead, money is made in typical pyramid fashion…from recruiting other people to market the program.  Sometimes, new «distributors» are persuaded to purchase inventory or overpriced products/services when they sign up.

Pyramid companies make virtually all their profits from signing up new recruits and often attempt to disguise entry fees as the price charged for mandatory purchases of training, computer services, or product inventory.

Pyramid schemes are not only illegal; they are a waste of money and time.  Because pyramid schemes rely on recruitment of new members to bring in money, the schemes often collapse when the pool of potential recruits dries up (market saturation).  When the plan collapses, most people, except the few at the top of the pyramid, lose their money.

Market Saturation

Although pyramid promoters claim that the possibility to earn is endless, this possibility cannot materialize due to market saturation.  For example, if a program begins with one person who recruits two people, each one of whom recruits two more people, and so on, in only 28 levels practically the entire population of the United States – every man, woman, and child – would be involved, as is illustrated below.

Level                  Number of New                     Total Number of
                             Participants                            Participants

1                                  1                                              1

2                                  2                                              3

3                                  4                                              7

4                                  8                                             15

5                                 16                                            31

6                                 32                                            63

7                                 64                                           127

8                                128                                          255

9                                256                                          511

10                              512                                         1,023

11                             1,024                                       2,047

12                             2,048                                       4,095

13                             4,096                                       8,191

14                             8,192                                      16,383

15                            16,384                                     32,767

16                            32,768                                     65,535

17                            65,536                                    131,071

18                          131,072                                    262,143

19                           262,144                                   524,287

20                           524,288                                  1,048,575

21                         1,048,576                                 2,097,151

22                         2,097,152                                 4,194,303

23                         4,194,304                                 8,388,607

24                         8,388,608                                16,777,215

25                        16,777,216                               33,554,431

26                        33,554,432                               67,108,863

27                        67,108,864                              134,217,727

28                       134,217,728                             268,435,455

 

When investigating a multi-level marketing opportunity, you should ask about market saturation and determine the saturation levels in your area of distribution.  Legitimate companies do not have too many distributors in one area.

 Warning Signs

Pyramid promoters are masters of group psychology.  Recruitment meetings create a frenzied, enthusiastic atmosphere where group pressure and promises of a large sum of money play upon people’s greed and fear of missing a good deal.  Promoters also openly discourage thoughtful consideration and questioning of the scheme.  Victims often find themselves tricked into participating.  At a recruitment meeting, you might hear phrases like «this is a ground floor opportunity which will change your life», «opportunities don’t go away, they go to other people», and «if you act now and work hard for three to five years, you can retire and live off of the residual income.»  Another warning sign is a confusing compensation plan.

Claims by a company that their plan has been «approved» by the Michigan Attorney General should be bright red flags and you should report such a claim immediately to our office.  A company that misrepresents one fact will likely misrepresent others.  While our office is able to tell you if we have taken any legal action, we will not comment on any specific investigation of multi-level marketing companies.  Additionally, we do not provide any advance form of approval for any company and if you want legal advice on whether a multi-level marketing opportunity is actually an illegal pyramid, you need to seek private legal counsel.

Chain Letters

The simplest form of pyramid scheme is the chain letter that asks the recipient to pay $1.00 or more to each of five names on a list, copy the letter, and then send it out to new people with the recipient’s name added to the list.  Many chain letters claim to be legitimate because they offer a product.  Upon close examination, the product is just a pretense.  Often the newsletter simply describes additional «get rich quick» schemes and may be the only item that new members «purchase.»  Alternatively, the newsletter may be offered for «free» to every new paying member.  In either case, the scheme is just a pyramid if it pays distributors to recruit new members rather than sell a real product to the wider public.  In recent years, pyramid schemes have become more sophisticated, and many have surfaced on the internet.

Use Common Sense and Consider These Tips

The pyramid scheme disguised as a multi-level marketing opportunity is not always easy to spot, but is just as much of a scam as the chain letter.  Here are some tips to consider before participating in a multi-level marketing program:

• Avoid any program that focuses more on recruitment of new people rather than the sale of a product or service to an end-user consumer.  If the opportunity for income is primarily derived by recruiting more participants or salespersons rather than by selling a product, the plan probably is illegal.  Several courts interpret greater pressure on members to sponsor new recruits than to market company merchandise as evidence of an illegal pyramid.

• Be skeptical of plans that claim you will make money through continued growth of your «downline» — the commissions on sales made by new distributors you recruit — rather than through your own sales of products.

• Be cautious about specific income or earnings claims.  Many programs boast about the incredibly high earnings of a few top performers («thousands per week» or a «six figure income»).  The reality is that most of the people recruited into the organization are not making anywhere near those amounts and most actually lose money.

• Beware when presented with «testimonies» from other distributors.  These «success» stories rarely reflect reality.

• Be cautious about participating in any program that asks distributors to purchase expensive inventory.  There are horror stories of people with a basement or garage full of merchandise that no one will buy.

• Make sure the product or service offered by the company is something you would buy without the income opportunity and the product or service is competitively priced.  Illegal pyramid schemes often sell products at prices well above retail or sell products that are difficult to value, such as health and beauty aids, new inventions or «miracle» cures.

• Never sign a contract or pay any money to participate in a multi-level marketing program, or any business opportunity, without taking your time and reading all of the paperwork.  Talk the opportunity over with a spouse, knowledgeable friend, accountant, or lawyer.  If you feel that you are being subjected to high-pressure sales tactics or are not being given enough time to review the details, go elsewhere.

• When questions are raised about pyramids, comparisons may be made to corporations where there is one person at the top who makes the most money.  What they fail to state is that corporations do not seek to recruit an unlimited number of employees or pay employees based on recruiting new employees.

• Beware when the products or services are simply vehicles for recruitment.  The products may be gimmicks and/or overpriced, but even high quality products may serve as a cover for recruitment activities.

Your Responsibilities

If you decide to become a distributor, remember that you are legally responsible for the claims you make about the company, its product, and the business opportunities it offers.  That applies even if you are simply repeating claims you read in a company brochure or advertising flyer.  If you decide to solicit new distributors, be aware that you are responsible for any claims you make about a distributor’s earnings potential.  Be sure to represent the opportunity honestly and avoid making unrealistic promises.  If those promises fall through, remember you could be held liable.

If you join a pyramid scheme disguised as a multi-level marketing program, your decision will affect not only you, but also everyone you bring into the program. Many people devote a substantial amount of time trying to market these worthless ventures.  Ultimately, if a multi-level marketing opportunity sounds too good to be true, it probably is.

FOR GENERAL CONSUMER COMPLAINTS, CONTACT THE ATTORNEY GENERAL’S CONSUMER PROTECTION DIVISION

If you have a general consumer complaint, please file a complaint with the Attorney General’s Consumer Protection Division at:

Consumer Protection Division
P.O. Box 30213
Lansing, MI 48909

517-373-1140
Fax: 517-241-3771

Toll free: 877-765-8388 FREE

www.michigan.gov/ag (online complaint form)

.