Consumer Safety & Awareness Part 13

History of Pyramid Scams

The Consumer Awareness Institute classifies several scams as pyramids. They include multi-level marketing, network and consumer direct marketing, as well as the typical pyramid schemes. Included in the multi-level marketing category are Shaklee, Herbalife, Amway, Avon, Mary Kay, Nu Skin, Sunrider, and Vector marketing. Wikipedia lists over 40 active companies in this group.

The earliest recognized pyramid schemes were chain letters. The initiator sent out an unknown number of postal letters stating something like, “This is a good luck letter. Put your name on the bottom of the list and send it to 5 people, plus the person on the top of the list.” If everyone followed through, eventually it would go to 5, then 25, then 225, then 625, and finally over 3,000 people.

If the scam was to, “Send $1 to the person at the top and put your name at the bottom of the list,” and if everyone followed through, the scheme would net around $3,000. The United States Post Office prosecutes pyramid schemes senders for mail fraud.

Many pyramid schemes involve selling products of little or no value. In the 1950s and 1960s, many such activities involved signing up at least 5 people you know to get important, priceless information on how to make money legally from such things as government or armed forces surplus auctions, confiscated goods, or some financial investments. You had to send their names in with $10 to get the information, as well as notify them that they can also participate. In most cases there was time pressure as it was a limited offer. If 500 people fell for the scam, the originator was $5,000 richer, which in those times was a year’s salary for the average worker.

Charles Ponzi, an Italian immigrant to America in 1903, who had been arrested in Canada for various fraudulent activities, made a fortune after World War I illegally trading international currency. In 1919 he established a company, the Security Exchange Commission, and advertised that investments in his company would receive a guaranteed return of 100% in three months. Thus, if you invested $100, 90 days later you would receive $200. He accepted amounts of from $10 to $50,000 from individuals.

Using new money that he received from those who heard about this amazing return, he paid off the initial investors, giving them the harvest he promised. The success of the Security Exchange Commission became well advertised and people flocked to send him money. His scheme only lasted nine months, but he accumulated over $15 million, a huge sum for 1920. He served time in jail and was deported back to Italy in 1934 where he eventually died nearly penniless.

In the 1960s, William J. Armantrout founded Modern Floor Fashions to sell carpeting. He ran his company as a pyramid scheme, netting millions. His salesmen sold overpriced and poor quality carpets to customers who were told that if they recommended up to ten others, they would get referral fees that would eventually reimburse them the total cost of the carpet. For each person they recommended that actually bought, they would get $60. If, eventually, those secondary clients recommended others who made a purchase, they would get $40. Thus if half of their recommendations purchased, they’d receive $300, and if half of those people’s referrals bought, they could potentially get an additional $1000. On average the carpets sold for between $1,000 and $1,500. Very few people saw more than $100 total in such commissions, and since the carpets provided considerable profit for the company, they did quite well until shut down by the government.

For six months in 1967, in Morgan City, Louisiana, Howard Blachly, operating under the trade names of Pioneer Products or Pioneer Marketing, sold water softeners using what they called a Referral Selling Plan. Along with two confederates, Blachly set up appointments with potential purchasers during evening hours. As part of the sales technique, it was required that both husband and wife be present. This is typical in a selling scam, as we will see when we look at pressure sales techniques.

A demonstration of the product was given by means of a miniature model of the water softener, and the advantages of using the treated, demineralized water in the home were explained. At the conclusion of the demonstration the parties who expressed an interest were then informed of the mechanics of the Plan. They were told that as a result of a promotional advertising plan, the family could not only acquire the water softener at no cost to themselves but also would have the opportunity to earn a profit. This was possible since each sale thereafter made to a future prospective customer whose name had been supplied by the current potential purchaser would entitle such purchaser to a referral sales commission of $40. No limit was placed on the number of referred parties that the purchaser could give. The right to an additional $40 sales commission also extended to secondary sales. Thus each sale to a third level customer would also net the current family $40.

Once the family was convinced, they signed a contract for the water softener for $610, including taxes, or for a time payment that came to $829 over 36 months. The contract also spelled out the referral commissions. A second copy, with additional information was also signed, by both the husband and wife and the salesperson. This one was, they were told, “for purposes of record keeping or for obtaining credit references.” In actuality, the second was a blank property deed, which, once filled out, turned the ownership of their house to Pioneer Products.

Blachly was convicted on 17 counts of mail fraud and sentenced to 3 years' imprisonment on one count, sentencing on the remaining counts suspended with 5 years' supervised probation.

In one of the first direct marketing cases heard in the United States, Ger-Ro-Mar and its president Carl Simonson, were convicted under the pyramid scheme statutes for using a technique now commonly used by the multi-level marketing companies we looked at earlier. In this case, the company enlisted the services of people to sell their products at wholesale and retail, requiring distributors to buy an inventory of varying size before they may participate in the program. A potential distributor (also called a "consultant") may enter at one of three levels ("Key Distributor," "Senior Key," or "Supervisor"), and eventually work up to a fourth and fifth level (District Manager and Regional Manager).

Entry into the program is through a non-refundable purchase of merchandise from the company or one of its distributors. All distributors except the lowest purchased directly from the company; a Key Distributor purchases from his sponsor. The initial purchase requirement for entry into the program is $300, which is discounted 35% to $215. As you advanced in management level, your purchase amounts also increased, first to $1,000, then $3,000. Each was also discounted.

Thus when the manager sold to a supervisor, the manager received a profit of around 15%. The manager then sold down to the next level, also getting 15%. The promotional literature stated that a district manager could earn up to $56,400 per year and Regional managers up to $90,600. The legalese was the phrase “up to,” and in reality no one came close, except the officers of the company.

There are several general techniques that identify pyramid schemes, and these also apply to mass-marketing companies.
Participants are recruited in an endless chain of participants.
Advancement is based on how many others you recruit.
Participants are expected to buy products or services in order to qualify for commissions or bonuses or to advance in the scheme.
The company pays commissions and bonuses on more than four levels of participants.

Next time we will discuss Multi-Level marketing, which, although they conform to the letter of the law, are in actuality considered selling schemes by most consumer advocates.