Consumer Safety & Awareness Part 15

Multi-Level Marketing and the Law -- Part 1

Multi-Level Marketing makes the owners and the initial first few who join wealthy on top of the backs of those who come after. No matter how they sell it, MLM is economic slavery and thievery. The FTC classifies all multi-level marketing company as pyramid schemes. On May 13, 1998, the Federal Trade Commission stated:

The Commission took its first concerted action against pyramid schemes in the 1970's during a boom in home-based business and MLM or direct selling. One-on-one marketing became common for many consumer items -- from cosmetics to kitchenware, and Tupperware™ parties became an icon of the era. Unfortunately, the rise in legitimate multilevel marketing was accompanied by a surge in pyramid schemes. Those schemes played off the popularity of MLM or network sales but paid more attention to networking than to selling actual goods.

One of the Commission's first cases was In re Koscot Interplanetary which involved a company that offered the opportunity to become a "Beauty Advisor" and sell cosmetics. The company's incentive structure really did not encourage retail sales. Instead, it encouraged people to pay $2000 for the title of "Supervisor" and purchase $5400 in Koscot cosmetics, and then to earn bonuses by recruiting others to make the same investments. The Commission found that Koscot operated an illegal "entrepreneurial chain" and articulated a definition of illegal pyramiding that our agency and the federal courts continue to rely on.

The Commission found that pyramid schemes force participants to pay money in return for two things. First is "the right to sell a product", second is "the right to receive, in return for recruiting other participants into the program, rewards which are unrelated to sale of the product to ultimate users.” The Commission explained that paying bonuses for recruiting: “. . . will encourage both a company and its distributors to pursue that side of the business, to the neglect or exclusion of retail selling. The short-term result may be high recruiting profits for the company and select distributors, but the ultimate outcome will be neglect of market development, earnings misrepresentations, and insufficient sales for the insupportably large number of distributors whose recruitment the system encourages."

In In re Amway Corp, another landmark decision from the 1970's, the FTC distinguished an illegal pyramid from a legitimate multilevel marketing program. At the time, Amway manufactured and sold cleaning supplies and other household products. Under the Amway Plan, each distributor purchased household products at wholesale from the person who recruited or "sponsored" her. The top distributors purchased from Amway itself. A distributor earned money from retail sales by pocketing the difference between the wholesale price at which she purchased the product, and the retail price at which she sold it. She also received a monthly bonus based on the total amount of Amway products that she purchased for resale to both consumers and to her sponsored distributors.

Since distributors were compensated both for selling products to consumers and to newly-recruited distributors, there was some question as to whether this was a legitimate multilevel marketing program or an illegal pyramid scheme. The Commission held that, although Amway had made false and misleading earnings claims when recruiting new distributors, the company's sales plan was not an illegal pyramid scheme. Amway differed in several ways from pyramid schemes that the Commission had challenged. It did not charge an up-front investment fee from new recruits, nor did it promote "inventory loading" by requiring distributors to buy large volumes of nonreturnable inventory. Instead, Amway only required distributors to buy a relatively inexpensive sales kit. Moreover, Amway had three different policies to encourage distributors to actually sell the company's soaps, cleaners, and household products to real end users.

First, Amway required distributors to buy back any unused and marketable products from their recruits upon request. Second, Amway required each distributor to sell at wholesale or retail at least 70 percent of its purchased inventory each month -- a policy known as the 70% rule. Finally, Amway required each sponsoring distributor to make at least one retail sale to each of 10 different customers each month, known as the 10-customer rule.

In its conclusion, the FTC states:

Beware of any plan that offers commissions for recruiting new distributors, particularly when there is no product involved or when there is a separate, up-front membership fee. At the same time, do not assume that the presence of a product or service removes all danger. The Commission has seen pyramids operating behind the apparent offer of investment opportunities, charity benefits, off-shore credit cards, jewelry, women's underwear, cosmetics, cleaning supplies, and even electricity.

If a plan purports to sell a product or service, check to see whether its price is inflated, whether new members must buy costly inventory, or whether members make most "sales" to other members rather than the general public. If any of these conditions exist, the purported "sale" of the product or service may just mask a pyramid scheme that promotes an endless chain of recruiting and inventory loading.

(Continued next week)