MLM or Pyramid Scheme?
Probably the most common question we hear: “Is this MLM actually a Pyramid Scheme?” Unfortunately, there usually isn’t a straight forward answer.
What is a pyramid scheme?
“A pyramid scheme is a business model that recruits members via a promise of payments or services for enrolling others into the scheme, rather than supplying investments or sale of products or services.” -Wikipedia
This isn’t the whole story. Most people see “sale of products or services” and immediately think every MLM who sell a product cannot be a pyramid scheme. The reality is many pyramid schemes sell products.
When sales of a product are mostly to recruits or among the program members then it’s probably a pyramid scheme. This means that the only money coming into the system is from new people joining. It doesn’t matter if that money is from new recruits “buying” products, or paying membership fees, etc. A small amount of sales doesn’t count, this is just selling to hide the scheme.
Red flags to watch out for
- Big earnings are from recruiting other people. Compensation plans focus on recruitment.
- Earnings from retail sales to customers outside the network are small or not emphasized. There is little or no data on how much is earned from these kinds of retail sales.
- People at lower ranks buy inventory that accumulates in their basements. See: inventory loading, bonus buying
- Lots of exaggerated claims: the products sell themselves, the products are too good to be true, passive income, become a millionaire, no skills needed
- Prices for products are inflated. Claims that the product has no comparable product available in the market.
- Commissions for recruiting new distributors. Especially when there is no legitimate product or service, or separate up-front membership fee. Similarly, commissions off of new recruits starter kits or membership fees.
- High membership fees, expensive starter kits, required monthly purchases, frequent and expensive training kits. These are all ways that lower recruits can pay into the higher layers of a pyramid.
Multi-level marketing and U.S. Law
Many participants in MLM companies will say “this is not a pyramid scheme, pyramid schemes are illegal.” This isn’t quite the right way to think about it.
Suppose you were to steal something from a store not get caught. You could say “I walked out of the store without paying and they didn’t say anything. Therefore, it isn’t shoplifting.” Most of us agree, that is not the right way to look at it. Not being caught doesn’t make it legal, it just means you haven’t gotten caught.
If you’re asking if an MLM is a pyramid scheme, the participant should tell you why the program is not a pyramid scheme. They should not tell you that the MLM hasn’t been caught. Talk through the program together and check for red flags.
The United States has federal laws (for the whole country) and state laws. The laws that apply to MLMs are around investments, marketing, consumer protection, and more. There are not really MLM specific laws. Because there are a lot of places where it’s not very clear if what MLMs are doing is illegal or not, it is up to the courts to decide. In these cases, someone, many people, or a government agency will sue an MLM company and the courts will decide whether the company’s actions are legal or not.
Many MLMs have been sued and found to be illegal. Even more companies have been forced to change their policies, compensation plans, and practices.
Here are documents the FTC has released to help us navigate the blurry lines of illegal MLMs and pyramid schemes:
FTC Guidance: “There are multi-level marketing plans – and then there are pyramid schemes.”
FTC Business Guidance to Multi-level marketing companies
FTC: The telltale signs of a pyramid scheme
FTC FACTS for Consumers: The Bottom Line About Multilevel Marketing Plans and Pyramid Schemes
We’re not affiliated with any MLM. We aren’t lawyers and this isn’t legal advice, but contacting a lawyer for legal advice can be a great idea. Please contact us with any feedback or questions!