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The Single Most Important Word In MLM |
| Here is another great article from "Lawdawg" archives that fits perfectly with the current uproar in
the Amway/
Primarily. In this post I quoted the Sixth Circuit Court of Appeals opinion in U.S. v. Gold Unlimited as a preview of the legal difference between a legitimate multilevel marketing business and a pyramid scheme disguised as an MLM company. The key distinguishing factor for the Sixth Circuit was something it called an "emphasis on recruitment versus sales." What does this mean? That's where "primarily" comes in. It's the key word in the Federal Trade Commission's definition of a "prohibited marketing scheme" (i.e. an "illegal pyramid scheme"). The following is the definition offered by the FTC and approved by the court in FTC v. Five Star Auto Club:
There are several extremely important points to understand in this definition. First, there is the definition of the type of plan that is potentially subject to this definition. There are two key elements of such a plan: (1) the payment by a participant (not necessarily in money, I'll talk about that later) for the right to particpate in the compensation plan; and, (2) income not primarily generated by selling products or services to retail customers who aren't themselves particpants in the plan. The latter element is expressed by prohibiting schemes in which "income" is derived "primarily" from either the recruitment of additional recruits or "non-retail sales" made to or by the participants recruits. Second, there is a clear definition of "retail sales" that exempts purchases made by the paricipants (or "distributors" or "IBOs") for their own use from being considered as legitimate retail sales. In other words, you cannot claim to be operating a legitimate MLM marketing a product or service where most of the income is generated from purchases made by the "distributors" themselves for their own self-consumption. The Third important thing to take from this definition is the meaning and use of the word primarily by the FTC. In this definition, the word refers to whether the income comes from recruiting or self-consumption or whether it comes from actual sales to retail customers who aren't partcipating in the compensation plan. What Does Primarily Mean? It means more than half. Many states have anti-pyramid statutes that mirror this language. For example, the Maryland statute defines a pyramid scheme as follows:
This very issue was discussed by the Maryland court of appeals in Schrader v. State. One of the issues in that case was whether there was a sufficiently clear meaning to the word "primarily". The court held that there was a definite meaning to the word "primarily", explaining:
The court in Schrader,
like the court in U.S. v. Gold Unlimited, gave a very concise explanation of
pyramid schemes disguised as MLMs: Pyramiding is a type of
multi-level marketing operation which theoretically serves as a method of distributing a
company's products to the public. Participants in the operation are spread out over
various distribution levels through which products are resold until they reach the
consumer. Id. However, because "one profits merely by being a link in the product
distribution chain, the emphasis is on recruiting more investor-distributors rather than
on retailing products." Note, Pyramid
Schemes: Dare to be Regulated, 61 Georgetown L.J. 1257, 1259 (1973). Why Is Primarily Part Of The Rule? The reason these schemes are illegal is because it is a mathematical certainty that the vast majority of participants in a recruiting scheme will not be able to recruit enough additional members to realize a return on their investment. In my next post, I'll go into the mathematics of a recruiting pyramid and why this is true. Sufffice it to say for now that if one cannot make a PROFIT without recruiting more people under them, that means that most participants in the scheme will lose money. Hence, recruiting schemes are illegal. There is little or no practical difference between a product based pyramid scheme and a chain referral scheme or Ponzi scheme with no product at all. Here's an example to illustrate what I mean: Let's say I want to start a new pyramid scheme. I decide that I want my pyramid scheme particpants to pay $100 each as their entry fee and that I'll pay back $35 on each membership in a complex compensation scheme to the various upline for each new partcipant. The remaining $65 I'll keep as profit. I can't just ask for cash payments, however, because that would be too obvious. Indeed, that would be a "pay to play" pyramid scheme - akin to a "gifting club" or the "airplane game", both of which are likely end with the promoters being criminally indicted. What I do instead is find a product - a "widget," let's say- that I can get from the supplier for $1 and that has or would have an ordinary retail market price of $1.50. I charge each new particpant in my scheme $101 to buy a widget and join the scheme with the right to recruit more widget buyers. The new participant and his upline share in the $35 pyramid kickback - which I'll now refer to as a rebate - or even more deceptively - a "discount." I make $65 profit and anyone who can recruit enough people buying widgets underneath them can eventually make a profit off their small share of the $35 kickback on each sale. What practical difference is there between this example and simply taking an up-front cash payment from each participant with no product at all? The difference in fair market value could be much less than in this example - say 20% to create this "pyramid premium" that is used fund the pyramid compensation scheme. The effect is still generally the same. Customers outside the scheme aren't interested in paying more for the products, which seriously curtails the ability of the "distributors" to sell the products outside the scheme. Thus, little or no money comes into the "marketing" venture from anybody other than its own participants. Again, as a matter of mathematical certainty, a person can only profit in such a scheme because several or many people are losing money in their downline to fund this "profit." If an MLM's product is primarily sold to actual customers who buy the product at the MLM's price and who don't participate in the "business opportunity", it practically guarantees that the "product" is not a cover for a pyramid scheme. Understand that the "product" can be a shill for an illegal scheme in two ways: (1) it might not be a real product at all - e.g. those one page "reports" that are "sold" in chain letter schemes that tell you how to perpetuate the scheme or books, tapes and seminars like those sold in "Dare to Be Great", that the court explained had little or minimal value to those outside the scheme; or, (2) it may be a real product but sold at an unreal "pyramid premium" price (as in my widget example). If it is the latter, there will not be a significant market for the product. If there is little or no reasonable retail market (i.e., the products aren't price competitive) the only people likely to buy them are the participants in the scheme. The only way for participants to make money is to recruit more participants to make the purchases and we are back to square one - with the vast majority of participants losing money so that a small number can profit. Thus, we have "primarily" - the single most important word in multilevel marketing |
