Q&A - Illegal Pyramid Schemes

Q Did the 1979 FTC ruling determine that Amway was not an illegal pyramid scheme?

A In the 1979 FTC v. Amway case, In re Amway, 93 F.T.C. 618 (1979), the Amway model was not ruled an illegal pyramid scheme due to "safeguards" provided by in the Amway business rules. These safeguards include the Retail Sales rule, now the Member Client rule, the 70% rule, and a 90% money-back policy. It is important to note that the FTC's conclusion in In re Amway was based on an express finding that at that time Amway had in place a system to effectively enforce its retail sales rules.

As the Administrative Law Judge explained in his memorandum opinion:

73. To ensure that distributors do not attempt to secure the performance bonus solely on the basis of purchases, Amway requires that, to receive a performance bonus, distributors must resell at least 70% of the products they have purchased each month. (RX 331, pp. 16­B to 17­B) The 70% rule has been in existence since the beginning of Amway. (S. Bryant, Tr. 4086) Amway enforces the 70% rule. (Lemier, Tr. 192­93; S. Bryant, Tr. 4056­59; Halliday, Tr. 6497)

74. Amway's 'ten­customer' rule provides that distributors may not receive a performance bonus unless they prove a sale to each of ten different retail customers during each month. (RX 331, pp. 1­B and 17­B) The Direct Distributors have the primary responsibility for enforcing the ten­customer rule in their own group. (S. Bryant, Tr. 4061­62) The ten­customer rule was started by Amway about 1970. Prior to that, there was a 25 sales rule, which required the distributor to make 25 retail sales a month without regard to the number of customers. (S. Bryant, Tr. 4085­86) The ten­customer rule is enforced by Amway and the Direct Distributors. (CX 823; Case, Tr. 3414­15; Medina, Tr. 4197; Zizic, Tr. 4138­43; Lincecum, Tr. 1266)

Q When can a MLM be considered an illegal pyramid scheme?

A Numerous courts have defined pyramid schemes to be those schemes where the majority of profits are derived from the participants of the scheme itself. For Multi-Level-Marketing, it is when there are little retail sales to those outside of the compensation scheme. Read the section The illegality of buyers' club pyramid schemes.

Q Did the recent Amway v. P & G case determine that Amway/Quixtar is not an illegal pyramid scheme?

A No. It did not.

It is important to note that the Amway v. P & G lawsuit in the Michigan federal court is not a pyramiding case. Amway Corp. v. Procter & Gamble Co., 1:98-CV-726, 2001 U.S. Dist. LEXIS 14455 (W.D. Mich. 2001). In fact, Amway was the plaintiff in that lawsuit and was suing P&G's and its attorneys, Dinsmore and Shohl, for allegedly defaming Amway by publishing that Amway is an illegal pyramid scheme. Thus, the issue of Amway is an illegal scheme was not before court. Rather, the issue before the court was whether there was any evidence to support P&G's and Dinsmore's statements that Amway is an illegal pyramid scheme in making out their "truth" defense to Amway's tortious interference cause of action based on defamation. The district court explained:

[T]his is a tort action about speech. Amway's only allegations regarding P&G and Dinsmore are that they gave documents to Schwartz, which Schwartz posted on his internet website. While Amway contends that it is the wrongful nature of P&G's and Dinsmore's conduct, rather than their false speech, which is at the heart of Amway's tortious interference claim. Amway has not pointed to evidence that P&G and Dinsmore engaged in any wrongful conduct other than delivering documents to Schwartz, nor has Amway pointed to any evidence that it was injured by any non-speech related conduct by P&G and Dinsmore.

Id., 2001 U.S.Dist. LEXIS 14455 at *9. P&G and Dinsmore moved for summary judgment on Amway's claim on the ground that Amway is a "public figure" for purposes of the 1st Amendment and had the burden of proving "malice" on the part of P&G and Dinsmore. Id. at *27. The district court granted summary judgment to the defendants, holding that there was no evidence that the defendant acted with reckless disregard for the truth. Id. at *35.

Far from finding that Amway is not a pyramid scheme, the court went on to summarize the evidence indicating that Amway may be an illegal pyramid scheme. First, the court summarized the law as to the difference between an illegal buyers' club pyramid scheme and a legitimate multi-level marketing scheme:

A pyramid scheme is one in which the profits of a few people at the "top" of an organization are made primarily from those below them within the organization, rather than from sales to persons outside the organization. The focus of a pyramid is to recruit more people into the group, rather than on retail sales. See Webster v. Omnitrition Int'l, 79 F.3d 776, 782 (9th Cir. 1996). The Sixth Circuit has given its approval to an instruction defining a pyramid scheme as a "process characterized by the payment . . . of money to the company in return for . . . the right to sell a product and the right to receive in return for recruiting other participants into the program rewards which are unrelated to the sale of the product to ultimate users." United States v. Gold Unlimited, Inc., 177 F.3d 472, 479 (6th Cir. 1999).

Id., 2001 U.S.Dist. LEXIS 14455 at *36-38. The court then went on to summarize the evidence that Amway actually is a pyramid scheme. 

P&G and Dinsmore have come forward with 163 pages listing the nature of the evidence on which they relied in asserting that Amway has not been enforcing the rules and has allowed its business to become an illegal pyramid scheme. The evidence includes news articles, internal Amway memoranda, Amway motivational tapes, trial testimony from other cases filed against Amway, and correspondence. P&G and Dinsmore have come forward with evidence that certain Amway distributors earn far more in their sale of motivational tools than from the sale of Amway products. They have produced evidence that although Amway set a 20% guideline for as a way to ensure proportionality of BSM sales to Amway product sales in 1983, some distributors have exceeded this guideline. They have produced evidence that many Amway distributors almost totally ignore the 10 customer rule. They have produced evidence that the operation of Amway's buyback rule may not be adequate, given the Ninth Circuit's ruling in Webster v. Omnitrition, 79 F.3d 776, 783-84 (9th Cir. 1996), that the restocking fee prevented summary judgment on the issue of whether Omnitrition was an illegal pyramid scheme. See Omnitrition, 79 F.3d at 783-84.

What P&G and Dinsmore knew about Amway also came from other claims that had been filed against Amway. Since the 1979 FTC decision, a number of cases have been filed against Amway alleging pyramid and RICO claims. P&G has produced evidence that Amway settled the Hanrahan case, which included a RICO count. Another court dismissed an action and counterclaim between Amway distributors on the basis that the transactions between the parties amounted to a pyramid scheme which was unenforceable as being against the public policy of the State of New York. Schaffer v. Talerico, 118 Misc. 2d 66, 67, 459 N.Y.S.2d 716 (City Ct. N.Y. 1983).

P&G and Dinsmore have produced internal Amway memoranda expressing the concerns of those at the top of the Amway corporation that the motivational tools business, if allowed to go unchecked, had a potential for becoming an illegal pyramid scheme [the district court's footnote cites the "Postma memo" and the "Directly Speaking" transcript]. Amway has not only addressed the issue of pyramid concerns internally, it has also publicly addressed the issue of whether Amway is an illegal pyramid on the Amway website. In addition to the information P&G and Dinsmore had when they filed the Texas case, discovery in this case has revealed internal Amway memoranda from Mulham and Halliday which reveal that Amway's highest executives were concerned about an illegal pyramid.

Id., 2001 U.S.Dist. LEXIS 14455 at *38-41 (footnotes omitted). The court also granted summary judgment on the basis of Michigan's fair reporting privilege, which protects individuals who fairly and accurately report information that substantially represents matters contained in court records. Id. at *44-45. 

On appeal, the Sixth Circuit affirmed the summary judgment for P&G and Dinsmore. Amway Corp. v. P&G Co., 346 F.3d 180 (6th Cir. 2003). Apparently not wanting to get into the 1st Amendment issues, the Sixth Circuit simply affirmed the summary judgment based on the Michigan fair reporting privilege. Although the Sixth Circuit mentions in a footnote that the FTC found Amway was not a pyramid scheme in its 1979 ruling in In re Amway, the Sixth Circuit's opinion does not otherwise address the pyramiding allegations. Amway v. P&G Co., 346 F.3d at n5.

Neither of the other two cases involving P&G and Amway dealt with the pyramid claims either. The Utah litigation against Amway and Randy Haugen dealt almost exclusively with P&G's defamation claim against Amway and certain distributors over the "Satanism rumor." See P&G Co. v. Haugen, 317 F.3d 1121 (10th Cir. 2003). In the Texas case, P&G did plead that Amway was an illegal pyramid scheme and brought a civil RICO claim along with the same defamation claims involved in the Utah case. The pyramid and RICO claims were dismissed for lack of standing since P&G was not a distributor and could not have been injured by the Amway pyramid scheme. See P&G Co. v. Amway Corp., 242 F.3d 539, 567 (5th Cir. 2001). The defamation claim was dismissed on res judicata grounds because it was already litigated in Utah. Id.

Thus, none of the litigation between Amway and P&G resolved the matter of whether Amway or Quixtar operates as an illegal pyramid under the law. Indeed, the only written opinion that delves into the topic to any significant degree is the Michigan federal district court reviewed above, which indicates that there is reason to believe Amway operates as an illegal pyramid. The most recent opinion, from the Sixth Circuit, simply did not address the issue.

The illegality of buyers' club pyramid schemes

It is interesting to note that by promoting and profiting from the BSM business and the "buyer's club" pyramid (where most of the products are bought for the personal use of the "distributors" themselves) Amway would fall within the Sixth Circuit's own definition of an illegal pyramid from the court's opinion in United States v. Gold Unlimited, Inc., 177 F.3d at 479. In affirming the use of a definition that excluded self-consumption of products from the "retail sales" requirements of the landmark Koscot case, the Sixth Circuit endorsed the position taken by the FTC and the Omnitrition court, and specifically pointed out that a basis for the Koscot case was the extensive self-consumption of products by the scheme's participants rather than actual retail customers. Id., 177 F.3d at 480. The court concluded:

Given the district court's instruction that a pyramid exists when a program's rewards relate to recruitment, not product sales, the jury necessarily found the possibility of saturation when it found that the defendants ran a pyramid scheme: "'The presence of this second element, recruitment with rewards unrelated to product sales, is nothing more than an elaborate chain letter device in which individuals who pay a valuable consideration with the expectation of recouping it to some degree via recruitment are bound to be disappointed.'" Omnitrition, 79 F.3d at 781 (quoting Koscot).

Id., 177 F.3d at 481. Indeed, the Sixth Circuit noted that the payment of money that is unrelated to sales of products to retail customers is the sine qua non of an illegal pyramid scheme under the Koscot test. Id. at n6 (citing Omnitrition).

Many other courts have viewed buyers' club-type pyramid schemes in the same manner as the Sixth Circuit, the Western District of Michigan, the Ninth Circuit and the FTC in In re Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975). As indicated in FTC v. Five Star Auto Club, No. Civ-99-1693, 2000 U.S. Dist. LEXIS 10548 (S.D.N.Y. 2000) and FTC v. Equinox Int'l. Corp., No. CV-S-99-0969-JBR, 1999 U.S. Dist. LEXIS 19866 (D. Nev. 1999), the FTC continues to consider a purported MLM in which most of the products are sold to the "distributors" rather than "retail customers" an illegal pyramid scheme. Id. ("Retail Sales do not include sales made by participants in a prohibited marketing scheme or multi-level marketing program to other participants or recruits in that scheme or program or to such a participants' own accounts").

Nor is this rule new. It was not new when the Ninth Circuit wrote about it in 1996 in Omnitrition. It is clearly the definitive factor in the landmark Koscot case and has been repeatedly applied by courts across the country to shut down schemes that, like Quixtar, involve unenforced retail sales rules and where, as a result, a small portion of the products are sold to retail customers. See e.g. State ex. rel. Webster v. Membership Marketing, 766 S.W.2d 654 (Mo.App. 1989)("The sales representative acquires nothing for resale to an ultimate consumer because the plan depends on that consumer becoming a salesperson himself and, in turn, persuading others to join and participate in the same way. The Amway exemption simply does not apply."); People ex rel. Hatigan v. Dynasty System Corp., 471 N.E.2d 236 (Ill.App. 1984)("The evidence overwhelmingly demonstrates that the primary emphasis is on commissions earned by building a down-line organization. Testimony established that TDSC was represented as a consuming organization and not as a selling organization. Commissions are not dependent upon retail sales to ultimate consumers, but are paid solely upon purchases made by distributors in the participant's down-line organization"); Schrader v. State, 517 A.2d 1139 (Md. App. 1986); State v. Phase II Sysems, Inc., 440 N.Y.S.2d 454 (S.C.N.Y 1981). The explanation from the California Court of Appeals in People v. Bestline Prods., Inc., 61 Cal.App.3d 879 (Cal. App. 1976) is not only typical of how courts have viewed schemes like these, but shows unequivocally, that they have been viewed in this light for decades before Omnitrition:

The Bestline plan, as alleged in the complaint and found by the court, offered compensation for recruitment based upon sales to the recruits. This element of the Bestline plan, which is what makes it a chain scheme under California law, serves to increase the certainty of deception by diverting the effort of all distributors from retail sales to the sales of distributorships. A pyramid sales plan under which the compensation for recruitment is limited to "payment based upon sales made to persons who are not participants in the scheme and who are not purchasing in order to participate in the scheme," does not come within the definition of endless chain schemes set forth in Penal Code section 327. The section, however, declares the policy of this state that such schemes are deceptive when compensation is offered "for introducing one or more additional persons into participation in the scheme" based upon sale to the person introduced. It is on the basis of this policy that participation in such schemes is made criminal.

Id.

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