explains pyramid schemes

There are many types of pyramid schemes with various characteristics.  Over time the United States Federal Trade Commission has modified their definition of an illegal pyramid to this:

"Pyramid" Definition from FTC vs. Equinox April 2000, is the same as FTC vs. Trek Alliance June, 2003

"Pyramid scheme" means a sales scheme, Ponzi scheme, chain marketing scheme, or other marketing plan or program in which participants pay money or valuable consideration to the company in return for which they receive:

    1. the right to sell a product or service; and
    2. the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of products or services to ultimate users.

For the purposes of this definition, "sale of products or services to ultimate users" does not include sales to other participants or recruits in the multi-level marketing program or to participants' own accounts.

Basically it says that any plan allowing participants to recruit other participants, where the majority of benefits (sales/profits) are not derived from people outside the compensation scheme, is illegal.

The FTC's definition comes after years of refinement.   The pyramid scheme promoters have constantly modified their plans to avoid the scrutiny of the FTC.  Pyramids started out promoting simple "pay to play" or "head hunting" schemes with fixed payments to participate in the scheme.  An example of this is the classic Ponzi investment scheme.  These were quickly ruled illegal and shut down. 

Next the pyramid promoters sold overpriced "products", where the price of entry into the pyramid scheme was disguised by mandatory fixed purchases of expensive goods.  The excessive price of the goods was the actual entrance fee to participate in the pyramid scheme.    The FTC quickly ran "mandatory" purchase plans out of business.

Next came the "optional" purchase of overpriced goods or "fake goods" that have no economic value to the general public.  Pyramid promoters could still survive and exploit the public's desire for get-rich-easy plans with "optional" purchases of various "products".

The inventory loading scheme was a slight modification of the "optional" purchase plans.  The purchase of products were "optional" so over zealous people could freely buy too much and they loaded inventory to buy themselves to the maximum bonus level, thereby getting a quick start.  The regulators added new requirements for buy back of products to eliminate the incentive to quickly pyramid with inventory loading and leaving the participants holding a lot of unmarketable goods.  The pyramid promoters quickly started offering refunds for their products but the "optional" purchase plans remained in tact.  One could still sell $100 Snickers bars in a product pyramid scheme and still be considered within the law.  The "optional purchase" $100 Snickers bar scheme would just be a $99.50 Ponzi scheme payment disguised by an expensive product.  

The FTC's latest response to the "optional" purchase programs with "refunds" has been to use the "sales to outsiders" or the "retailing" test.   The test basically asks the question if the products would have a genuine value to the general public in absence of the pyramided compensation scheme.  This would be the real world proof that the products marketed had real world value or if was just an elaborate disguise for yet another type of product pyramid scheme.    If more than 50% of the benefits derived from the plan are from sales to those not expecting to participate in the compensation scheme, then the plan is legal.  The basic question here is, can the participant reasonably expect to earn money from retailing the products?  If the product has a real world value then it would be proven by the existence of strong sales to those not participating in the compensation program.

The latest variance in the argumentation is Quixtar's "legal fiction" argument about the legality of the tools business relates to the expectancy issue.  The Quixtar legal department contends that since the majority of IBOs do not actually receive money from the tools business that they are in fact "retail customers" to that business.   This issue was however addressed years ago in the MMI (5-Star Auto) case, where commissions only became payable after participants reached level 4. Never the less they were all considered participants by the court, since they expected to be able to earn money once they achieved the minimum threshold.  

The following chart depicts the various characteristics of pyramid and marketing schemes, which show up in the legal case precedents. The important characteristics to be considered are up-front payments, headhunting fees, level of retail sales, and finally a 90% buy back policy to prevent inventory loading.

You can see the trend from upper left to the lower right, that in the absence of headhunting fees, mandatory purchases, and up front purchases that the focal point becomes the level of retail sales to non-participants.

From the evolution of the pyramiding regulations one can broadly define the characteristics of a legal pyramid or chain marketing scheme.  To be legal a plan must meet ALL of these requirements.

  1. No required fixed fee to join

  2. No minimum required purchases to made

  3. A refund provision ensuring at least a 90% refund on what is purchased

  4. At least 50% of the benefits are derived from those not participating in the plan

Here are some of the typical Amway/Quixtar distributor "legality" arguments.

1. For The Quixtar Products Business

Quixtar doesn't pay head hunting fees for recruitment

This is true, but this is only the first test for determining if a plan is illegal.  The issue of the percentage of retail sales is not addressed in this argument.

Quixtar is not a pyramid since I can earn more than the people above me

Sure you can earn more than the people above you, but it has nothing to do with the FTC definitions.  The issue of the percentage of retail sales is not addressed with this IBO argument.

Quixtar has rules requiring retail sales

True.  Quixtar has the 50PV or $100 rule.  The rule is quite easy to circumvent with the "self-reporting" option on Quxitar's web site.   Additionally an IBO with 150PV in personal sales and 50PV of Member/Client would have of only 33% coming from retail customers.  The rules have sufficient loop holes that they are plainly not enforced.  The "buy from yourself" mentality prevails in the business.

2. For The Line of Sponsorship Tools Business

There are no headhunting fees paid in the tools business

This is true, but this alone doesn't met all four requirements of the FTC.
See detailed argument below

The purchase of tools is completely optional

This is true, but this alone doesn't meet all four requirements of the FTC.
See detailed argument below

Those not earning from tools are "retail customers"

False. See detailed argument below

BSM's (tools) are completely refundable and covered by inventory loading rule

False. Read carefully the BSMAA contract.  See detailed argument below

The tools business is not subject to any regulatory legislation

False. See detailed argument below

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Legality of the Quixtar tools program
Attorney IBOs have made the following assertions as to why the BSM compensation program is completely legal.

  1. It is not a "multi-level" opportunity. It cannot be a pyramid and would not be regulated under any laws.
  2. The purchase of BSMs is completely optional. No purchases are required as consideration to participate in the plan.
  3. Members, who are not compensated, are then by default "retail customers" of the scheme.
  4. There are no "headhunting" fees paid for recruiting people into the scheme.
  5. BSM's are completely refundable.

1. Chain Marketing Scheme
Let's look at the tool's business structure.

IBOs recruited into their lines of sponsorship are granted the right to recruit other IBOs. IBOs are also granted the right to be compensated for sales of BSMs to their downline IBOs, once they meet certain requirements. Further more, those IBOs they recruit can too benefit from selling BSMs to their respective recruited downlines. This type of business is globally defined as a chain marketing scheme. The FTC certainly has the authority to regulate schemes like these.

Many IBOs are made aware of the opportunity to earn money from the "B" type business (BSMs) from their line of sponsorship as a second business in the Quixtar opportunity.

IBOs confirm the chain marketing aspect of their plans when they notes that that compensation in the tools' plans is also made upon the sales of goods and services to other participants who may be compensated in the plan. Most states have chain-marketing laws and deceptive trade practices acts. To say then that tools business falls under no regulation or regulatory agency because it is not a "MLM" is totally absurd. Besides the FTC definition of an illegal marketing scheme, there are also many state laws concerning chain marketing, or endless chains.

Here is a random example from California, Penal Code Sec. 327 for chain marketing schemes. It reads as Follows:

Every person who contrives, prepares, sets up, proposes, or operates any endless chain is guilty of a public offense, and is punishable by imprisonment in the county jail not exceeding one year or in state prison for 16 months, two, or three years. As used in this section, an "endless chain" means any scheme for the disposal or distribution of property whereby a participant pays a valuable consideration for the chance to receive compensation for introducing one or more additional persons into participation in the scheme or for the chance to receive compensation when a person introduced by the participant introduces a new participant. Compensation, as used in this section, does not mean or include 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.

IBOs have even gone on to note the Michigan statute:

  1. a plan or scheme or device,
  2. by which
    1. a participant gives valuable consideration for the opportunity to receive compensation for inducing other persons to become participants in the program, or
    2. a participant is to receive compensation when the person introduced by the participant introduces one or more additional persons into participation into the plan.
      1. each of whom receives the same or similar right, privilege, license, chance or opportunity.

Clearly since IBOs can recruit other IBOs and eventually earn commissions from their volume, the business has the basis of a chain marketing scheme. Chain marketing schemes are regulated by numerous laws, including the FTC.

2. Up-Front Payments
Attorney IBOs correctly point out that the lines of sponsorship doe not require any up-front payments to participate in business , and there is also no requirement to purchase any minimum amount of BSMs. The real issue comes down to the term of "consideration paid for the opportunity".

This issue was brought up in the Membership Marketing Incorporated (MMI) case, also know as "Five Star Auto".

"Although it is not required for marketing representatives to be 5-Star Plus
members themselves (have purchase the plan), it is encouraged that
they subscribe first, to demonstrate their faith in the product."

The Missouri Court of Appeals, Western District court in Five-Star Auto ruled:

"The fact that a sales representative may or may not also become a 5-Star
Plus member by payment of dues is irrelevant to the question of consideration."

This was due to the fact that consideration was granted by the member when agreeing to abide by MMI marketing policies for the concurrent benefit of commissions to be earned. In this case no money was exchanged for the purpose of having consideration

Attorneys must however know that the term "consideration" applies to more than just making a cash payment. It generally means the surrender of any valuable right. As the attorney highlights, IBOs participate in BSM profits based on reaching a certain pin level and by having certain levels of BSM sales to their groups. The consideration is the work/purchase/recruiting necessary to obtain the level in order to share in the BSM profits. Although there is no written contract, there is a "contract." There is a promise that if a particular IBO reaches a certain pin level with the line of sponsorship , they will obtain a share of the BSM profits for those they have recruited. A contract is an offer and an acceptance supported by consideration. The offer is the "diamond lifestyle" pitch, which includes at least implicitly the right to profit from BSMs. The acceptance is the IBO following the upline's instructions to recruit enough downline to reach the pin level necessary to share in the BSM income. Legally, this is known as "acceptance by performance."

IBO attorneys argue notes there is not "pay to play" issue:

The tools business has no "pay to play" as it may sometimes be called. As a recipient
from the compensation plan, there are no mandatory subscriptions, sign-up
fees, or minimum purchases to qualify for payment.

This argument was rejected in two cases. The first case was in The Dynasty Systems Corporation case:

TDSC contends that its activities do not constitute a pyramid sales scheme because the Act
requires that a person exchange money or other value for the right to benefit. TDSC argues
that under its *880 programs, a person may become a "dynasty distributor" without
purchasing any products or services. TDSC points out that, due to a change in its policies
effective April 1, 1984, a dynasty distributor earns maximum commissions from
purchases of products by distributors in his down-line organization without regard to
his participation in the System. Prior to this change, a participant would not earn the
full amount of the commission unless he purchased a minimum amount of products
from the affiliated companies, the tapes and the computer reports each month. We do
not, however, find this change in policy to be determinative.

The argument was also considered and rejected by the North Carolina Court of Appeals in State ex rel. Edmisten v. Challenge, Inc. (1981), 54 N.C.App. 513, 284 S.E.2d 333.

The North Carolina statute defined a pyramid distribution plan as " 'any program utilizing a pyramid or chain process by which a participant gives a valuable consideration for the opportunity to receive compensation or things of value in return for inducing other persons to become participants in the program.' " (54 N.C.App. 513, 516-17, 284 S.E.2d 333, 336.) The defendants argued that their activities did not constitute an unlawful plan because an "Independent Sales Agent" need not purchase any products or services in order to earn commissions from the recruitment of new sales agents. In rejecting the defendants' argument, the court held that the statute is violated if an individual pays consideration, whether or not he is required to pay it.
TDSC referenced in Unimax vs. People of the State of Illinois

Certainly if one isn't required to pay, the line of sponsorship training materials none the less gives the impression of the need to "pay to be successful". The purchase of these materials are of course completely optional, but those "wanting to succeed" should purchase them.

3. Retail Sales to non-Participants in the Plan
I suggest that all Quixtar IBOs building their businesses, hoping to have a big "B" type business, who are not yet participating in the compensation plan, are never the less participants in the scheme. They are not retail customers, but rather still-yet uncompensated participants.

In the MMI (5-Star Auto) case, commissions only became payable after participants reached level 4. Never the less they were all considered participants by the court. They were not retail customers, just uncompensated participants.

"Commissions actually become payable only after a sales representative has
reached the Level 4 downline at which point the representative is directly
or indirectly responsible for 120 5-Star Plus memberships."

The fact that only a small amount of IBOs participate in the BSM compensation becomes irrelevant based upon the 5-Star case. The situation only amounts to more highly leveraged pyramid with an absolutely huge front end investment (in time and money) before you get to participate in the profit from your downline recruits' BSM purchases. Just because the payback is delayed or conditioned on the amount of recruiting an IBO does, doesn't mean he isn't a participant.

From The Dynasty Systems Corporation case referenced in Unimax vs. People of the State of Illinois:

Evidence that motivational tapes and management computer services sold by organization,
which otherwise qualified as pyramid sales organization, had not been sold to individuals
who were not "distributors" of the organization, was sufficient to establish that the
organization fell within definition of a pyramid sales scheme prohibited under statute
because benefits received by participants were primarily based upon inducement of
others to participate and not contingent on the volume of goods sold to ultimate consumers
. S.H.A. ch. 121 1/2 , PP 261(g), 262A(2).

I would speculate, as a practical matter, that there are no Quixtar Platinums participating in the BSM compensation scheme who themselves did not participate in it coming up through the ranks. Maybe the attorney can elaborate in his next letter what would happen in the hypothetical example where a Platinum stopped purchasing and promoting the system who was receiving compensation from it, yet still had sufficient volume to qualify for a pay-out. There are other lines of sponsorship in Quixtar where Platinums stop getting BSM compensation if they themselves stop subscribing to the system.

I suggest that majority of sales are therefore being made to the participants of the scheme themselves. According to the FTC definition, this would be illegal.

4. Headhunting Fees
Compensation in these cases can not be only from headhunters fees but can also come from commissions the downline organization generate. Previous court cases show that commissions from sales to downline can also be considered compensation for purposes of applying the law. Many precedent cases did not have head-hunting fees but were still prosecuted as illegal marketing schemes. The headhunting fees were implied to be contained in the commissions of those they recruited, when the purchases were mainly for the participants own consumption.

'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).
(product sales to non participants)

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");

The attorney stated in so many words:

Qualification is not based upon recruitment/enrollment, but only on sales level

This is kind of a chicken and the egg argument. Since the line of sponsorship motivational products have little or no use outside of the Quixtar organization, the only way to increase sales volume is to sell more to existing IBOs or recruit more IBOs who will purchase them. He could easily have written "Eligibility is based exclusively upon sales volume, which can only be achieved by recruiting more people who buy our BSMs". It would still say the same thing since they probably sell the majority of BSMs to those working to one day participate in their scheme. Practically speaking, BSM sales volume can only be increased by recruiting new IBOs who will buy them.

From The Dynasty Systems Corporation case referenced in Unimax vs. People of the State of Illinois:

The marketer acquires "the opportunity to receive a benefit or thing of value" by way of commissions,
which are themselves "primarily based on the inducement of additional persons" to buy into
the Unimax system. Marketers' commissions, therefore, are "not primarily contingent on the
volume of goods, services or other property sold or distributed * * * to persons for purposes
of resale to consumers," but are entirely unrelated to the sale of goods or services available
through the Buyers' Service and are obtained only by recruiting more persons into Unimax.
See Ill.Rev.Stat.1985, ch. 121 1/2 , par. 261(g).

5. Buy Back Rules

Quixtar has an excellent 100% money back guarantee. I've heard that Quixtar will also pay the shipping costs. If the lines of sponsorship have such a policy, I have never seen it written down. Maybe they would care to send me a copy of it? The tools refund policy via the BSMAA contract is not as generous as the attorney leads his readers to believe. Interesting to note is that the Business Support Materials Arbitration agreement specifically excludes tools that were purchase for inventory (non-personal use).

" 8. Refund policies -- ...... Business Support Materials purchased for stock or inventory, or for any reason other than the buyer's personal use, are not subject to this policy but shall be governed by whatever refund policy is agreed to with the selling IBO. For seminars, rallies, and other meetings, the selling IBO shall buy back any tickets purchased for the buyer's personal use for a period of 30 days...... "

Unlike the Quixtar refund policy, the BSMAA refund policy specifically states many conditions and specifically excludes BSMs purchased for non-personal use. It appears that the BSM scheme also has no effective buy-back policy to prevent inventory loading. Chain-marketing schemes with no buy back rule to prevent inventory loading can also be ruled illegal.

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