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The FTC and Better Business Bureaus warn consumers against falling prey to pyramid schemes masquerading as legitimate MLMs. How are consumers to tell the difference?
"Be cautious of plans that claim you will make money through continued growth of your "downline" - the commissions on sales made by new distributors you recruit - rather than through sales of products you make yourself," said the FTC in its officials warning posted on its website.
But if people followed this admonition very few would ever join an MLM. Marketing literature almost universally emphasizes MLM's unique financial opportunity to earn money by "duplicating yourself" rather than doing all the selling personally. The money in MLM, as anyone who has ever been solicited knows all to well, resides in the downline. Distributor enrollment is the name of this game.
So when does emphasis on building a downline pass from legal to illegal? State court cases are increasingly using one simple standard. It is that the MLM must derive at least 70% of its income from retail sales to non-distributors. If less than 70% of income comes from sales to these non-distributors, the courts have concluded the MLM company is in the business of endlessly recruiting distributors who recruit distributors. In short, they are pyramid schemes, not sales and distribution companies.
Pyramid schemes are illegal because they cannot mathematically sustain themselves. The system may not necessarily collapse but it can never deliver on its promise of financial success to any but a very few. To remain viable the illicit business must therefore continually replace the financial losers.
This 70% standard was recently applied in four cases in North Carolina prosecuted by the NC Attorney General's Office. NC Assistant Attorney General, Kristine Lanning, calls North Carolina "hostile territory" for pyramid scheme promoters.
The four companies include Club Atlanta Travel, Destiny Telecomm International, Inc., Tele-Card International, and International Heritage, Inc. These four companies had enrolled 40,000 distributors in North Carolina alone. The large number of people enrolled by these lesser known companies in just one state gives some indication of the extent to which MLM is touching people's lives in an illegal manner.
Destiny Telcomm International, as one case in point, is a California company which marketed discount phone cards.
"Upon joining the Destiny Program, each participant purchased at least one Destiny phone card after which they were told they could earn commissions upon the recruitment of other participants," the court document states. Destiny paid its participants on the "binary" compensation plan, a new method gaining popularity among MLM companies.
In the court settlement, Destiny agreed that "at least 70% of all North Carolina sales shall be retail sales to persons who are not connected in any way to the Destiny sales force. The ruling also excluded from the 70% portion sales to individuals who subsequently became Destiny representatives.
Few states are as active in enforcing pyramid scheme laws as North Carolina and even in this state there are limits on the Attorney General's ability to investigate and prosecute MLMs.
Astute readers may already be questioning how Destiny, Tele-Card Network and others are required to prove that 70% of their sales are to non-distributors when other much larger companies acknowledge their sales are well below this standard. Amway, for example, according to its own literature, states that only 18% of its income is from retail sales made to non-Amway distributors.
The uneven application of the law points toward the need for broad and universal federal regulation and oversight of the MLM industry.