Many MLM operations deliberately or inadvertently end up being pyramid schemes.
The actual meaning of the Pyramid scheme is an operation in which the individual who joins the earliest makes most of the money while the people joining later stand to earn a pittance, if at all.
In the business model, which is a pyramid, the participants have to pay a hefty amount for a one-time purchase or make periodic purchases by paying considerable amounts to earn income from the performance of the downline marketing organization. In a pyramid model, the participants who joined earlier stand to make more money than the new participants.
In a pyramid scheme, the participants are encouraged to purchase a certain amount of product at fixed (weekly/monthly) intervals, even if they already have more inventory than they can use or sell.
The participants may even have to buy products before they are eligible to be paid or get specific bonuses/commissions.
Some direct selling companies, which are pyramids, may sell quality items at competitive prices. However, some offer overpriced goods, have questionable benefits as compared to similar products available in the market.
Types of pyramids
- Without products
- One time investments
- Periodic investments
- With products (Token/Real value/Inflated value)
- One time purchase
- Periodic purchases
1. F.T.C. v. 2Xtreme Performance International L.L.C. (1999), JFM99CV-3679 (N.D. Maryland, December 9)
Case Synopsis: At the request of the Federal Trade Commission, a U. S. District Court Judge has halted the operation of an alleged pyramid scheme and frozen the defendants' assets, pending trial. The F.T.C. alleges that consumers lost substantial sums of money to the scheme and has asked the Court to order consumer redress after a trial on the merits of the agency's charges.
Court Ruling - On December 9, 1999, the F.T.C. filed suit in U. S. District Court for the District of Maryland seeking a Preliminary Injunction and an asset freeze, pending trial. After a two-day preliminary injunction hearing that concluded February 25, 2000, Judge J. Frederick Motz found that based on the F.T.C.'s preliminary evidence, it is likely to succeed in proving in a full trial that the defendants deceived consumers. Accordingly, Judge Motz issued preliminary injunctions prohibiting the defendants from operating illegal pyramid schemes and making various misrepresentations pending trial. The injunctions also froze the individual and corporate assets to preserve them for consumer redress.
2. F.T.C. v. Amway Corp. (1979), 93 FTC 618
Case Synopsis: In F.T.C. v. Amway (1979), the Court ruled that Amway was not operating a Pyramid scheme because they were not charging a large sum of money upfront and noted the following provisions and controls in their operating procedures: 1) 70% or all distributor purchases were required to be resold before re-ordering (preventing inventory loading), 2) the ten customer rule which required each distributor to make retail sales to at least ten different customers each month, and 3) the company's buyback policy which offered a minimum 90% refund on all product returned to the company in saleable condition (Vander Nat and Keep 2002).
Court Ruling: This landmark case and ruling saved the direct selling industry from extinction, and it opened up and showcased it as a viable business model.
3. F.T.C. v. Equinox Int’l Corp. (1999), CV-S-99-0969-JBR-RLH (Nevada, August 3)
Case Synopsis- The F.T.C. and five states (Hawaii, Maryland, Nevada, North Carolina, Pennsylvania and South Carolina) filed a joint action on August 3, 1999, alleging that the defendants operated a pyramid scheme, made false earnings claims, failed to disclose material information, and violated the F.T.C. Act as well as state securities laws, deceptive trade practices laws, false advertising laws, pyramid laws, and licensing requirements. The Court granted the F.T.C. and states' request for an ex parte TRO and imposed a freeze on the defendants' assets and a receivership over their business.
Court Ruling: On September 14, 1999, after a full hearing, the Court issued a modified preliminary injunction against the defendants. Pending a full trial, the order prohibits any pyramid activity or misrepresentations about earnings. In addition, it requires defendants to modify their business terms and keeps a receiver in place to monitor defendants' business and prevent the dissipation of assets.
4. F.T.C. v. Five-Star Auto Club Inc. (1999), Civ. No. 99-1693 (CM) (S.D.N.Y., March 8)
Case Synopsis: Complaint Synopsis: Five Star promised online consumers an opportunity to lease their "dream vehicle" for free while earning between $180 and $80,000, based only on the payment of an annual fee and $100 in monthly payments and recruiting others to join. The F.T.C. alleged that Five Star Auto was an illegal pyramid scheme, a deceptive trade practice. They also claimed that Five Star misrepresented the financial gain from joining the company through earnings claim representations.
Legal Issue: Is Five Star Auto an illegal pyramid scheme, and is Five Star liable for false and misleading claims regarding earnings potential and participants' likelihood of success in the program made by independent contractors?
Court Ruling: The U.S. District Court for the Southern District of New York ruled, after a trial on the merits, that Defendants, on their own and through representations by independent contractors, violated Section 5 of the F.T.C. Act by making false and material claims that consumers participating in the Five Star program could lease their "Dream Car for Free" and earn a substantial income. The Court further ruled that Defendants were operating a pyramid scheme and therefore violated the F.T.C. Act by failing to disclose material information that because of Five Star's pyramid structure, the majority of participants had not and could not achieve the promised car or income.
5. F.T.C. v. Fortuna Alliance L.L.C. (1996), Civ. No. C96-799M (W.D. Wash., May 23)
Case Synopsis: On October 30, 1997, the F.T.C. filed another contempt action against Fortuna and all individual defendants except Monique Delgado. The F.T.C. alleged that these defendants had failed to pay the additional $2 million required for consumer redress and that they had failed to provide copies of ongoing solicitations, as required. The F.T.C. also alleged that the defendants and their lawyer had misrepresented the effect of the prior consent agreement, stating that Fortuna's prior solicitations had been legal. Hearings on the contempt action were held on Dec. 4 and 17, 1997, and defendants were ordered to comply with the final order and make additional redress payments.
Court Ruling: On June 5, 1998, the Court entered a final contempt order, banning defendants from promoting any marketing program until their $2.2 million deficiency was paid. The F.T.C.'s redress administrator made partial payments to remaining consumers. Overall, 15,622 consumers from the U.S. and 70 foreign countries received approximately $5.5 million in refunds.
6. FTC v. FutureNet Inc. (1998), Civ. No. 98-1113 GHK (AIJx) (C.D. Calif., February 17)
Case Synopsis - Defendants claimed recruits could earn substantial incomes by joining a multi-level marketing program selling Internet access devices, but according to the Commission, defendants ran an illegal pyramid, where income was dependent not on product sales but on recruitment of paying members "downline."
Court Ruling: The Commission announced settlements with the two remaining defendants, Robert De Pew and David Soto. The settlements bar them from
- participating in any future pyramid schemes;
- misrepresenting sales, earnings or other material facts about products or services they sell;
- selling electric power or other energy services without meeting licensing and registration requirements; and
- participating in any multi-level marketing program owned, operated or controlled by the other FutureNet principals.
Both defendants also are required to obtain $1 million performance bonds before engaging in future multi-level marketing. If their financial disclosure statements are shown to be false, they also will face a $21 million judgment.
7. F.T.C. v. Global Assistance Network for Charities (1996), Civ. No. 96-2494 PHX RCB (D. Ariz., November 5)
Case Synopsis - Defendants allegedly operated a pyramid scheme that purported to raise money for charities. Consumers paid an initial fee of $70 and $50 a month after that for membership. Defendants' promotional materials claimed that consumers would receive over 9 $89,000 per month once their matrix was filled. Defendants also claimed that 10% to 100% of the earnings would be donated to charities. Defendants marketed their program on a Web site as well as through other media. In October 1996, the defendants estimated membership at 200 people.
Court Ruling: F.T.C. filed an action against the defendants, alleging violations of § 5 of the F.T.C. Act. The complaint alleges that defendants' representations that consumers would receive over $89,000 per month and receive a full refund if they did not make a profit were deceptive. On the same day, the Court granted an ex parte Temporary Restraining Order, which among other things, prohibited the defendants from continuing to market G.A.N.C., froze the defendants' assets and required the defendants to provide access to their business records. On November 14, 1996, the Court issued a preliminary injunction order which extended relief similar to that contained in the TRO for the duration of the action. On April 24, 1997, the Court entered a stipulated final order, requiring defendants to pay $4,900 in consumer redress.
8. F.T.C. v. JewelWay International Inc. (1997), Civ. No. 97-383 TUC JMR (D. Ariz., June 24)
Case Synopsis- Defendants ran an alleged pyramid scheme via a Web site and through group presentations, offering consumers the chance to earn up to $2,250 a week plus bonuses for the purchase of expensive homes, automobiles, and vacations, by participating in a purported multi-level marketing scheme to sell fine jewellery. Consumers paid $250 to $2,750 or more and recruited at least two new JewelWay representatives. On June 24, 1997, the F.T.C. filed a complaint alleging the pyramid scheme was deceptive, in violation of the F.T.C. Act, and the Court entered an ex parte TRO and appointed a receiver. In addition, the defendants stipulated a preliminary injunction.
Court Ruling: The Court approved a stipulated permanent injunction and final order. The order requires a payment of $5 million in redress for approximately 150,000 investors. In addition, the order prohibits all defendants and JewelWay representatives from operating any pyramid schemes and requires the defendants to establish a product re-purchasing program.
9. F.T.C. v. Nia Cano (1997), Civ. No. 97-7947 IH (AJWx) (C.D. Calif., October 29)
Case Synopsis: The F.T.C. alleged that defendants ran a pyramid scheme and falsely promised consumers an unsecured VISA or MasterCard and the opportunity to receive $18,000 in monthly income. The defendants purportedly recruited new members at live sales presentations. In addition, many participants built their downline through unsolicited bulk e-mail ("spam"). F.T.C. filed a complaint against the defendants. The Court entered an ex parte TRO, ordered a freeze on the defendants' assets, and appointed a receiver to oversee the defendants' business. On November 20, 1997, the Court held a contested hearing to determine whether a Preliminary Injunction should issue. The Court found that a Preliminary Injunction should issue and that the asset freeze and receivership should remain in place.
Court Ruling: The settlements provide nearly $2 million in consumer redress, enjoin the defendants from operating pyramid or Ponzi schemes, and liquidate the businesses involved in the alleged scheme. The Court approved settlements with individuals Tkalec and Lewis on October 14, 1998, and on March 17, 1999, the Court approved the Receiver's redress plan.
10. Webster v. Omnitrition International Inc. (1996), 79 F. 3d 776, 781- 782 (9th Cir.), cert. denied, 117 S. Ct. 174 U.S. (No. 94-16477)
Court Ruling: Multi-level marketing or vertical marketing programs are surfacing with greater frequency in marketing goods and services. Such multi-level marketing programs are often promoted through appeals to the entrepreneurial spirit and wealth creation. In Webster v. Omnitrition International, Inc., the Ninth Circuit Court of Appeals examined the differences between legal multi-level marketing programs and fraudulent pyramid schemes.
Central Issue: The central issue was whether Omnitrition could establish as a matter of law that its sales and marketing program was not a pyramid scheme.