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Through the Looking Glass: Spotting MLMs and Pyramid Schemes

Multi-level marketing (MLM) companies and pyramid schemes share similarities like recruitment-focused structures but have key differences, such as the sale of products in MLMs versus pyramid schemes that redistribute payments and fees to early investors. However, some MLMs still prioritize enrolling distributors over product sales to help scale and grow. This warrants examination as MLMs promote flexibility and big earning potential, but the reality is very difficult for most participants.

MLMs saturate markets by tapping out social connections, making continued recruitment challenging. Their compensation plans favor top ranks while later distributors often struggle. For reference, just 13 cycles of each distributor recruiting six people exceeds the Earth’s population, illustrating why most at the bottom of these marketing companies lose money from initial investments and inventory purchases. The touted income claims rarely match the actual experience of overwhelming market saturation, unequal pay and the endless need to recruit. With long odds against profiting, it is prudent to approach any new MLM with careful analysis as some of these companies take advantage of distributors and hide their true nature behind the veil of an authentic MLM.

Defining MLMs and Pyramid Schemes

Multi-level marketing is a system where participants earn commissions on their personal product sales, as well as sales made by people they recruit. The focus is supposed to be selling products directly to customers.

In contrast, pyramid schemes are solely focused on recruiting new members into the funnel. Money flows upwards in a pyramid scheme to reward early investors with returns funded by later participants’ fees. Pyramid schemes can also require participants to purchase and resell a set number of products regardless of if they are out of inventory or not, which causes serious financial strains, but gives off the impression that they are a multi-level marketing opportunity.

Source: Security and Exchange Commission, U.S. Federal Govt.

There are several red flags that may indicate a fraudulent MLM or pyramid scheme:

· Requiring an upfront investment or bulk product purchases to join.

· Unrealistic income claims.

· No income disclosure statement.

· High-pressure sales tactics focused on recruitment and stocking inventory.

While MLMs and pyramid schemes have some superficial differences, their structures are essentially identical — both take a pyramid shape with the top of the pyramid having the highest earning potential.

Most MLMs are not profitable unless members can continuously recruit new distributors who successfully sell products to consumers. As MLMs grow, the goal shifts to enrolling more people to grow the business and allow others to earn commissions off of their recruits’ sales, rather than strictly product sales on their own. However, if the emphasis shifts solely to recruitment, that puts MLMs into dangerous territory of appearing to operate a pyramid scheme.

Case Study: Herbalife

In 2016, the Federal Trade Commission (FTC) accused Herbalife, a leading MLM company, of incentivizing recruitment over retail product sales. Most Herbalife distributors made little or no money, and many lost money entirely.

According to former FTC Chair, Edith Ramirez, Herbalife was “not determined not to have been a pyramid.” This case illustrates the gray area between MLMs and pyramid schemes. Herbalife escaped pyramid scheme charges by paying a settlement and agreeing to make significant changes to their business structure.

How to Recognize Pyramid Schemes

Be wary of any company urging you to invest or buy inventory before doing thorough research. If you suspect an MLM may be a pyramid scheme, ask questions before joining or investing:

· Request their income disclosure statement.

· Research the company reputation through news, reviews, etc.

· Take time to evaluate the opportunity and resist pressure.

While some MLMs are legitimate businesses, many have compensation structures and incentive plans similar to illegal pyramid schemes. Be skeptical of outsized income claims and recruitment focused pitches. Do your due diligence before investing time or money to avoid getting caught in a scheme.

Read More: The Unhealthy Reality Behind Health MLMs

SOURCE: ACFE Insights – A Publication of the Association of Certified Fraud Examiners

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