Is Multilevel Marketing (MLM) the same as an Illegal Pyramid Scheme?
Have you ever heard someone suggest that MLM or network marketing is an illegal pyramid scheme?
The answer to whether MLM is an illegal pyramid scheme or a legal, legitimate business model is based on a 2018 Federal Trade Commission document, which I'm going to go through step-by-step in this post.
According to case law, yes, network marketing (a.k.a MLM) is legal and is not an illegal pyramid scheme.
The case that established this law was the 1979 FTC vs. Amway case. The judge ruled that Amway’s multilevel marketing program was a legitimate business opportunity as opposed to a pyramid scheme.
It was a four-year-long litigation that started in 1975, with the final ruling given in 1979.
This established case law is what makes the structure of multilevel marketing (paying on more than one level) legal today.
Now, if you're a part of a network marketing company or you're looking to join a network marketing company, you want to make sure that you are not in fact involved in an illegal (or even borderline illegal) pyramid scheme.
How can you tell the difference between a legal MLM company and an illegal pyramid scheme?
One of the things that established the legitimacy and legality of the business model for Amway was a rule in their policies and procedures that you needed to have ten retail customers in order to earn on downline commissions.
I personally feel this is an important point, because if you can't get retail customers, then you're going to have a hard time training your team to get customers. You would have an enormous amount of volume if each person had ten customers, and so I think it's a good idea, even though this is under the corporate policy side of things, not a legal point.
Having a “Buy-back” policy was the other thing that Amway had as an example that made it legal. They would buy back unsold, unopened inventory.
They also had something called the “70%” rule, where you can’t order more inventory unless you have sold at least 70% of your previous inventory. This is not a retailing rule. This is an inventory rule, and it was to prevent people from warehousing products and holding onto too much inventory. So, Amway had some of these good practices and they won their court case, which was the precedent for network marketing becoming legal.
Fast forward to 2018, when the FTC issued “Business Guidance for Multi-level Marketing,” which went into detail on what is legal and what isn’t legal or is a pyramid scheme.
I’m going to summarize some of the key points for you below but I suggest you read this because I just think it's a good idea for you to know what’s okay and what’s not in our industry. You can see this here: https://www.ftc.gov/tips-advice/business-center/guidance/business-guidance-concerning-multi-level-marketing
Business Guidance for Multi-level Marketing Income Misrepresentation
1. Income Misrepresentation
This is a big one in terms of what the Federal Trade Commission is looking at. If you use a hypothetical income, or if you use your own example when giving someone an idea of how much money he can make as a rep, always show an actual average income statement. Also, don't make product claims. That's going to be coming from a different direction. That's the Food and Drug Administration and not the Federal Trade Commission, but you can still end up being an illegal company because of the distributor doing this.
2. Large Membership Fees
If it is company policy to charge large membership fees, that company is likely to be a pyramid scheme. Typically, when you join a network marketing company, it's going to be somewhere between $25 and $50 to become a representative. That's not a large membership fee. Another expense when starting in a network marketing business is for trying the products personally. Anyone would want to try a product before getting into that business, right? If it costs $1,000-2,000 or something like that, that's an amount that makes sense for your personal consumption, but if it costs a whole lot for you to try out the product, then that's a different story, and could indicate an illegal business. Large membership fees allow front-end loading, so if the company is allowing people to load people up with $5,000-$10,000 worth of products, then it's likely a pyramid.
3. Being Paid Commission On Enrollments
There’s another point mentioned on being paid commissions for solely enrolling someone in the business. There is a difference between an upline getting paid a commission when a person joining a network marketing business buys products or services to explore the business and a person getting paid a commission on just enrollments. So the company can't pay commissions on enrollment but can pay commissions on products that a person may buy.
4. Product Purchase Intent
Now, this is the big one. This is where the point of the spear is right now, as opposed to 30 years ago. The Federal Trade Commission is looking at what a person’s intent is in ordering products. If that intent is to consume the product, it's likely legal. If it is to sell the product to a customer it’s likely legal. If it is to earn commissions, then it’s likely illegal. If the intent is comp plan driven, meaning the reps are only purchasing products to earn a commission, then it's likely illegal. What do we mean by comp plan-driven? In some compensation plans, they motivate a person to buy the inventory to earn commissions That's going to cross over a line, because your intent in buying that inventory isn’t to consume it or to sell it but to earn more commissions, and that's where it gets shady. That's what the Federal Trade Commission doesn't like.
I hope this has clarified for you a little bit about what makes a business legal or illegal.
Please do me a favor and comment down below. Tell me what you think about what I've shared in this post. Let me know your view of how this works. I think I'm explaining it the best way I can, so I'd love to hear what you have to say about it. Do you like it? Even if you don’t like it, I want your feedback. I'm good with it. What you think about these topics matters to me, so let me know.
PS. The FTC Document I refer to, you can see it here.