Is It a Pyramid Scheme?

Is that direct-sales opportunity legit? What you need to know...

Illustrated Briefcase on Pyramid Anna Parini
Tell friends that you're joining an MLM and "Is it a pyramid scheme?" is probably the first thing they'll ask. "There's no one law that defines what a pyramid scheme is," says attorney Douglas Brooks. But the key distinction between a legit MLM and an illegal pyramid scheme is the emphasis on retail sales, according to the Federal Trade Commission (FTC): "If the money you make [from an MLM business] is based on your sales to the public, it may be a legitimate multilevel marketing plan. If the money you make is based on the number of people you recruit and your sales to them, it's not. It's a pyramid scheme."

But it can be tricky to evaluate the role of retail sales before you join. "One common misconception is that an MLM can't be a pyramid scheme as long as it offers a product that really works the way it's advertised," says Dr. William W. Keep. In fact, the FTC has found several companies to be pyramid schemes even though they offered products on the retail market. "The key is that a pyramid scheme makes most of its money when people in the distribution network buy those products and/or pay various fees associated with membership," says Dr. Keep. "The scheme is funded by sustaining ongoing recruitment, with little or no regard to retail product sales."

For MLMs that have crossed into pyramid schemes, products are in fact just window dressing. "There are operations out there that say they're all about selling product but then whisper on the side that all you really have to do is recruit people," says Joseph Mariano, of the Direct Selling Association. "We've worked tirelessly to make sure there's a clear distinction between us and them." Many MLMs have policies in place to emphasize the importance of retail sales and distinguish them from pyramid schemes. The most common are the "70 percent rule," where the company requires you to show that at least 70 percent of your prior month's order was sold to retail customers before you place a new inventory order and the "90 percent refund rule," where the company promises to refund you 90 percent of the purchase price on any products you can't sell. "These are good policies," says Brooks. "The problem is that nobody goes around to inspect whether a company is really following them." 

Buyer Beware

Visit consumer.ftc.gov/scam-alerts to check whether a company you're considering working with/for has been investigated by the Federal Trade Commission. Consumer-rights advocate Robert FitzPatrick also tracks ongoing litigation against MLMs at PyramidSchemeAlert.org. But remember: Just because a business isn't listed in one of these places, that doesn't mean it's not a scam.