What is a Pyramid Scheme?

By:   Lynn M. McKeel, Fall 2017 IAC Student Intern

Knowing the difference between a legitimate MLM and a Pyramid Scheme could save you thousands of dollars. Vigilance will not only help you make sound business decisions but it could help save your reputation and relationships. Please use your best judgment and consult an attorney before signing any documents. When considering the factors described below, consider all conversations with recruiters, representatives, or consultants. An illegal business operation is not going to come out and introduce themselves as a pyramid scheme. In this dog eat dog world, you must look at all proposals with a critical eye and not be afraid to ask direct questions. Remember, although it may be difficult to ask such direct questions, it will be much harder to broach the subject after you’ve signed a contract and spent thousands of dollars in initial buy-in costs.

When discussing the following aspects with your recruiter/consultant it is always best to take notes for your own records.

In its most basic definition, a pyramid scheme relies exclusively on the recruitment of new consultants to make money. The documentary “Betting on Zero” describes the differences between a pyramid scheme and a legitimate MLM. Undercover video footage shows some of the tactics described below. If you are currently involved in a business model described below or you are considering buying into a model described below, please refer to FINRA, the SEC, the FTC, or an attorney for guidance moving forward.

A pyramid scheme will exhibit the following characteristics:

  • No Genuine Product or Service. MLM programs involve selling a genuine product or service to people who are not in the program. Be wary if no underlying product or service is being sold to others. The product should be tangible. Avoid speculative or inappropriately priced goods.
  • Emphasis on Recruiting. If a program primarily focuses on recruiting others to join the program for a fee, be careful. Be skeptical if you will receive more compensation for recruiting others than for product sales. If a recruiter tells you the “real money” is in growing your downline or to spend less time selling products and more time recruiting others you may be involved in a pyramid scheme.
  • Buy-in Required. The goal of an MLM program is to sell products. Be careful if you are required to pay a buy-in to participate in the program, even if the buy-in is a nominal one-time or recurring fee (e.g. $10 or $10/month).
  • Promises of High Returns in a Short Time Period. Look out for pitches of exponential returns and “get rich quick” claims. High returns and fast cash in an MLM program may suggest that commissions are being paid out of money from new recruits rather than revenue generated by product sales.
  • Easy Money or Passive Income. Be skeptical if you are offered compensation in exchange for little work such as making payments, recruiting others, and placing advertisements.
  • No Demonstrated Revenue from Retail Sales. Ask to see documents such as financial statements audited by a certified public accountant (CPA), showing that the MLM company generated revenue from selling its products or services to people outside the program. Some states, such as Georgia, require the production of a disclosure statement containing this information prior to entering any contract.
  • Complex Commission Structure. Be concerned unless commissions are based on products or services that you or your recruits sell to people outside the program. If you do not understand how you will be compensated, be cautious.

Sadly, some of the most prevalent pyramid schemes posing as MLMs target Spanish-speaking and immigrant communities. But if you are not a part of this demographic, don’t let down your guard. Communities with high concentrations of stay at home spouses and single income households are also vulnerable to the grips of pyramid schemes. Consider Utah for example. Utah has the highest rate of stay at home moms in the country and their leading industry, second only to tourism, is direct sales. Utah has the highest concentration of MLMs in the country, making its citizens exceedingly vulnerable to pyramid schemes and unsustainable MLM ventures.

If you believe you have been defrauded by a pyramid scheme, please consider filing a complaint with the SEC.