By Fall 2020 Student Advisor Andrew Quillen
Multilevel Marketing companies (MLM), also called direct selling or network marketing, are businesses that create revenue by using a non-salaried workforce (“sellers”) to sell products or services directly to consumers.[i] The trick is that sellers generally pay a membership or recruitment fee, and they must purchase the inventory they will sell with their own funds. This upfront inventory-investment from sellers protects the MLMs profits but puts the seller at high risk of losing money in the venture. Further, this scheme ensures that most of the earnings MLMs realize only benefit very high-level employees in the business. The Consumer Awareness Institute (CAI) recognizes that MLMs “can be extremely harmful, causing huge losses for those who invest the most in the schemes.”[ii]
MLMs rope-in participants by appealing to the American dream of pulling one’s self up by the bootstraps to earn a solid income.[iii] While the offers of “unlimited income,” “being your own boss,” and “starting a business on the cheap with little training” are appealing, the high-investment cost and low to non-existent return earn these companies the labels “flawed, unfair, and deceptive.”[iv] MLM schemes often prey on veterans, military dependents, and even some active duty servicemembers by peddling false hopes of a consistent and mobile income flexible enough for a military lifestyle.[v]
How Does an MLM Work?
MLMs often involve the person-to-person sales of cosmetics, wellness products, or home decor items, typically sold through product parties by friends or family members.[vi] Many MLMs have become household names (e.g., Mary Kay, LuLaRoe, Herbalife, Pampered Chef, and Amway).[vii] They thrive on a growing pyramid of new recruits to be sellers, pushing recruitment fees and commission incomes up the pyramid to those above them.
Because MLM profits are pushed vertically, the real benefit for a participant comes from recruiting others to join. Each person a seller recruits supplements their own commission, building a pyramid-style income stream.[viii] This means the folks on the bottom make little to no income, while moving up the ladder (through recruiting others) is the only way to break even or earn a small income. For example, the CAI found that the top 200 Amway earners in Wisconsin earned a net income of minus $900 a year—the story in Utah was similar in 2004.[ix] Further, the Institute found that on average only “[a]pproximately two distributors … operated profitably out of 20,000 total.”
Folks at the top of the MLM are usually the only ones who make a decent income—MLMs often advertise this minority, top-level income to entice new sellers.[x] While the advertised income is appealing, getting to the top of the ladder is near-impossible because (1) MLMs present very high attrition rates for new sellers, (2) the sale-commissions often do not make up for the cost of purchasing stock for direct-sale, and (3) the flawed market practices the MLMs generally permeate.[xi]
Abuses and Risks
Many critics claim that “presenting [an] MLM as a ‘business opportunity’ or ‘income opportunity’ is a misrepresentation” and that the “flawed, unfair, and deceptive” practices of MLMs create “a systemic problem.”[xii] This is primarily due to the masking of the structural earning limitations for most sellers and recruits, and the false narrative of an uncompetitive market for sellers presented by the MLM.
MLMs present recruits and sellers with a flawed vision of the market; they assume an infinite and uncompetitive market.[xiii] Simply, this means an MLM’s profitability hinges on the theory that there are unlimited buyers out there, and the market is untouched by other sellers or products. This is inherently flawed. Many sellers find that potential buyers are not interested in their MLM products, and that they are not the only seller in the market. This is what makes MLMs inherently flawed, unfair, and deceptive.[xiv]
MLMs present structural limitation which suppress earnings and make profitability near-impossible for recruits and sellers. Because profits and commission fees travel disproportionately up the MLM pyramid, most recruits and sellers see little-to-no profit. Research by the CAI shows that 99% of recruits lose money because of high membership fees and the cost of seller-purchased products.[xv] Further, it found that in a selection of 350 MLMs, 100% of them were recruitment-driven and the “vast majority of commissions paid” going to a small groups of “top-of-the-pyramid promoters.”[xvi]
Are MLMs Legal?
MLMs’ legality is complicated by the fact they look and act similar to illegal pyramid schemes. The Federal Trade Commission (FTC) has held that a company may be an illegal pyramid scheme when participants pay “money to the company in return for […] (1) the right to sell a product and (2) the right to receive”—in return for recruiting other participants into the program—“rewards which are unrelated to sale of the product to ultimate users.”[xvii] Essentially, pyramid schemes “involve compensation for recruiting regardless of consumer sales. In such schemes, participants receive rewards for recruiting in the form of ‘headhunting fees’ or commissions on mandatory inventory purchases by the recruits known as ‘inventory loading.’”[xviii]
While pyramid schemes are illegal scams principally based on recruitment and investment, legal MLMs offer a product-focused approach for sellers along with recruitment.[xix] The primary difference between pyramid schemes and MLMs is based on the products they sell. If the company makes its income primarily from the sale of products to actual end-users, it is likely a legitimate MLM.[xx] If the company makes the majority of its revenue off of participation fees from new and continuing sellers, it may be a pyramid scheme. Because most MLMs require large capital investments from new sellers (i.e. participation fees and seller-purchased products) but also include product sales, it is sometimes difficult to separate them from a pyramid scheme. Despite the similarities between the two business styles, the FTC recognizes that pure MLMs are legal.[xxi] But, distinguishing between the two can be challenging for courts and attorneys, let alone a potential recruit or seller.
Many MLMs have been prosecuted for illegal activities, often reflective of pyramid schemes. For example, the FTC charged AdvoCare, a health and wellness MLM, as a pyramid scheme in October 2019;[xxii] it is also suing Neora, another health and wellness MLM.[xxiii] The FTC shut down 2xtreme Performance International[xxiv] and Equinox International in 2000, two notorious MLM-pyramid schemes.[xxv] And in January 2020, the FTC sued Success by Health, an instant coffee MLM.[xxvi] In addition to this selection of FTC suits, many MLMs settle private and public law suits every year,[xxvii] such as Herbalife’s huge $200 million settlement around 2016.[xxviii] These cases generally turn on “deceptive promises about how much money distributors will earn” as well as their predatory recruitment-focused practices.[xxix]
How MLMs Impact the Military
Since their growth in the 1960s, MLMs have presented “a systemic problem” in our society, generally preying on the unemployed, low-income individuals, veterans, and military dependents.[xxx] Through peddling claims of “flexible hours,” “high incomes,” and “being your own boss,” MLMs look particularly attractive to our service veterans and military dependents facing employment challenges.
Military spouses largely face high levels of unemployment or underemployment, despite generally having higher-levels of education than their civilian counterparts.[xxxi] While many spouses seek employment, the difficulties of military life—such as moving every three to four years, being stationed overseas, and deployments—make it challenging for dependent spouses to pursue jobs or careers while their spouse is on active duty.[xxxii] MLMs will intentionally target military spouses to benefit from the transience of military life.[xxxiii] This lifestyle opens the product and recruitment stream to new opportunities each time the family moves.[xxxiv] While the MLMs clearly benefit from military spouses, it is hard to say the reverse.
MLMs entice spouses with an opportunity to be flexibly employed while touting the prospect of making money. While MLMs feign to be the solution to the employment issues incumbent upon military spouses, they present the same risks and abuses outlined previously. Unfortunately, many military spouses fall victim to MLM schemes. As expected, these schemes cost the military household money and often cost the family many valuable relationships and friendships.[xxxv] Because MLM success rests on recruiting others to the company, many military spouse recruits burn bridges with friends and family in pursuit of their MLM’s mission.[xxxvi]
Veterans also make ripe targets for MLMs. For at least two-thirds of veterans, the transition from military to civilian life presents tremendous challenges.[xxxvii] They often cite “finding a job” as the greatest challenge in the transition; many struggle to transfer their skills to the civilian environment.[xxxviii] The employment challenges facing veterans make MLMs—who peddle the dream solution: no-skill requirements and ultimate independence—look like the perfect solution. Rather than being a solution, MLMs often make veterans’ situation worse by creating debt and pushing new sellers to fracture existing relationships.[xxxix] For an unemployed veteran, losing money and those who support you presents a grave threat to your success.
If someone comes offering a job where you can “be your own boss” and have “flexible, part-time work hours while making thousands,” it just might be too good to be true. These operations often take recruits’ money and time while giving back debt and ruined relationships. It is important that military families and veterans understand the risks associated with MLMs so they do not fall into the trap as many have before. When approached with an opportunity like this, do some investigation. Research the company and consult a financial advisor before diving in.
[i] Gregory Karp, The fine line between legitimate businesses and pyramid schemes, CHI. TRIB., Feb. 10, 2013, https://web.archive.org/web/20200809180345/https://www.chicagotribune.com/business/ct-xpm-2013-02-10-ct-biz-0210-herbalife-20130210-story.html.
[ii] Taylor, Jon M. “The Case (for and) against Multi-level Marketing.” Appendix A: The History of Pyramid Schemes and Multi-level Marketing, Consumer Awareness Institute, Jon M. Taylor (2011), accessed at https://www.ftc.gov/sites/default/files/documents/public_comments/trade-regulation-rule-disclosure-requirements-and-prohibitions-concerning-business-opportunities-ftc.r511993-00012%C2%A0/00012-57312.pdf.
[iii] Vincent G. Ella, Multi-Level or Pyramid Sales Systems: Fraud or Free Enterprise, 18 S.D. L. REV. 358 (1973).
[iv] Taylor, supra note 2; see Ella, supra note 3; see also Karp, supra note 1.
[v] Crispin Burke, The Truth About Multi-Level Marketing Businesses and How They Hurt Military Members, Task & Purpose, Jan. 29, 2018, https://taskandpurpose.com/career/truth-multi-level-marketing-businesses-hurt-military-members/
[vi] Karp, supra note 1.
[viii] Ella, supra note 3.
[ix] Taylor, infra note 12.
[xi] Id.; Taylor, supra note 2.
[xii] Taylor, supra note 2; Taylor, Jon M. “The Case (for and) against Multi-level Marketing.” Chapter 7: MLM’s Abysmal Numbers, Consumer Awareness Institute, Jon M. Taylor (2011), accessed at https://www.ftc.gov/sites/default/files/documents/public_comments/trade-regulation-rule-disclosure-requirements-and-prohibitions-concerning-business-opportunities-ftc.r511993-00008%C2%A0/00008-57281.pdf.
[xvii] In re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 166-167 (1975).
[xviii] In re Amway Corp., 93 F.T.C. 618, 97-98 (1979).
[xix] Fed. Trade Comm’n, Multi-Level Marketing Businesses and Pyramid Schemes, accessed on January 10, 2021 at https://www.consumer.ftc.gov/articles/0065-multi-level-marketing-businesses-and-pyramid-schemes.
[xx] See id.; see also Debra A. Valentine, International Monetary Funds Seminar on Current Legal Issues Affecting Central Banks: Pyramid Schemes. Federal Trade Commission (1998).
[xxi] See In re Amway Corp., 93 F.T.C. 618 (1979).
[xxii] Press Release, Fed. Trade Comm’n, Multi-Level Marketer AdvoCare Will Pay $150 Million To Settle FTC Charges it Operated an Illegal Pyramid Scheme (Oct. 2, 2019), https://www.ftc.gov/news-events/press-releases/2019/10/multi-level-marketer-advocare-will-pay-150-million-settle-ftc.
[xxiii] Press Release, Fed. Trade Comm’n, FTC Sues Multi-Level Marketer Neora, formerly known as Nerium, Alleging it Operates as an Illegal Pyramid Scheme (Nov. 1, 2019), https://www.ftc.gov/news-events/press-releases/2019/11/ftc-sues-multi-level-marketer-neora-formerly-known-nerium.
[xxiv] Press Release, Fed. Trade Comm’n, FTC Halts Pyramid Scheme (Apr. 10, 2000), https://www.ftc.gov/news-events/press-releases/2000/04/ftc-halts-pyramid-scheme.
[xxv] Press Release, Fed. Trade Comm’n, Equinox International Settles Case with FTC, Eight States Nearly $40 Million in Restitution for Alleged Pyramid Victims (Apr. 25, 2000), https://www.ftc.gov/news-events/press-releases/2000/04/equinox-international-settles-case-ftc-eight-states-nearly-40.
[xxvi] Press Release, Fed. Trade Comm’n, FTC Acts to Shut Down ‘Success by Health’ Instant Coffee Pyramid Scheme (Jan. 16, 2000), https://www.ftc.gov/news-events/press-releases/2020/01/ftc-acts-shut-down-success-health-instant-coffee-pyramid-scheme.
[xxvii] Lisette Voytko, Herbalife, Younique, LuLaRoe And Other MLMs Suddenly Under Fire, Forbes, Nov. 11, 2019, https://www.forbes.com/sites/lisettevoytko/2019/11/07/herbalife-younique-lularoe-and-other-mlms-suddenly-under-fire/?sh=280e3dd97db6.
[xxviii] Press Release, Fed. Trade Comm’n, Herbalife Will Restructure Its Multi-level Marketing Operations and Pay $200 Million For Consumer Redress to Settle FTC Charges (Jul. 15, 2018), https://www.ftc.gov/news-events/press-releases/2016/07/herbalife-will-restructure-its-multi-level-marketing-operations.
[xxix] Karp, supra note 1.
[xxx] Taylor, supra note 12; Ella, supra note 3.
[xxxi] Gonzalez, Gabriella C., et al., Evaluation of the Military Spouse Employment Partnership: Progress Report on First Stage of Analysis. Santa Monica, CA: RAND Corporation, 2015. https://www.rand.org/pubs/research_reports/RR1349.html.
[xxxii] Id.; see Burke, supra note 5.
[xxxiii] Michelle Black, Multi-Level Marketing and Military Families: How to Spot a Scam, Magnify Money, Nov. 11, 2019, https://www.magnifymoney.com/blog/news/multi-level-marketing-military-families/#popular
[xxxv] See Alexandra Mondalek, Why MLMs Are So Appealing to Military Spouses, May 29, 2018, https://www.racked.com/2018/5/29/17377706/multilevel-marketing-companies-military-spouse
[xxxvi] See Burke, supra note 5.
[xxxvii] Prudential Finance, Inc., Veterans’ Employment Challenges: Perceptions and experiences transitioning from military to civilian life, Sep. 4, 2012, 2018, https://eoa.oregonstate.edu/sites/eoa.oregonstate.edu/files/veterans_employment_challenges.pdf
[xxxix] See supra, “Abuses and Risks” section.