Pyramid schemes want immunity from the feds — here’s why

Recently the Direct Selling Association (DSA) proudly endorsed the Moolenaar amendment to the FY 2018 Financial Services and General Government Appropriations bill; regrettably, a truly anti-consumer protection amendment.

We should not be surprised, since in recent years the DSA has pivoted away from emphasizing retail sales to consumers, adopting the view that purchases by recruits pursuing an elusive business opportunity are sufficient.

First, consider the innocuous portrayal of the direct selling industry as one that provides “the ability to buy goods and services in the comfort of their own homes from friends, family members, and neighbors.”

{mosads}In the past two years a global US-based MLM company and DSA member settled with the Federal Trade Commission, agreeing to increase reporting, significantly restructuring its distributor model, seven years of monitoring, and a $200M penalty.

Vemma, once a fast-growing MLM company that targeted college students and recipient of a DSA award, agreed to FTC demands that radically changed its compensation structure. Both companies agreed to identify and track sales to non-distributor customers.

Vemma will not likely survive the court-imposed changes. Shifting from one hundred years of using distributors to sell to non-distributor customers, the DSA version of direct selling no longer includes those retail customers.

What the customers get told is yet another concern. Research by the non-profit TruthInAdvertising.org, “found that 97 percent of DSA member companies selling nutritional supplements have distributors marketing their products with illegal health claims.

Not only are distributors making dubious claims but TINA.org also documented DSA member companies making health claims that violate the law” — hardly the image of consumers safely buying from friends and family.

The DSA claim of “millions of [satisfied] direct sellers and their customers,” runs counter to many MLM company recruitment records in 10K reports and court cases.

The DSA claim of “income opportunities that afford them [participants] the same kind of freedom and flexibility they enjoy as consumers” also does not fit the data.

Information from two well-established MLM companies and DSA members show the average distributor makes the equivalent of working two hours per week at the federal minimum wage, not counting expenses incurred while selling, hardly income that brings “freedom and flexibility.”

More importantly, as near as we can tell, no MLM company tells current or potential recruits the percentage of top income earners that are the same people year in and year out. Little turnover at the top means only a few (if any) have a chance at life-altering income.

No federal law defines a pyramid scheme. But the DSA incorrectly asserts that what constitutes a pyramid scheme is not clear to “anyone.” Twenty years of successful FTC prosecutions have established a consistent set of principles endorsed by the courts, and apparently feared by the DSA.

The courts and FTC know what constitutes a pyramid scheme even if the DSA does not. Highlighted below, the Moolenaar amendment will define away established precedent for identifying an illegal pyramid scheme.

The DSA calls for clarity. But unlike the FTC and the courts, the DSA’s position muddies the waters. It proposes that direct selling does not require selling products primarily to people who are not distributors — a position that critically contradicts the Ninth Circuit decision in BurnLounge, the most recent fully litigated FTC pyramid scheme case.

The court upheld the district court’s finding that BurnLounge was an illegal pyramid scheme, and based its holding in large part on its finding that rewards to BurnLounge distributors were “not tied to consumer demand.”

Consistent with the DSA’s position, the Moolenaar amendment alters decades of established pyramid scheme case law in at least three ways:

1) sales to customers outside the distributor network are not required, while the courts and the FTC have previously determined such sales fundamental to the business model, 2) the sale of any product or service would protect even the most egregious compensation plan from prosecution, including those which by design ensure (as has previously happened) that more than 90 percent of participants lose their money and earn no income, and 3) the amendment relies on a product buy back policy as the basic protection, when in fact a distributor’s residual inventory may represent only a small portion of purchases that were made to remain “eligible” for those ever-elusive rewards.

In summary, the amendment will make behaviors previously ruled illegal by the courts now beyond the reach of the FTC. Consumers will suffer.

William W. Keep is the dean of the School of Business at The College of New Jersey. Peter J. Vander Nat, Ph.D., Senior Economist, Federal Trade Commission (Retired).

The views expressed by contributors are their own and are not the views of The Hill.