Multi-Level Marketing, America’s Largest – and Least Investigated – Consumer Fraud

On September 27, 2006 Robert L. FitzPatrick delivered a one-hour presentation at the 7th Annual Fraud Conference of the Association of Certified Fraud Specialists in San Francisco. ACFS is a professional organization of attorneys, private investigators, forensic accountants, corporate loss management and audit managers and federal and state regulators. The following essay is based on his presentation and on meetings and conversations with the conference attendees

The 7th Annual Fraud Conference of ACFS offered a stark picture of the status of fraud in American and globally. The theft of data and identities has grown into a worldwide industry with document forgers, phishers, hackers, and fake credit card makers. Globalization of business and digitization of data have dramatically increased fraud opportunities. A toxic combination of low paid, disaffected workers handling increasingly valuable data on millions of private citizens results in a growing incidence of fraud. Justifying fraud against huge and insensitive corporations is increasingly easy for otherwise honest people.

Multi-level marketing is an integral part of this new culture of fraud. The chances of being defrauded by an MLM are far greater than having your identity stolen, yet the professionals in fraud prevention largely overlook the insidious fraud of pyramid selling schemes. At present, our Federal Trade Commission, whose recent chairman was an attorney representing the Amway Corporation, has turned a blind eye to pyramid selling schemes in the marketplace. The FTC has prosecuted about 20 pyramid selling schemes and has developed well defined criteria of distinguishing pyramid scams from legitimate direct selling companies. These criteria primarily concern the level of retail selling carried out by the companies’ sales agents as opposed to an emphasis on recruiting an ever-expanding number of “sales” agents.

But since 2000, the FTC has effectively declared a moratorium on investigating and prosecuting pyramid selling scams. With the FTC not enforcing the law, few state Attorney General offices will take on these national or international schemes. Predictably the number of “non-retailing” recruitment scams has multiplied. Safe from prosecution in the US, many now are aggressively setting up operations in poorer countries, claiming they are the best that America has to offer in “free enterprise” and “business ownership” opportunities.

Pyramid Selling Scams vs. Direct Selling

Pyramid selling scams are actually much closer to the classic definition of fraud than identity theft, which is now more akin to common thievery. Identity data is a new commodity and has much greater value than many other tangible items that were historically targets of theft. In many instances data theft is little more than a new form of shoplifting or burglary. And the manipulators of this stolen data are analogous to traditional fencers of stolen merchandise.

MLM, however, employs sophisticated deception and diversion. It seeks to operate openly in the legitimate marketplace, posing as “direct selling.” But the hallmark of the scam is the absence of direct selling. Virtually none of the products is ever sold to retail customers. Instead, products are sold as part of a business propositions to new “distributors.” Each “distributor’s” investment constitutes the “consideration” paid for the right to recruit other investors. And the commissions they receive are rewards derived directly from the investments of new recruits. The only way to gain a profit is to enroll another investor. The products that the schemes sell serve to disguise the pyramid structure and to launder the classic pyramid scheme transactions.

Far from a direct selling company operating in an open market, the MLM is a closed system with fixed prices and a built-in ratio of losers to winners. 99% will always lose in this closed system. This is known and understood by the perpetrators from the day the scheme opens its doors. Yet, they will promote it as the “greatest opportunity in the world” and the “chance of a lifetime.”

In the disguise of “direct selling” companies that offer cosmetics, soap, long distance phone services or vitamins and food supplements, the MLM appears to many people as a business much like any other. In reality, as practiced by the vast majority of MLM companies, MLM is a classic “sting” operation. The victims not only give over their own money to the scheme but are persuaded also to aid in luring others, usually their own friends and family.

MLMs Designed to Inflict Financial Harm

The MLM business model is elegantly designed to inflict financial harm on thousands of people and to enrich only the top promoters of the scheme. The model consists of a pyramid hierarchy in which top positions are gained though “endless chain” recruiting.

Profitable income is available only to those who recruit large numbers below them. Basic math shows that this could only be achieved by a fraction of one percent. The income plan is a complicated formula of commissions that richly reward those at the very top while giving little to those at the bottom, a reverse of the commission formula used by legitimate direct selling companies.

Surrounding the inherently fraudulent business model is a web of deceptions and diversions to prevent the consumers from grasping the true nature of the scam. Religion or religious references are regularly employed as diversions or to stave off suspicion. Victims are told to focus on their goals and dreams rather than doing due diligence. Family and social networks s are utilized to spread the scheme in which trust and even love are leveraged and commercialized. Some people have noted the classic techniques of brain washing and cult practices in MLM operations. These include strict hierarchies, authoritarianism, censorships, restrictions on relationships, constant bombardment with propaganda, and a continuous breakdown of the individual in favor of the “team.”

Most important, the scheme convinces new recruits that “success is up to you” and “if you fail, it will only be your own fault.” The “system” is presented as fool proof if followed precisely. All failures – and 99% will always fail – are falsely attributed to weakness, lack of confidence or ambition or “negativity” on the part of the individuals. Hence the scam is seldom examined even after the victim quits the scam. 50-75% quit within one year and 95% will have quit within several years. These countless victims bear their losses in silence and shame.

Facing the prospect of shameful failure, many can be lured into further losses by “top gun” promoters who sell proprietary “success tools” to the new recruits. Often the sales of these items are carried out with a parallel system of pyramid rewards, constituting a pyramid within the pyramid and inflicting additional losses on the recruits.

The Endless Chain, a Fraudulent Proposition

At the heart of all these scams is the promise of income derived from the “endless chain.” This is a fraudulent proposition in the same league with the “bait and switch” and the stolen identity. It is a mirage, a delusion, a lie. In the past, the endless chain proposition was viewed as a per se fraud and was routinely prosecuted. Now, in the guise of “direct selling” companies that employ PR companies, top law firms and make large political contributions, endless chain recruitment schemes are currently treated as legitimate. Most enjoy full immunity from prosecution.

The MLM fraud is carried out on a vast scale. Even the lesser known MLM schemes can enroll hundreds of thousands over the course of several years. They operate globally by adapting the false promises to each country and using local perpetrators who are positioned at the “top” in their respective territories.

Just as the public is ill-equipped or prepared for the risks and perils of identity theft, most people are peculiarly vulnerable to MLM fraud. Its promises of financial freedom, early retirement, low initial investment and its claims that large numbers of people earn significant income find an eager audience. High levels of credit card debt, job insecurity, rising costs of healthcare and education, globalization and the pressure of new technology weigh heavily on everyone. The offer of the “world’s greatest opportunity” and a “new system” resonate strongly.

Lack of Law Enforcement by FTC Equates to Government Endorsement of Fraud

But as seductive as the claims are and as vulnerable as most people are, other factors are equally important in enabling MLM scams to impoverish millions of people each year. These other factors involve law enforcement, government regulation and consumer protection.

1. MLMs are not required to report, monitor or disclose retail activity, the key factor that delineates legitimate direct selling from pyramid recruitment scams. Without any monitoring requirement, the fiction of “direct selling” can be maintained by unscrupulous recruitment scams.

2. MLMs can solicit investments and sell distributorships without informing the investors about historical failure rates, average losses, costs or payout distribution. The fiction of “individual” failure can therefore be maintained. Many people who “fail” are left with the haunting thought that they are “losers.” They do not understand that virtually everyone loses in the MLM system. This is the way the scheme is designed and the so called winners have only gained the money of the losers through deception.

3. Without retail sales or any other financial data disclosures, pyramid schemes can operate openly until the government “proves” fraud, a costly and time-consuming endeavor for regulatory agencies facing staff cut-backs and other priorities.

4. Huge campaign contributions have provided political protection to the largest pyramid selling schemes. This protection serves as a legal umbrella for all types of pyramid schemes to flourish without prosecution. Immunity for some becomes impunity for most. Lack of law enforcement becomes government endorsement.

MLM Fraud, a Part of Everyday Life Now

The deceptive solicitations of MLM promoters are now a staple of daily life. Who has not been solicited? Who has not had a close friend of relative involved, at least briefly, in one of these schemes?

The losses to consumers are in the tens of billions each year. Perhaps even more costly is the damage to personal, family and community life. Pyramid Scheme Alert receives reports each week of divorces, bankruptcies, loss of credit, repossessions, disruption of family or friendships, church congregations divided, and anger and retribution in small towns or in the workplace – all due to the insidious spread of MLM recruitment fraud.

Public education is crucial, yes, but the public cannot be expected to avoid these calculated, well funded and sophisticated frauds without support. Fraud specialists in government and in Corporate America are critical to ending the current epidemic of pyramid selling scams.

Fraud Specialists are needed to uncover and reveal the fraud behind the disguises;
to confront the fraud when it insinuates itself at the table of legitimate power; to hold legislators accountable for enacting and enforcing laws against pyramid fraud; and to uphold the values of fair and transparent business that pyramid scheme fraud negates with its predatory and deceptive practices.
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