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(Professor of Internet & media law for MBA executives of Silicon Alley in lower Manhattan, and entertainment attorney, New York & the U.S. Federal Courts).
I. Multilevel Marketing/PyramidsSo called, "Multilevel Marketing" (MLM) has become a huge industry despite onerous Federal and state satutes designed to curtail "pyramid" activities and provide a consumer protective cocoon against, so-called, "Shady operators." Nikken (medical magnets), Shaklee (nutritional vitamins) and Amway (homelier products) are but a few of the hugely successfully door-to-door peddlers now doing multi-billion revenues. Moreover, MCI, Sprint and Collate Palmolive are but a few of the more "traditional" blue chip, major brands now employing MLM sales tactics. These multinationals can hardly be considered "shady."So, what is the difference? How is the start-up entrepreneur to weave a path through the maze of regulations to stay legal and not defined as a "pyramid?" A web of Federal and state anti-pyramid statutes are intended to make
up a comprehensive consumer MLM protection umbrella. These laws are designed
to protect individuals from being defrauded through illegitimate programs
which lure participants with the promise of easy money by compensating
them from the "buy-in" of additional participants rather than from legitimate
product sales. These "Distributorship" buy-in programs have been called
"Ponzi schemes," "airplane plans," "pyramids," "chain letters," and many
other names. Although known in the United States only during the twentieth
century, these schemes date back to Biblical times. Such programs have
cost their participants hundreds of millions of dollars. Federal and state
regulatory agencies have sought to proscribe such illegal activity in multiple
ways, including the use of anti-pyramid, mail fraud, business opportunity,
franchise, lottery, and securities laws
(Each of these areas of law
will be discussed in succeeding chapters).
Whether a program is a legitimate multilevel marketing plan or an "illegal" pyramid depends principally on: (1) the method by which and/or amount of products or services sold; and (2) the manner in which participants are compensated. Essentially, if a marketing plan compensates participants for sales by their "enrollees," "recruits," and/or their downline enrollees and recruits, that plan is multilevel and thereby qualifies for the "labyrinth" of regulatory over-sight. If a program compensates participants, directly or indirectly, merely for the introduction or enrollment of other participants into the program, it is a pyramid. But generalities are sophomoric; and, each program must be evaluated by their facts and method of operation (the, "MO"). Return to Top of Page A. Legislative Intent and Judicial InterpretationAs a practical matter, it is impossible for legislators to anticipate the infinite creativity of promoters and individuals who devise, implement, and promote such legal or illegal enterprises. Accordingly, anti-pyramid and multilevel statutes, like most consumer protection legislation, are drafted and interpreted very broadly so that they might encompass all of the possible permutations of an illegitimate scheme, and thus have a jurisdictional basis for regulating them. It is a broad "long-arm" statue approach that seeks to cast a wide net on operators.The analysis used by regulators to evaluate multilevel marketing programs
is essentially two-fold. The first of the two foci ("focuses" if you are
from Idaho) involve a review of the theoretical or conceptual design of
the compensation plan. More precisely stated, does the compensation plan,
as written, appear to compensate participants: (1) merely for the introduction
of additional participants into the program; or (2) for the sale of goods
or services to "end consumers." If it does the former, it constitutes the
most classic example of a pyramid. If it does the latter, it may pass through
the first prong of the analysis. Suffice it to say that the vast majority
of new MLM companies do not run afoul of this first predicate hurdle. Historically,
they, as well as many existing companies, have had problems with the second
component of the analysis.
The second aspect of the analysis involves the "operational analysis" of the compensation plan. Notwithstanding the conceptual or theoretical design of the plan, the law asks: "what in fact do distributors spend their time doing?" More precisely stated, in actual operation, what type of activity does the compensation plan "incent" -- the recruitment of additional distributors or actual sales. As discussed below, despite the sale of products or services by distributors, the compensation plan can nevertheless constitute a pyramid scheme, even with enormous product sales. The operational analysis involves factual and subjective determinations. Over the decades, courts have developed a litany of factors by which they evaluate compensation programs. The definitive (and amorphous) test is, "what is the emphasis of the program?" If the emphasis of an MLM program is on recruiting (rather than product or service sales), it will be designated a pyramid. While none of us has a crystal ball by which we can divine the future operation of an MLM program, having reviewed countless plans, regulators have developed substantial prognosticating skills. Only the lack of government funding and manpower have curtailed regulators in recent years from going after many obvious violators. Generally, consumer outcry, press or a civil case brings in regulatory police action. MLM companies are therefore well advised that "staying legal" requires much more than merely developing a program that meets state and federal requirements and definitions. Rather, it must be an ongoing "dynamic" process of continual vigilance, good PR and consumer relations together with managerial oversight actions that ensure that distributors stay within, not merely, the rule of law, but also the intended spirit of the law. It will be interesting to see how the regulatory agencies deal with
this ever expanding body of law as this ever expanding area of commerce
develops and as MLM programs prolitherate on the Internet across state
and national jurisdictions. To assist in developing MLM programs
online, we are developing a non-exaustive list of suggested criteria (available
upon request). However, a little knowledge can be dangerous and this article
is not intended to substitute for close direction with your attorney and
other advisers.
B. Is Your Program Multilevel?Multilevel marketing companies must guard against being classified as a pyramid on both the state and federal levels by putting in place protective procedures. The majority of states statutorily regulate multilevel, or more precisely anti-pyramid, activity. Federal regulation, on the other hand, is primarily a function of administrative and judicial decisions arising from a series of private party civil actions together with a 'Web' of Federal Trade Commission litigation and rulings.A common misconception in the MLM industry is that the "down-line" number of sales people must be limited to merely a few levels of distributors; and, this distinction will save them from being defined as a pyramid. This is a prime example of how a little knowledge can be very dangerous, indeed. This misconception may have evolved from the Glenn Turner cases of the mid-1970's, a pyramid promoter whose "Dare To Be Great" program ran afoul of the law in several states bringing on some of the very first protective legislation in this area. These early statutes sought to limit the number of layers down, based upon a Ponzi scheme philosophy, I suppose. Ponzi was a promoter at the turn of the century who devised a scheme whereby he would pay out an enormous return on your investment by merely using new money coming in from new investors to pay earlier investors; thus, "Ponzi Scheme" entered the vernacular to mean an illusionary investment program whereby new money pays off old money (early investors), like a chain letter. In theory, this could go on to infinity, incorporating everyone on the planet, or in Ponzi's case, all of his fellow Italians in his neighborhood. Of course, eventually, there was nobody left in the neighborhood to invest and the scheme collapsed. State regulators sought to limit the number of levels down so as to avoid the Ponzi characteristics in the early regulations that followed the Glenn Turner MLM investigations. However, the law has developed considerably since the 1970's. Even two or three levels could now be viewed as an illegal pyramid. 1. State Statutory ApproachesAs regards pyramids and multilevel marketing plans, state statutes have taken two distinct approaches. A sophisticated minority of state laws "specifically define" and regulate multilevel marketing plans. These states include Georgia, Louisiana, Maryland, Massachusetts, Puerto Rico, and Wyoming.Georgia's statute provides a typical definition of a multilevel marketing company: Return to Top of Page "Multilevel distribution company" means any person, firm, corporation, or other business entity which sells, distributes, or supplies for a valuable consideration goods or services through independent agents, contractors, or distributors at different levels wherein such participants may recruit other participants and wherein commissions, cross-commissions, bonuses, refunds, discounts, dividends, or other considerations in the program are or may be paid as a result of the sale of such goods or services or the recruitment, actions, or performances of additional participants.(1)The definitions of a multilevel company or multilevel marketing plan in the other states that specifically define multilevel marketing are identical or very similar to Georgia's. Broken into individual components, the elements that must be met to
establish a multilevel company or multilevel marketing plan include: Return
to Top of Page
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