This week we heard news of $20 million (hidden in a box spring) being seized by the federal agents in its ongoing investigation of TelexFree, a multi-level marketing company that the government says was a massive Ponzi scheme. You can read all about the TelexFree case on Patrick Pretty’s blog.
News reports about TeleFree refer to it as a Ponzi scheme (also called pyramid scheme). What isn’t mentioned anymore is the fact that it operated as a multi-level marketing company, just like Amway, Mary Kay, Herbalife, LuLaRoe, and hundreds of other companies you hear about on a daily basis. While it is NOW acnowledged that TelexFree was a Ponzi scheme, there was a time when it operated exactly as these other MLMs do.
According to the complaint affidavit, TelexFree, Inc., and TelexFree LLC (collectively, TelexFree) provided Voice over Internet Protocol (VoIP) telephone services, for which customers can sign up via a website maintained by TelexFree. It is alleged that TelexFree was actually a pyramid scheme, and that between January 2012 and March 2014, TelexFree purported to aggressively market its VoIP service by recruiting thousands of “promoters” to post ads for the product on the Internet. Each promoter was required to “buy in” to TelexFree at a certain price, after which they were compensated by TelexFree, under a complex compensation structure, on a weekly basis so long as they posted ads for TelexFree’s VoIP service on the Internet.
It is alleged that the ad-posting requirements were a meaningless exercise, in which promoters cut and pasted ads into various classified ad sites provided by TelexFree which were already saturated with ads posted by earlier participants. According to the affidavit, TelexFree derived only a fraction of its revenue from sales of VOIP service—less than 1 percent of TelexFree’s hundreds of millions of dollars in revenue over the last two years. The overwhelming majority of its revenue—the other roughly 99 percent—came from new people buying into the scheme. TelexFree was allegedly only able to pay the returns it had promised to its existing promoters by bringing in money from newly recruited promoters.
TelexFree (like other MLMs) maintained an air of legitimacy by purporting to sell a legitimate service, namely VOIP service. This is what other MLMs do in terms of selling makeup, vitamins, clothing, etc. This legitimate product or service makes the scheme legal under U.S. laws.
However, the catch is that the product is merely the cover. What these companies are REALLY selling is the opportunity. They are far more interested in the endless recruiting of new distributors/representatives into the scheme. THAT is where the money is, because actual retail sales to third party customers are so low. The money is in bringing in new distributors who make purchases of products and services, sometimes in large quantities in the beginning, other times in increments on a regular basis.
The companies cover themselves by saying that the representatives should not be buying the products unless they are selling them. But the truth is that the reps keep buying in order to maintain their status or get to the next “level” in the company, regardless of whether the products are being sold. (And most often the products are NOT being sold.)
The MLM companies have plausible deniability. They can say that the participants aren’t “buying into the scheme” or aren’t “paying to play” because they’re just paying for a product that they’re supposed to resell to a third party customer. But the companies know the truth. They know that the distributors are stockpiling products because they have no hope of actually retailing them.