Pyramid Legalization Act of 2016

A new bill is making its way through Congress, and it’s titled “Anti-Pyramid Promotional Scheme Act of 2016.” What’s it all about? It is an attempt by the Direct Selling Association and multi-level marketing companies to make sure that their pyramid schemes are never shut down. It is a bunch of fluff that is designed to look like it protects consumers, while the bill is really protection for MLMs. It makes inventory loading (getting recruits to buy inventory to “qualify” for commissions, regardless of the fact that they will likely never be able to sell that inventory) perfectly legal under basically all circumstances.

Attorney Douglas Brooks has analyzed the bill and dubs it the “Pyramid Legalization Act of 2016.” This is his analysis:

In the guise of an “anti-pyramid” bill, the proposed legislation would more accurately be called the “Pyramid Legalization Act of 2016.”   The bill would make it extremely difficult if not impossible to prosecute the most pernicious forms of deceptive multi-level marketing programs and product-based pyramid schemes.

The core substantive provision of the bill is the definition of “ultimate user”.   Under the FTC’s seminal Koscot decision it was clear that the rewards for distributors had to be funded from sales to persons who were not participants in the marketing plan.

The bill would reverse this requirement and permit rewards to be paid from sales to participants, subject only to the vague and unenforceable provision that the participants’ purchase “is not made solely for purposes of qualifying for increased compensation.”   This language would pose an insurmountable challenge to any enforcement action by the FTC, as it would require the agency to poll vast numbers of participants to ascertain whether their purchases were motivated “solely” or only partially for purposes of increasing compensation.

The bill’s definition of “pyramid promotional scheme”, while ostensibly based on Koscot, ignores the FTC’s more recent experience in prosecuting product-based pyramid schemes, in that it narrowly focuses on compensation derived from the participant’s “introduction of another person into the plan.”    The promoters of modern pyramid schemes have become much too sophisticated to be caught by this definition.   As the 2004 FTC Staff Advisory noted, “Modem pyramid schemes generally do not blatantly base commissions on the outright payment of fees, but instead try to disguise these payments to appear as if they are based on the sale of goods or services. The most common means employed to achieve this goal is to require a certain level of monthly purchases to qualify for commissions.

As I noted in a recent article in Seeking Alpha, the essential problem with most MLM programs is the use of such inventory purchase qualifications in their compensation plans.   Prohibition of such requirements would be the simplest method for distinguishing between legitimate MLM and pyramid schemes, and would not harm any program that is truly based on bona fide retail selling. See http://seekingalpha.com/article/3847676-multi-level-marketing-modest-proposal

There are other serious flaws with the proposed legislation, including the “inventory repurchase” provisions, which contain a wide range of loopholes based on terms such as “appropriate set-offs” and “legal claims.”   Perhaps the worst is the provision that exempts “inventory that has been clearly described as not subject to the plan or operation’s inventory repurchase program.” This exemption is so broad that it swallows the rule.

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