Is every multi-level marketing company a pyramid scheme?

No. “Not all MLM businesses are illegal pyramid schemes,” and a court decides by looking at how the business operates in practice. The FTC’s pyramid claim against Neora failed on a record where roughly 80% of sales were to end users and the remainder, about 20%, were to brand partners.

Does having a real product, or making some retail sales, protect a company?

Not by itself. A pyramid scheme “cannot save itself simply by pointing to the fact that it makes some retail sales.” A valuable product does not change the result either, because “simply because a MLM’s product has value does not render an unlawful pyramid scheme lawful.”

Does it matter if participants buy product for their own use?

It matters, but it does not settle the question. FTC staff guidance, described in the Neora findings, said that product bought and consumed to satisfy genuine personal demand “is not in itself indicative of a problematic MLM compensation structure,” and that the analysis instead “involves a comprehensive analysis of a variety of factors.” That guidance is not legally binding. The point also cuts the other way: “evidence that distributors purchase and consume product for the purpose of qualifying for recruitment incentives is evidence of a pyramid scheme.”

Do “not guaranteed” or “results may vary” disclaimers protect a promoter?

Not when the overall impression is still that substantial income is realistic. In the SBH matter the court held that “saying that income is not ‘guaranteed’ does not detract from the net impression that affiliates could ‘reasonably expect’ financial freedom by following Defendants’ instructions.” The same court found that the defendants’ “occasional use of disclaimers did not alter the net impression created by these and other income representations.”

Is a written 70% rule or buy-back policy enough to avoid pyramid status?

Only if the company actually enforces it, because courts weigh whether policies against inventory loading are effectively enforced. In the SBH matter, the court counted it against the company that it “failed to track retail sales by affiliates and made little effort to create the sort of safeguards against inventory-loading that other MLMs often utilize.”

Does a pyramid scheme have to involve a product, and do state definitions differ?

Not always. The FTC’s BINT complaint called a chain-referral scheme “a type of pyramid scheme that does not typically involve the sale of products or services.” State statutes can also define the term in their own words. The Arkansas provision quoted in that complaint covers any plan through which a person gives consideration for the opportunity to receive compensation primarily from introducing other persons rather than from the sale and consumption of goods, services, or intangible property.

Is there a bright-line test for when an MLM becomes a pyramid scheme?

No. The FTC has said that “determining whether an MLM is a pyramid scheme requires a fact-intensive, case-by-case analysis.” For that reason the Commission said it “will continue to challenge unfair or deceptive practices in the MLM industry through Section 5 of the FTC Act” rather than through the Business Opportunity Rule. The courts have not filled the gap with a sharper line. In the Neora fee decision, the court noted that apart from the two-part test, “no authority binding on this Court has defined an ‘illegal pyramid scheme’ or provided clear guidance to ‘separate[] illegal pyramid schemes from legitimate multilevel marketing programs.’”

OpportunityLegal test

Pyramid scheme

Berkeley Robinson, Managing Attorney at Robinson Law Firm PLLC

Author

Berkeley Robinson, Esq.

Managing Attorney, Robinson Law Firm PLLC

Berkeley has served as the go-to counsel for many scaling businesses in a transactional and litigation management capacity. Before becoming an attorney, Berkeley grew sales teams, ran online marketing campaigns, and did everything else an entrepreneur does—and still does today as the founder of two online businesses.

Definition

“Pyramid scheme” is used in more than one setting, and its meaning depends on the context. In consumer protection, a pyramid scheme is a scheme characterized by the payment by participants of money to the company in return for which they receive (1) the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate users. Source: FTC v. Neora LLC, Findings of Fact and Conclusions of Law (quoting In re Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975)) Satisfaction of the second part “is the sine qua non of a pyramid scheme.” Source: FTC v. Noland, Order Granting FTC's Motion for a Preliminary Injunction (D. Ariz.)

Key legal rules

Because a pyramid scheme claim is judged under Section 5 of the FTC Act, five rules decide whether a plan crosses the line and whether the pitch for it is lawful:

Operating a pyramid scheme is an unfair or deceptive act or practice under Section 5(a) of the FTC Act—including where rewards are largely for recruitment rather than product sales, or where a multi-level compensation system is funded primarily by payments made for the right to participate. Source: FTC v. Neora LLC, Findings of Fact and Conclusions of Law (quoting In re Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975))
The first part of the test “can be satisfied by a required purchase to become [an affiliate]” or a “required purchase of non-returnable inventory to receive the full benefits of the program.” Source: Order, Lead Action and Contempt Action (Part 9/14)
Not all MLM businesses are illegal pyramid schemes; a court must look at how the business operates in practice, including whether the company has promulgated and effectively enforced policies to prevent inventory loading. Source: FTC v. BurnLounge, Inc., 753 F.3d 878 (9th Cir. 2014)
An income representation is deceptive under Section 5(a) if it is likely to mislead customers acting reasonably under the circumstances and is material; failing to disclose that a program’s structure ensures the vast majority of consumers cannot achieve substantial income is a deceptive material omission, and a “results may vary” disclaimer does not cure a claim when consumers may reasonably take unusual earning potential as typical. Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), Order
Those who supply recruiting materials containing false claims are liable too: “[t]hose who put into the hands of others the means by which they may mislead the public, are themselves guilty of a violation” of Section 5(a). Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), Order

For the sake of space, this page lists only the primary rules related to this term that most businesses should follow. More may apply to your situation, and your unique facts affect how they apply.

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Why these rules exist

Pyramid schemes are unlawful because their structure, rather than any single statement, leaves most participants with a loss. Participants can make money only if there are participants below them, the pool of possible recruits eventually runs out, and the people at the bottom, who are the vast majority, lose money because no one is left beneath them. Source: FTC v. Global Assistance Network for Charities, Complaint Courts have put the consequence in terms of fraud: “Pyramid schemes are said to be inherently fraudulent because they must eventually collapse.” Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), Order

The second part of the test is decisive because it “tends to induce participants to focus on the recruitment side of the business at the expense of their retail marketing efforts, making it unlikely that meaningful opportunities for retail sales will occur.” Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), Order Because a plan’s written terms can say one thing while its rewards do another, courts “look beyond a company’s policies and procedures and examine how the company operates in practice.” Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), Order

Enforcement examples

FTC v. BurnLounge, Inc. (online music store sold through recruited “Moguls”)

FTC v. BurnLounge, Inc., Opinion of the Ninth Circuit Court of Appeals Affirming Judgment of the United States District Court for the Central District of California

The FTC filed its complaint in BurnLounge on June 6, 2007, alleging that the defendants promoted an illegal pyramid scheme, misrepresented that participants were likely to make substantial income, and failed to disclose that most participants were not likely to do so. Source: FTC v. BurnLounge, Inc., Brief of the Federal Trade Commission (9th Cir.), Statement of the CaseParticipants joined by buying packages that included a BurnPage and merchandise, and they earned rewards by recruiting new participants to buy packages. Source: FTC v. BurnLounge, Inc., 753 F.3d 878 (9th Cir. 2014)After a bench trial, the district court found a 93.84% failure rate for Moguls, meaning that 93.84% of them never recouped their investment. Source: FTC v. BurnLounge, Inc., 753 F.3d 878 (9th Cir. 2014)

Outcome. The Ninth Circuit held that the district court’s “conclusion that BurnLounge was an illegal pyramid scheme was amply supported by the evidence.” Source: FTC v. BurnLounge, Inc., 753 F.3d 878 (9th Cir. 2014)The final judgment ran against BurnLounge and its founder, jointly and severally, for $16,245,799.70 to reimburse injured consumers. Source: Final Judgment and Order for Permanent Injunction and Other Equitable Relief Against Defendants BurnLounge, Inc., Juan Alexander Arnold, John Taylor and Rob DeBoer, § IVOn appeal, the court of appeals agreed with most of the calculation but remanded part of the award against the company for clarification. Source: FTC v. BurnLounge, Inc., Nos. 12-55926, 12-56197, 12-56228 (9th Cir.) (memorandum)

FTC v. Vemma Nutrition Co. (nutrition and energy drinks sold through “Affiliates”)

FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), Order

Vemma’s policies did not require a purchase to become an Affiliate, but in practice the company strongly encouraged a $600 Affiliate Pack on which bonus eligibility was contingent, plus $150 monthly auto-delivery to keep bonuses. Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), OrderThe company’s own records showed that about 86% of its U.S. product sales in 2013 went to Affiliates, and about 71% in 2014. Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), OrderIts stated 70% rule was audited by contacting 15 of more than 90,000 Affiliates a month, and the Receiver found that Vemma had never disciplined an Affiliate for failing to certify. Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), Order

Outcome. In ruling on the preliminary injunction, the court found that the evidence “leaves little doubt that the FTC will ultimately succeed on the merits in demonstrating that Vemma is operating a pyramid scheme.” Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), OrderIt did deny the FTC’s request for a preliminary injunction on the pyramid claim against one top Affiliate, Mr. Alkazin. Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), Order

FTC v. Noland (Success By Health coffee and supplements, and VOZ Travel)

FTC v. Noland, Order (May 11, 2023)

In the Success By Health (SBH) plan, each form of compensation other than a first phase that paid nothing required recruiting, though not sales to ultimate users, to earn any meaningful money. Source: FTC v. Noland, Order (May 11, 2023)The VOZ Travel program required enrollees to buy $1,000 to $2,795 “packs” to reach a travel platform that was never completed. Source: FTC v. Noland, Order (May 11, 2023)When the receiver reopened sales without the commission structure, SBH product sales fell by nearly 95%. Source: FTC v. Noland, Order (May 11, 2023)

Outcome. The court had already granted summary judgment against VOZ Travel, and after a bench trial it concluded that “the FTC should also prevail on its pyramid scheme claim as to SBH.” Source: Order, Lead Action and Contempt Action (Part 9/14)A bar on participating in multi-level marketing was warranted, the court found, because the defendants “have shown themselves to be utterly incapable of operating an MLM business in a lawful manner.” Source: FTC v. Noland, Order (May 11, 2023)The court was unwilling, however, to extend the bar to business coaching. Source: FTC v. Noland, Order (May 11, 2023)

FTC v. Trek Alliance, Inc. (direct-selling program with a “Trek Pay Plan”)

Complaint - Trek Alliance; Trek Alliance, et al: Stipulated Final Order for Permanent Injunction and Other Equitable Relief Against Defendant Harry Flagg

The Trek complaint alleged that representatives bought at least $2,000 of product to raise their potential compensation, because they were led to believe they were unlikely to earn substantial pay unless they bought enough to reach the rank of Field Representative or Supervisor. Source: FTC v. Trek Alliance, Inc., ComplaintTrek had a 70% rule, a six-receipt rule, and a buy-back policy meant to prevent inventory loading, but the complaint alleged that these policies were “routinely disregarded and are not adequately enforced.” Source: FTC v. Trek Alliance, Inc., Complaint

Outcome. The stipulated order against Harry Flagg recites that he disputes liability and that there has been no final adjudication on whether he participated in any illegal pyramid scheme. Source: FTC v. Trek Alliance, Inc., CV-02-9270 (C.D. Cal.), Stipulated Final Order Against Defendant Harry FlaggThe order nonetheless prohibits him from engaging or participating in any Prohibited Marketing Program and requires him to pay $20,000 in equitable monetary relief. Source: FTC v. Trek Alliance, Inc., CV-02-9270 (C.D. Cal.), Stipulated Final Order Against Defendant Harry Flagg

FTC v. Neora LLC (multi-level marketing program)

Findings of Fact and Conclusions of Law

Under Neora’s compensation plan, every reward beyond the first few required some recruitment element. Source: FTC v. Neora LLC, Findings of Fact and Conclusions of LawThe FTC’s pyramid theory nonetheless ran into a different record: the vast majority of Neora’s product sales went to customers who bought with no incentives tied to the compensation plan. Source: FTC v. Neora LLC, Findings of Fact and Conclusions of Law

Outcome. The court held that the fact “that 80% of revenues come from ultimate user sales weighs heavily against a finding that Neora focuses exclusively or almost exclusively on recruiting as opposed to sales.” Source: FTC v. Neora LLC, Findings of Fact and Conclusions of LawOn that basis it concluded that Neora “is not operating as an illegal pyramid scheme.” Source: FTC v. Neora LLC, Findings of Fact and Conclusions of Law

FTC v. Moore (chain-referral “blessing loom”)

Complaint for Permanent Injunction, Monetary Relief, and Other Relief

The BINT complaint described the program as “a chain-referral scheme, a type of pyramid scheme that does not typically involve the sale of products or services.” Source: Complaint for Permanent Injunction, Monetary Relief, and Other Relief (“Blessing Loom” Pyramid Schemes)It alleged that the defendants promised investment returns as high as 800 percent without tying the money members could earn to selling products. Source: Complaint for Permanent Injunction, Monetary Relief, and Other Relief (Defendants’ Business Activities)

Outcome. The complaint further alleged that BINT’s structure required perpetual, exponential growth, because for every member who received the promised payout, eight additional members had to pay into the scheme. Source: Complaint for Permanent Injunction, Monetary Relief, and Other Relief (Defendants’ Business Activities)

Exposure

A pyramid-scheme case can freeze a business before any final ruling. In the Vemma matter, the court entered a temporary restraining order that appointed a receiver over the company and froze the assets of Vemma and Mr. Boreyko. Source: FTC v. Vemma Nutrition Co., No. CV-15-01578-PHX-JJT (D. Ariz.), Order In the SBH matter the early orders likewise produced a receiver to operate SBH and an asset freeze. Source: FTC v. Noland, Order (May 11, 2023)

Money judgments in these matters have been large. A proposed stipulated order against Vemma would enter judgment of $238,000,000 jointly and severally as equitable monetary relief. Source: [Proposed] Stipulated Order for Permanent Injunction and Monetary Judgment Against Vemma Nutrition Company, Vemma International Holdings, Inc., and Benson K. Boreyko, § VII The remainder would be suspended once the required payments and asset transfers were made. Source: [Proposed] Stipulated Order for Permanent Injunction and Monetary Judgment Against Vemma Nutrition Company, Vemma International Holdings, Inc., and Benson K. Boreyko, § VIIAdvoCare International and its former chief executive officer agreed to pay $150 million and be banned from the multi-level marketing business, according to the FTC’s case summary. Source: AdvoCare International, L.P., Case Summary (E.D. Tex.)In BurnLounge, the Ninth Circuit held that the district court did not abuse its discretion by holding the company’s founder jointly and severally liable with the company for the total amount of consumer harm. Source: FTC v. BurnLounge, Inc., Nos. 12-55926, 12-56197, 12-56228 (9th Cir.) (memorandum)

The route to money has narrowed since those judgments. In April 2021 the Supreme Court held in AMG Capital that the FTC may not obtain “equitable monetary relief such as restitution or disgorgement” under § 13(b) of the FTC Act. Source: FTC v. Noland, Order (May 11, 2023) In the SBH matter the FTC accordingly sought money only on its rules-based claims, not on its pyramid-scheme and false-statements claims. Source: FTC v. Noland, Order (May 11, 2023)The same court nonetheless imposed a $7,306,873.14 compensatory civil sanction in a separate contempt action, owed jointly and severally by the contempt defendants. Source: FTC v. Noland, Order (May 11, 2023)

Orders also bar people from the industry. The AdvoCare order permanently enjoins the settling defendants from engaging in, participating in, or assisting others with any Multi-Level Marketing Program, including any product- or service-based pyramid scheme. Source: AdvoCare International, L.P.: Stipulated Order for Permanent Injunction Against Defendants AdvoCare International, L.P. and Brian Connolly (Oct. 9, 2019), § IA bar can reach participants as well as owners. Kale Flagg’s stipulated order, which recites that he disputes liability, lists serving as a distributor, compensation plan participant, or recruiter of any such program as prohibited. Source: Stipulated Final Order for Permanent Injunction and Other Equitable Relief Against Jeffrey Kale Flagg, § IIndividuals can also be reached for the company’s violations. In its summary-judgment memorandum in the Noland matter, the FTC argued that an individual is liable for a company’s violations of the FTC Act if the individual “had authority to control” the unlawful acts or “participated directly” in them. Source: FTC v. Noland, Plaintiff FTC’s Memorandum in Support of Motion for Summary Judgment as to Liability (Mar. 12, 2021)

State law runs alongside federal enforcement. The FTC and Kentucky complaint cited a Kentucky statute that “declares it unlawful for any person to establish, promote, operate, or participate in any pyramid distribution plan.” Source: Complaint for Permanent Injunction and Other Equitable Relief (FTC and Commonwealth of Kentucky), Counts V–VI It also quoted a provision under which the Attorney General, on a finding of willful violation, “may recover, on behalf of the Commonwealth, a civil penalty of not more than two thousand dollars ($2,000) per violation.” Source: Complaint for Permanent Injunction and Other Equitable Relief (FTC and Commonwealth of Kentucky), Counts V–VIThe Arkansas provision quoted in the BINT complaint is stated more simply: “It is unlawful to promote any pyramid promotional scheme.” Source: Complaint for Permanent Injunction, Monetary Relief, and Other Relief (quoting Ark. Code Ann. § 4-88-109)

FAQs

1.Findings of Fact and Conclusions of Law. FTC v. Neora LLC, Findings of Fact and Conclusions of Law (quoting In re Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975))
2.Order Granting FTC's Motion for a Preliminary Injunction. FTC v. Noland, Order Granting FTC's Motion for a Preliminary Injunction (D. Ariz.)
3.Findings of Fact and Conclusions of Law. FTC v. Neora LLC, Findings of Fact and Conclusions of Law (quoting In re Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975))See also Order. Order, Lead Action and Contempt Action (Part 9/14)See also Findings of Fact and Conclusions of Law. FTC v. Neora LLC, Findings of Fact and Conclusions of Law (quoting In re Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975))