PYRAMID SCHEMES AND THE INTERNET: Resources to Counteract the Threat

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PYRAMID SCHEMES AND THE INTERNET Resources to
Counteract the Threat

• Jon M. Taylor, Ph.D., President,
• Consumer Awareness Institute
• and Director, Pyramid Scheme Alert
• an international web-based non-profit
  organization to expose and prevent pyramid scheme
  abuse world wide

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What is a pyramid scheme?

• Simply put, a pyramid scheme is a plan under
  which a person pays another person for the right
  to be paid primarily from the introduction of
  still other persons into the plan in an endless
  chain of recruitment, rather than from the sale
  of goods or services to consumers.

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What is a pyramid scheme? (continued)

• As an endless chain recruiting device, a pyramid
  scheme is an infinite program in a finite
  population. Some are actually mega-pyramids of
  pyramids on pyramids.

4
What is a pyramid scheme? (continued) Of
course, we are not talking about building
structures, but about people participating in a
program who are grouped in the shape of a
pyramid, with a few on the top and many on the
bottom.
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What is a pyramid scheme? (continued)

• Of course, many organizations are shaped like
  pyramids corporations, government
  organizations, sales organizations, etc.with a
  few people on the top and many on the bottom. In
  this presentation you will see how illegal
  pyramid schemes differ from more normal
  organizationsand how they exploit participants.

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Why are pyramid schemes illegal?

• A few at the top are enriched at the expense of a
  downline of investors at the bottom who are sold
  an opportunitywhich is actually a mathematical
  trick that defrauds participants of their
  investments.
• For example, for a chain letter in which each of
  five participants pays in 5 for five levels
• 5x525
• 25x5125
• 125x5725
• 725x53,625
• 3,625x518,125
• TOTAL 22,625 Sounds great! BUT

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Why are pyramid schemes illegal? (continued)

• Typically, the payoff is 0 for approximately 90
  of participants who are left at the bottom of the
  pyramid when it collapses or is shut down.
• In any pyramid scheme, the vast majority of
  participants will always be in a losing position
  at the bottom, regardless of how long it lasts.

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Why are pyramid schemes illegal? (continued)

• Pyramid schemes are promoted as money making
  opportunities, but are structured as an endless
  chain of recruitment without regard to market
  (de facto) saturation.
• Misrepresentation is always present, whether the
  scheme is promoted in person or over the
  Internet.
• It is impossible for their recruiters to meet
  their promises, except for a few Top of the
  Pyramid Promoters (TOPP's for short).

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Most common types of pyramid schemes

• Classic, 1-2-4-8 no-product pyramid schemes
• Internet report chains (variation of chain
  letters that were once common)
• Internet matrix marketingnew web-based MLMs
• Ponzi schemesrecruiting new investors to repay
  earlier investors in an endless chain
• Product-based pyramid schemes (recruiting
  MLM's)the most common and the most damaging

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PYRAMID SCHEMES on the web

• Many pyramid schemes are now using the Internet
  to help them entrap people.
• Most of the major pyramid schemes are based in
  the USA, and some product-based pyramid schemes
  recruit aggressively overseas.

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Classic 1-2-4-8 no-product pyramid
schemesgifting schemes, birthday parties, and
other ruses

• One person recruits two people, each of whom
  recruit two more (four), each of whom recruit two
  more (eight), for a total of 15 participants.

• All pay in, and all of the money goes to the
  person at the top of the pyramid, who moves on,
  and each person moves up a level to begin a new
  pyramid.

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No-product pyramid schemes Gifting/affinity
groups

• Womens Empowerment Groups (Women Helping
  Women, etc.) Gifting Networks (The Birthday
  Party)
• Some fail to see these as pyramid schemes because
  Its only a gift.
• For helpful information, go to
• www.pyramidschemealert.org

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No-product pyramid schemes, continued

• At some point, the program collapses due to de
  facto market saturation, or authorities shut it
  down. In either case, approximately 90 of
  participants lose money.
• No-product pyramid schemes are easy to spot and
  relatively easy to stopat least as compared to
  product-based pyramid schemeswith approximately
  a 99.9 loss rate. Thats right99.9!

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Internet report chains

• You are invited by e-mail (spam) to provide a
  report (the content is irrelevant, and is often
  provided for you), pay for a series of four or
  five reports in a chain, then add your name to
  the bottom of the list.
• If all those invited actually participated,
  everyone would make a large amount of moneyuntil
  the pool of prospects runs its course and (as
  with all pyramid schemes), about 90 of
  participants are left on the bottom with no
  payoff.

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Internet report chains, continued

• Losses are minimal,
• but sometimes report chains flood the Internet
  and become a nuisance.

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Ponzi schemesrecruiting new investors to repay
earlier investors in an endless chain

• These happen only occasionally.
• The more common Ponzi schemes are MLM's that
  dont sell products to end users, but primarily
  to recruits
• recruiting in one area,
• then moving on to another area or country so
  earlier investors can try to recoup their
  original investment
• only to further enrich those at the top of the
  pyramid.

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Product-based pyramid schemes

• They can be considered recruiting MLM's, as
  opposed to retail MLM's, which pay the bulk of
  their commissions to distributors for actual
  sales to consumers.

• These are MLM's (multi-level/network marketing
  programs) that use compensation plans that reward
  recruiting far more than selling products.
• TOPP's (top of the pyramid promoters) gain huge
  commissions from the purchases of downline
  distributors, almost all of whom lose money.

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Recruiting MLM's do the most damage of all the
pyramid schemesconsumers lose many billions of
dollars world wide each year.

• Recruiting MLM's (PPS's) are usually disguised as
  direct sales businesses
• but have a higher loss rate than classic
  no-product pyramid schemes
• even worse than roulette and other forms of
  gambling.

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Recruiting MLM's make extensive use of the
Internet.

• This eliminates borders and makes for Ponzi-style
  world-wide expansion, (as a group) literally
  plundering vulnerable 2nd world countries of
  billions of dollars each year!
• Matrix marketing is now using the Internet to
  promote web-based matrix programs on E-bay.

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How does one recognize a recruiting MLM that is
disguised as a legitimate direct sales business?

• Study the compensation planwhich is often posted
  on a companys web site.
• When the pay plan is understood, the fraud is in
  plain sight.
• Five characteristics, or Red Flags signal a
  product-based pyramid scheme, or recruiting MLM

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Five causal and defining characteristicsof
recruiting MLMs, or product-based pyramid schemes

• Five key characteristics have been identified by
  Dr. Jon Taylor of the Consumer Awareness
  Institute, who has now researched the topic for
  ten years. He has compared MLMs with all other
  forms of sales distribution to which MLM is often
  compareddirect sales, insurance, franchising,
  recruiting, etc.

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Five causal and defining characteristicsof
recruiting MLMs, or product-based pyramid
schemes, continued

• They are causal in that they identify the causes
  of abnormally high loss rates for participants,
  and
• They are defining because they define the
  difference between exploitive PPSs and all other
  sales models.
• But to keep it simple, we will refer to them as
  the five red flags of a product-based pyramid
  scheme.

• Watch for the 5 red flags

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1st characteristic of recruiting MLMs, continued

• Recruiting of participants is unlimited in an
  endless chain
• of empowered and motivated recruiters recruiting
  recruiters

Red flag 1
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2nd characteristic of recruiting MLMs, continued
Red flag 2

• Advancement in a hierarchy of multiple levels of
  distributors is achieved by recruitment,
• rather than by appointment.

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3rd characteristic of recruiting MLMs, continued
Red flag 3

• Ongoing purchases by distributors are encouraged
• in order for them to be eligible for commissions
  and to advance in the business (pay to play)

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4th characteristic of recruiting MLMs, continued

• The company pays commissions and/or bonuses
• to more than five levels of distributors.
• (Participants are not really distributors, but
  buyers.)

Red flag 4
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5th characteristic of recruiting MLMs, continued

• For each sale, company payout for each upline
  participant equals or exceeds that for the person
  actually selling the product.
• This creates an inadequate incentive to sell
  products and an excessive incentive to recruit a
  huge downline.

Red flag 5

• 5
• 5
• 5
• 5
• 5
• etc.

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Effects of recruiting MLMs, or product-based
pyramid schemes

• When these five red flags appear in an MLM
  compensation plan, approximately 99.9 of
  participants lose money! (based on available
  data)
• When the losers quit, replacements are
  recruited, using the same empty promises.
• The TOPP's profit handsomely from their losses!
  How?
• by ongoing sales of expensive products and
  services to hopeful new recruits, not to
  consumers, as they claim to do. This is how they
  continue receiving large commission checks.

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Where do we get the 99.9 loss rate for
recruiting MLM's, or product-based pyramid
schemes?

• Through analyses of FTC and SEC filings, internal
  company documents and memos, and fact findings in
  court cases.
• Through surveys of persons who prepare tax
  returns of MLM participants, including TOPP's,
  complemented by surveys of households where there
  is a concentration of MLM participants

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The Winners and the Losers in Recruiting MLMs

• Approx. income
  who lose
• of top distributors investment
• Company A 137,000/year 99.99
• Company B 747,063/year 99.94
• Company C 240,000/year 99.92
• Company D 1,080,000/year 99.91
• Company E 121,000/year 99.87
• Company F 1,200,000/year (est.) 99.98
•  
• RTTP Renaissancethe Tax People (shut down by
  the state of Kansas as an illegal pyramid scheme)
  

• The others are prominent MLM's still operating.

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Cost to the economy of recruiting MLMs,

• Tens of billions of dollars defrauded from
  participants every year.
• Billions in state and local tax revenues lost
  each year from unjustified tax writeoffs.
• Resources diverted from real needs.

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Psychological and social costs of recruit-ing
MLMs and other pyramid schemes

• Emphasizes crass materialism.
• Strip mines enthusiasm.
• Contaminates important relationships.
• Floods the Internet, along with other scams.
• Breeds disrespect for law enforcement.
• Typical comment Why doesnt somebody DO
  something about these scams?

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Why are product-based pyramid schemes more
harmful than no-product schemes?

• A higher percentage of participants lose money.
• They tend to endure longer (evolving into Ponzi
  schemes), causing greater aggregate losses.
• They are less easily understood due to complex
  compensation plans which obfuscate the fraud.
• Victims seldom complain, so law enforcement
  seldom gives them priorityunless oriented
  towards proactive enforcement.

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Why victims of recruiting MLMs seldom complain

• They have been conditioned to blame themselves
  for failing to work the system.
• I failed.
• They fear consequences from or to their upline
  (who may be a close friend or relative)
• I wont tell!
• Lack of enforcement leads to the belief
• They must be legal or theyd have been stopped
  by now.

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Challenge for consumer protection

• Even with a 90 loss rate, a no-product pyramid
  scheme offers about 100 times as much chance
  (10)of realizing a profit as a product-based
  pyramid scheme (1/10 of 1)!
• Thats 100 times as much!
• Yet the DSA (Direct Selling Association), which
  has been virtually taken over by MLM's) promotes
  legislation that carries criminal penalties for
  no-product pyramid schemes,
• but exempts product-based schemes (MLM's with
  trademarked products) from pyramid scheme
  prosecution.
• Doesnt this legislation get things backwards?
• Are we failing to look critically at the claims
  of these MLMs to be legitimate direct sellers?

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DSA legislation

• The effect of DSA-influenced pyramid scheme
  legislation is to make the most damaging schemes
  exempt from action as a pyramid scheme.
• SOhow can law enforcement protect consumers in
  states where DSA legislation is in effect?
• (or where it has always been difficult to enforce
  anti-pyramid laws against recruiting MLM's)?

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Deceptions and misrepresentations by
product-based pyramid schemes

• THE BIG LIE
• Rememberall states have some legislation against
  misrepresentation, deceptive sales practices, or
  simple fraud.
• Therefore, since all types of pyramid schemes
  MUST misrepresent in order to survive and grow,
  such laws can be applied to product-based pyramid
  schemes in any state.

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How to prevent unwise DSA (Direct Selling Assn.)
legislation

• Go to the web site for PSA (Pyramid Scheme Alert
  www.pyramidschemealert.org) where Robert
  Fitzpatrick has posted an excellent analysis of
  the problems with DSA legislation.
• At least one state legislature has been prevented
  from passing DSA-originated legislation based on
  this information.

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The benefit of swift and proactive enforcement
against pyramid schemes

• By stopping any major pyramid scheme before it
  gathers steam, huge consumer losses can be
  prevented (losses that otherwise may never be
  recovered). Why?
• Because each participant is empowered and
  motivated to recruit others in an endless chain
  of participants. So it will not stopand may grow
  rapidlyuntil it collapses or is stopped. So the
  sooner it is stopped, the better.

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How to more effectively protect consumers
against pyramid schemes

• Become informed, especially about pay plans of
  recruiting MLM's
• Inform legislators of the dangers of
  DSA-influenced legislation.
• Focus on the more damaging schemes by watching
  for the 5 Red Flags.

Watch for the 5 red flags.
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How to more effectively protect consumers
against pyramid schemes, (continued)

• Carefully evaluate and link up with outside
  resources, including useful web sites to enhance
  your effectiveness.
• Direct consumers to these resources.
• Perform outreach education to prevent pyramid
  scheme abuse.

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Helpful web sites for countering pyramid schemes

• www.mlm-thetruth.com - 10 years research and
  guides to help consumers protect themselves from
  product-based pyramid schemes. Posted by Jon
  Taylor, Ph.D., President, Consumer Awareness
  Institute
• www.pyramidschemealert.org - The Pyramid Scheme
  Alert PSA web site is an excellent source of
  information on legal cases, news, action alerts,
  research, and analytical tools. But be aware of
  DSAs web site identity diversion (the web
  version of identity theft). If you type the wrong
  domain suffix - .org or .net or .com, you
  will be directed to DSAs site.
• www.mlmwatch.org - MLM's with health
  implications critically evaluated by Dr. Stephen
  Barrett. Valuable bulletins.
• www.mlmsurvivor.com - NOT MLM survivors.comanoth
  er identity diversion. One of the most popular
  and helpful consumer-friendly sites on the web.
• www.falseprofits.com - Sponsored by Robert
  Fitzpatrick

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Other sites reporting on MLM's and pyramid
schemes

• www.vandruff.com/mlm - Classic article Whats
  Wrong with Multi-level Marketing offers useful
  insights.
• www.ftc.gov - Minimal help is given by the FTC.
• www.bbb.org -The Better Business Bureau is of
  virtually no help in this area. Many MLMs are
  members, so their bulletin on MLMs reflects the
  public statements of the DSA.
• PLUSMany states and organizations offer advice
  to consumers, with varying amounts and quality of
  helpful information