An Analysis of 'Marketing Fraud: An Approach for Differentiating Multilevel Marketing from Pyramid Schemes' Under Standard Protections Offered by Legitimate Direct Selling Firms

Abstract

Direct selling (DS) is a long-standing and legal retail distribution channel whose distributors act as retail salespeople, sales managers, and personal consumers of the firm’s products. The FTC, state Attorneys General, and other plaintiffs prosecute firms they argue operate illegal pyramid schemes, which have superficial commonalities with (but are not identical to) legitimate DS firms. Confusion can therefore arise about the legality or illegality of the defendant firm’s business.

One paper whose analysis and results have been used in prior pyramid scheme prosecutions (Vander Nat and Keep 2002, “VK”) develops a set of “metrics” claimed to apply to the assessment of any DS firm’s business for possible signs of pyramid scheme operation. However, the model’s analysis rests on an unwarranted assumption that distributors’ personal-consumption purchases should not be counted as consumer sales.

This paper documents how the VK model fails to account for the appropriate categorization of DS distributor purchases as end-user sales. A re-analysis of the VK model with the proper analytic correction shows that VK’s proffered “metrics” are not meaningful under the standard business protections offered by a legitimate DS firm. As a result, the VK model is unreliable as a general tool in pyramid scheme determination.

Keywords: Direct Selling, Network Marketing, MLM, Multilevel Marketing, Distribution Channels, Pyramid Schemes, Marketing, Fraud, FTC

JEL Classification: K22, M31, M38