Multi-level marketing has been in the public eye recently, with NXIVM’s trial underway. Due to podcasts preceding the trial and it’s highly public nature, people are asking questions about the MLM giant and where the line is drawn between MLMs, pyramid schemes, and Ponzi schemes.
This blog takes a look at whether an MLM counts as fraud. As well, we examine the differences between MLMs, pyramid schemes, and Ponzi schemes.
Ponzi Scheme Overview
Ponzi schemes are a type of fraud. They face some of the harshest penalties for financial crimes.
Bernie Madoff perpetrated the largest Ponzi Scheme in history and was sentenced to 150 years and ordered to forfeit $170 million in assets.
In a Ponzi scheme, the schemer defrauds the investors. They create an enterprise (typically nonexistent) and promise investors quick returns and low risks. As new investors join, their investment capital is portrayed as coming from product sales. These funds pay the original investors.
Each time new investors join their funds go up the chain, paying out earlier investors. When the new investor flow eventually runs out the scheme unravels.
Although a basic Ponzi scheme is in a pyramid shape, it’s different from a pyramid scheme.
Pyramid Scheme Overview
A pyramid scheme is harder to prove than a Ponzi scheme. Although it’s another form of investment fraud it portrays itself as selling products or services.
Pyramid schemes work by having investors/participants pay a fee to sign up to sell the product/service. That investor can then recruit more investors/participants under them. Typically, people are buying the licence to sell a product.
Although they have a product or service to sell, these businesses actually make their money from signing up new members rather than through sales. Pyramid schemes can become large and complex, and proving that the revenue is through recruitment rather than product sales is often difficult.
For example, Herbalife has been investigated as a pyramid scheme in multiple countries. In the USA they were forced to pay $200 million in damages, although they were never officially declared a pyramid scheme. In fact, they’re still operating in the US with strong sales numbers.
In Belgium, Courts initially ruled Herbalife was a pyramid scheme fraud. In 2013, the Court of Appeals reversed this decision, deciding their business model does comply. Publicly, there remains a heated debate as to whether their model is fraudulent or legitimate. However, thus far, Courts have struggled to make any financial crimes ruling stick.
Multi-Level Marketing (MLM) Overview
What makes it so difficult to prove that a business is pyramid scheme is it’s similarities to an MLM. Multi-Level Marketing is not fraud, although fraudulent businesses may pose as MLMs.
An MLM is made up of a non-salaried workforce. The flow is a pyramid shape. A person signs up under a distributor, and purchases product from them. They then sell that product for a profit, keeping a percentage of the sales for themselves. The distributor also gets commissions from the sales of everyone who signs up under them.
The person who purchases from the distributor can then become a distributor themselves by signing people up underneath them.
MLM VS Pyramid Scheme
In a legal MLM, it’s possible to make money selling directly to customers. The primary goal is selling the product, not recruiting salespeople. A pyramid scheme focuses on recruitment.
MLM vs Ponzi Scheme
A Ponzi scheme is generally presented as investment management services. Although MLMs and pyramid schemes are often presented as investment opportunities, the idea is that the person signing up will sell a product or service.
Is Multi-Level Marketing Fraud?
Strictly speaking, Multi-Level Marketing (or Network Marketing) is not fraud. However, they can be difficult to distinguish from fraudulent businesses. At the ground level, Ponzi and Pyramid schemes can be indistinguishable from Multi-Level Marketing.
Toronto Fraud Defence Lawyer
If you or a loved one are facing fraud charges, you need an experienced Toronto fraud lawyer. William Jaksa has over a decade of experience as a criminal lawyer including defending financial crimes and fraud charges.
Contact us today for a consultation.