When Charles Ponzi organized the Securities Exchange Company in Boston in 1919 and issued promissory notes payable in 90 days with 50 percent interest, he kicked off a storm of investment frenzy which duped just about everyone, including politicians, law enforcement officers, and reporters. He tricked speculators by using the money of new investors to pay old investors huge "profits".

Ponzi took in over $15 million from this and other schemes before his house of cards collapsed, causing losses for thousands and leading to jail time and his eventual deportation to Italy in 1934. Incidentally, there were similar schemes prior to Ponzi (for example, John Law’s “Mississippi Bubble” scheme in France in 1719 and William Franklin Miller’s Franklin Syndicate in 1899—a.k.a. “520 percent Miller”), but the Ponzi name stuck for this type of phenomena.

Some consider Ponzi schemes as separate and distinct from pyramid schemes, but as one writer observed,

Ponzi and pyramid schemes do have similarities. Both are fraudulent arrangements for the receipt and redistribution of money with early participants winning and those who enter later losing. In each case it is essential to continue the game with new infusions of money, for if the play ends and there is an accounting, there must be a deficit and cries of pain. But where Ponzi promised a definite return on one’s investment—albeit a huge one—the possibilities in a pyramid were almost limitless as new subscribers feed those who joined before.

Furthermore, the machinery of the pyramid is always explained and is, in fact, one of its alluring features, whereas Ponzi plans invariably refer obscurely to exotic investments that are really irrelevant and usually nonexistent. In some cases the pyramid seems almost acceptable socially, as in the cases of chain letters or distributorship plans, but there has never been any question about the vice of Ponzi schemes.”¹

Later came chain letters, beginning with the “send-adime” letter widely appearing in Denver in 1935, which bore the heading “Prosperity Club” and the slogan “In God We Trust” This led to the $1 chain letter in Omaha, chain letter agencies or “factories, and the “Circle of Gold” which spread from California throughout the country in the late 1970’s—all of which used the postal system.

Many of these chain letters went underground because of aggressive enforcement of federal mail fraud statutes. Still other variations, such as chart and airplane games, emerged later.

“Chain selling” or “chain distribution” systems, the basis of multi-level marketing, was an eventual offshoot from chain letters. With chain selling, the selling of products was made through multiple levels of distributors, each of whom received some type of compensation for the sales of those recruited at lower levels, or one’s “downline.”

In 1967 Glenn W. Turner began an incredible distribution scheme in Orlando, Florida.

His line purported to be cosmetics, featuring mink oil as a special ingredient, but in reality he sold distributorships. A participant paid a fee and became a distributor, entitling him to sell the cosmetic products, but more important, entitling him to sell other distributorships. Little selling of the cosmetics actually took place, for the real money was to be made in the sale of distributorships. Those transactions were essentially the same as in the chain letter, or the airplane or chart games, in that the new participant paid one fee to the party who brought him in, another to the party at the top, and then assumed a position at the bottom of the pyramid.

Over five years, Turner “parlayed $10,000 . . . into a conglomerate that generated a cash flow of $200 million, and in which as many as 100,000 people may have invested. . . .Two main business organizations were developed to carry out his activities: Koscot (‘Kosmetics Company of Tomorrow’) Interplanetary, Inc., the sales arm, and Dare to Be Great, Inc., the training body.”²

I cannot leave the Turner case without quoting the following, which sounds like many typical MLM opportunity meetings today:

Would-be [Dare to Be Great] participants were brought to staged gatherings in places like hotel ballrooms where clean-cut young men, each with a rhinestone pin of a flag . . . attached to his lapel, subjected them to the rigors of high-pressure salesmanship. . .” These gatherings, called “Adventure Meetings” or “Golden Opportunity Meetings,” were described by one judge as being like an old-time revival meeting but directed toward the joys of making easy money rather than salvation. Their purpose is to convince prospective purchasers, or ‘prospects,’ that Dare is a sure route to great riches.

At the meetings are employees, officers, and speakers from Dare, as well as purchasers (now ‘salesmen’) and their prospects. The Dare people, not the purchaser-‘salesmen,’ run the meetings and do the selling. They exude great enthusiasm, cheering and chanting; there is exuberant handshaking . . . The Dare people dress in expensive, modern clothes. . . . they drive new and expensive automobiles, which are conspicuously parked in large numbers outside the meeting place.

Dare speakers describe, usually in a frenzied manner, the wealth that awaits the prospects if they will purchase one of the plans. Films are shown usually involving the ‘rags-to-riches’ story of Dare founder Glenn W. Turner. The goal of all of this is to persuade the prospect to purchase a plan . . . and thus grow wealthy as part of the Dare organization.³

It is against this backdrop that we will look at the illegality of pyramid schemes and how they are often distinguished from “legitimate” MLM programs.

The FTC has described the essential features of an illegal pyramid scheme as follows:

Such schemes are 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. . . As is apparent, the presence of this second element, recruitment with rewards unrelated to product sales, is nothing more than an elaborate chain letter device in which individuals who pay a valuable consideration with the expectation of recouping it to some degree via recruitment are bound to be disappointed.⁴

It appears that pyramid schemes are considered illegal when legitimate products are subordinated to the emphasis on sales rights and overrides from recruiting a network of participants, quite unrelated to sales of products themselves. Such programs lead to inflated and unrealistic promises and inevitable market saturation. So pyramid schemes allow a few opportunists to take advantage of the ignorance and vulnerability of an unwitting populace—who fail to see that mathematically only a few can succeed at the expense of failure and losses of the masses recruited into any given program.

But there is a business model that is at least as pyramidal and powerful as any illegal pyramid scheme—and in my opinion more pernicious because of its more pervasive effects. It is a phenomenon that has for the most part escaped recognition as a pyramid scheme because legitimate products are offered and the money required for entry into the system is nominal, usually less than $100 for a kit of sales materials and samples. Yet it costs consumers billions of dollars every year — dwarfing illegal pyramid schemes to a mere speck in comparison. The business phenomenon of which I speak is multi-level marketing (MLM), more recently referred to as network marketing (NWM).

One problem with using a generic term exclusively is that new schemes are being generated by the hundreds, many claiming to have solved the problems of MLM’s. “Network marketing,” for example, was a term coined to get around the onerous sound of “multi-level” marketing—which almost implied a pyramid scheme. But for now I will use the generally accepted “MLM” acronym.

According to an FTC release on May 23, 1979, Amway—one of the earliest MLM companies—was ordered by the FTC “to stop fixing retail and wholesale prices and misrepresenting the profitability of Amway distributorships.” Since that time Amway Corporation (as a company) has been more careful about making inflated promises to prospects. However, on a far more important issue, Amway and—by extension—an emerging industry triumphed. The complaint that Amway’s sales plan was an illegal pyramid scheme was dismissed by the Commission—a major coup for Amway and for all MLM companies that followed.

It is this latter point that has given credence to MLM and led to enormous growth in an industry that in the past decade has cost consumers tens of billions of dollars and left tens of millions of participants holding the bag of broken promises—and in many cases—broken lives.

To be fair to responsible enforcement agencies and to those who draft laws relating to pyramid schemes, it is extremely difficult to define what is and what is not a pyramid scheme. MLM, for example, is continually reinventing itself in new versions and complex compensation systems—partly to get around legislation against pyramid schemes. So it is not surprising that a simple definition of what constituted a pyramid scheme was adopted. How that definition is applied, however, is open to interpretation.

Consumers continue to be provided with misleading information (regarding what constitutes a pyramid scheme) from government agencies and from the Better Business Bureau. Sources favorable to MLM, such as the Direct Selling Association (using the “Direct Selling Education Foundation” as a front), MLM industry sources (such as Upline), and business and “opportunity” publications (such as Success magazine) then expand upon and perpetuate these misconceptions.

1. Joseph Bullgatz , Ponzi Schemes, Invaders from Mars, and More Extraordinary Popular Delusions (New York: Harmony Books, 1992), p. 36.
2. & 3. Ibid, p. 42-3
4. In re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1180 (1975), gaff’s mem, sub nom. Turner v. FTC 580 F .2d 701 (D.C. Cir. 1978).