PYRAMID: Yes or No?

By Jeffrey A. Babener
© 2001

A Twenty Year Standard

No legal ruling has had more impact on the direct sales industry than the landmark FTC v. Amway decision. (In the Matter of Amway.) In 1975, the FTC accused Amway of operating as an illegal pyramid. After four years of litigation, in 1979, Amway prevailed. An administrative law judge ruled that Amway's multilevel marketing program was a legitimate business opportunity as opposed to a pyramid scheme.

In a promotion called "Dare To Be Great" ... like other pyramid schemes, the only "commodity" that moved through this program was money. No viable goods or services, sold at fair market value, accompanied the recruiting activities.

Had Amway lost, MLM history after 1979 may have been nonexistent. Amway's victory paved the way for hundreds of MLM companies that would follow. So significant was the decision that the FTC during the next 20 years focused on "deceptive" practices of MLM companies such as earnings representations or medical claims rather than attacking the "structure" of MLM programs. (Only in recent years has the FTC begun to question the "personal use" component of the MLM model.)

The "Pyramid" Cases

The MLM/network marketing/direct sales industry was proceeding on a safe legal course until a proliferation of pyramid programs appeared on the scene in the 1970s. A promotion called "Dare To Be Great" promoted by Glen W. Turner was one example. Like other pyramid schemes, the only "commodity" that moved through this program was money. No viable goods or services, sold at fair market value, accompanied the recruiting activities. Virtually every state had residents who were impacted by this and other programs which officials successfully argued were mere "headhunting" schemes.

The FTC established the earliest guidelines regulating illegal pyramids and other unlawful entrepreneurial chains: In Koscot Interplanetary Inc., (1975), the FTC was highly critical of:

Large membership fees,
Front-end loading and inventory loading,
Programs in which distributors were misled as to the amount of commission they might reasonably earn, and
Programs in which commissions were not based on the sale of product to the ultimate consumers.

The Securities and Exchange Commission (SEC) also stepped into the Dare to Be Great picture, demonstrating that securities statutes also apply to the industry. In SEC v. Glen W Turner Inc., (1973), the U.S. Ninth Circuit Court of Appeals reaffirmed that the securities acts were "designed to protect the American public from speculative or fraudulent schemes of promoters." The Dare To Be Great program was ruled to be an "investment contract" under the securities laws and thus subject to regulation by the SEC. This was a landmark ruling in establishing the distinction between "speculative or fraudulent schemes" and legitimate direct sales activities. It also helped establish the SEC’s role in upholding the rights of legally operating companies and the right to prosecute offenders.

The Koscot, Dare To Be Great, and other pyramid cases left a sour taste in the mouth of the American public. The decisions during the early 1970s represent a low point in the legal history of the industry. As a result of the activities of a few, the industry was penalized by an overreaction by regulatory authorities. State legislators and attorneys general often dedicated themselves to eliminating all forms of direct sales activities in an attempt to leave no avenue open for illegal pyramid schemes or unethical salespeople to operate within their states’ borders. Virtually every state adopted "pyramid" statutes which, unfortunately, are often so vague and ambiguous as to invite arbitrary and capricious enforcement. The industry also found itself affected by the application of combinations of business opportunity statutes, franchise and security statutes, state lottery, and referral statutes as well as enforcement activity by the U.S. Postal Service through its lottery and fraud statutes.

The Amway Safeguards Rule

The FTC’s prosecution of Amway in the mid-1970s could have dealt a death blow to the entire MLM/network marketing/direct sales industry. In The Matter of Amway, 1979, the agency attempted to make the case that Amway was a pyramid scheme and, therefore, a deceptive trade practice under FTC consumer laws.

The case lasted several years. Amway prevailed, and in the landmark 1979 ruling its marketing method was ruled to be a legitimate business opportunity. This decision has become known as the "Amway Safeguards Rule," which is currently one of the most significant sets of legal standards by which courts and regulatory agencies determine the legitimacy of an MLM/network marketing/direct sales company.

In the administrative law judge's decision, three salutary features were pointed out with respect to the Amway program:

1.         Amway required its representatives to engage in retail selling, under the "ten retail customer policy" which appeared in the agreement that representatives signed upon enrollment. This rule required that representatives make 10 sales to retail customers as a qualification for eligibility to receive commissions and bonuses on sales/purchases made by other representatives in their personal sales organization.

2.         Amway required its representatives to sell a minimum of 70% of previously purchased product before placing a new order. (Amway’s rules recognize "personal use" for purposes of the 70% rule.)

3.         Amway had an official "buy-back" policy for unsold, unopened inventory. This policy had some reasonable restrictions, including a specified maximum length of time since the item was originally purchased by the representative and that the item was still current in the company’s product offerings to consumers. The policy also included a minimal "restocking" fee. (Buy-back policies are significant especially for their protection of representatives who choose to terminate their affiliation with a company, and do not want to be "stuck" with unsold inventory.)

By abiding by these three criteria, network marketing and direct sales companies provide themselves with an "umbrella of legal protection." The Amway Safeguards Rule has been successfully cited many times since 1979 in defense of legally operating companies.

The Amway Case is Still the Rule

More than two decades later, the Amway decision is cited in virtually every federal or state case involving an MLM company. Although tension will always exist between the industry and government over the definition of a "retail sale" [i.e., distributor personal use v. nonparticipant sales], the Amway safeguards test continues to be the "gold standard" in evaluating the difference between legitimate MLM v. illegal pyramids.

To view the actual text of the landmark FTC v. Amway decision, please visit The Amway Case.