How MLMS stay 'legal'

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One of the credibility-building factors that modern multi-level marketing (MLM) companies rely on is the assertion that they're legal. Often, it's said that if a company wasn't following the laws, they would have bee shut down by now.

Those things do sound credible. Average consumers assume that the government cracks down on businesses that are breaking the law. But the sad fact is that the FTC, the organization in charge of regulating MLMs and pyramid schemes, has chosen not to act against almost all MLMs.

Only a select few MLMs and pyramid schemes are targeted by the FTC. The rest are allowed to exist and operate as they please.

The key to avoiding being labeled a "pyramid scheme" by a government agency is having a "product" (or service) upon which your scheme is based. Traditional pyramid schemes only involve an exchange of money between people. MLMs skirt this by including a product in the mix – people are supposedly exchanging money for a product.The problem with the products and services "sold" by MLMs is two-fold:
  1. The product is almost always overpriced. The prices are set high because there are many levels in the pyramid that need to be paid a commission when the company sells a product to a distributor. The company generally attaches some sort of affinity to the product to justify the high price – the product is touted as innovative, of superior quality, or it has some other detail not offered in other products on the market.
  2. Very little actual product is ever sold to an end-user. Most of the products purchased by MLM distributors are not sold to third-party users. Instead, the purchases are usually made to qualify for some higher level of commission in the scheme, and the distributors end up storing piles of products at their homes.
So participants in MLMs are pretending to exchange money for products to retail. The truth is that they're exchanging money for dust-collectors, which is no better than a traditional pyramid scheme.
The government could crack down MLMs for the lack of actual retail sales. It is clear to those who study MLMs that the existence of products doesn't truly legitimize the schemes, since the products aren't being sold.

But for now, the FTC has chosen not to act, so it's clear that MLMs will continue their sham of retail selling businesses indefinitely.

Forensic accountant Tracy L. Coenen, CPA, MBA, CFE performs fraud examinations and financial investigations through her company, Sequence Inc. Forensic Accounting. The Association of Certified Fraud Examiners honored Tracy as the 2007 winner of the prestigious Hubbard Award and her first book, Essentials of Corporate Fraud, will be on bookshelves in March 2008.
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