On May 10, 2022, Jonathan Perlman was quoted in Forbes Advisor on how pyramid schemes work and how to tell them from an MLM or a Ponzi scheme.
According to the article, a pyramid scheme is a scam where a so-called marketing company promises to help you earn big profits in exchange for recruiting new participants into the scheme. On the surface, a pyramid scheme appears to be a legitimate company selling products or services, but the goal is to grow the number of participants in the scheme rather than grow product sales. The "pyramid" in the name comes from the structure of the scam, where one participant recruits several additional participants to work for them. These members then recruit more new participants beneath them… and so on.
"At the top of the pyramid, the founder or founders are essentially receiving fees from every participant below them," said Perlman.
Multilevel marketing companies and pyramid schemes share similar business models.
However, MLM companies may operate as legitimate businesses, whereas pyramid schemes are always illegal.
Perlman adds that while MLMs and pyramid schemes share a pyramid-shaped structure, legitimate MLMs tend to focus more of their business on product sales than on building a team of salespeople to generate commission.
The FTC applies a multifactor test to determine whether an enterprise is an unlawful pyramid scheme or a lawful MLM, including things like how the structure operates as a whole, marketing, representations, participants' experiences, compensation plans, and the incentives baked into the compensation structure.
For an MLM to be considered legal and not a pyramid scheme, it must adhere to the FTC's 70% rule. This rule states that "at least 70% of all goods sold must be purchased by non-distributors," says Pearlman.
Pyramid schemes and illegal Ponzi schemes share certain similarities as well. In most cases, orchestrators of a Ponzi scheme only ask for a single "investment," with big returns promised later. In fraudulent investment clubs, recruiting new investors is a higher priority than choosing legitimate investments. There is usually a promise of fast returns, and the orchestrators of the scheme encourage initial investors who have already received "returns" to create their own investment clubs. Those investors invite their friends, business associates, and relatives to join and invest in the scheme.
"For doing this, the schemer promises the investment club creator a cut of each dollar that club members invest," said Perlman. "The club creator is also told to teach the investment club members how to start their own clubs, for which they will receive compensation and then pass on compensation to the initial club creator, and so on."