Pyramid Scheme Victims In The U.S.: Has Anything Changed In The Last Dozen Years? by William Keep

Summary

FTC Fraud Surveys serve multiple purposes, including to identify the presence of pyramid scheme victims.

Size matters, especially when it comes to sample size.

A result that is not ‘statistically significant” is still a result.

Identifying and deciding to prosecute a pyramid scheme disguised as a legal MLM company can take years. Consequently, estimating the annual number of MLM-type pyramid scheme victims remains anybody’s guess-ranging from 100% among those who see an inherently flawed MLM business model to a very low percent among those who believe in effective, trade association led self-regulation. Even a low percent would produce hundreds of thousands, and potentially over a million, pyramid scheme victims annually in the United States, causing hundreds of millions of dollars of harm. The potential for such a level of harm should get the attention of even the most business-friendly legislator and prosecutor. That it has not done so comes not from a lack of harm but rather from a lack of reliable data.

At this point we have literally no reliable estimate of the number of annual pyramid scheme victims, the amount of harm, or whether this decades-old problem has gotten worse or better. In a previous article I mentioned the lack of reliable information coming from the three previous FTC Fraud Surveys. Here I explore that issue in detail.

Let’s begin by giving the FTC its due. Trying to judge the most frequent and damaging forms of consumer fraud in a country with a population in excess of 300 million people is not easy. Many countries do not even try. Like most organizations and virtually all government agencies, the FTC pursues multiple priorities with limited resources. Complicating the task, the FTC does not even have a federal law defining what constitutes an illegal pyramid scheme for guidance. Nonetheless, they have tried. The results established a rough baseline but no real guidance on whether the problem has gotten better or worse.

In 2003 the FTC conducted its first comprehensive fraud survey, polling a sample of 2,500 adult Americans. That survey (results reported in 2004) established pyramid scheme victims seventh among the ten most common forms of consumer fraud, with an estimated 1.55 million pyramid scheme victims the previous year. The survey also found pyramid scheme victims to be second in terms of individual loss and first, by a large margin, as the least likely to complain. Attempts to extract meaningful data by asking more questions about specific types of fraud victims becomes inherently difficult as the relevant data-the “N”-becomes smaller and smaller. This effect becomes evident in the very large 95% confidence intervals reported. The “true” number of pyramid scheme victims in the previous year identified in the survey falls within the range of 800 thousand and 2.33 million, with 1.55 million as the midpoint.

In 2005 the FTC repeated the survey (results reported in 2007) with some adjustments. The sample size was increased and the definition of a pyramid scheme victim changed to be “defined more conservatively” (p. 12). On the surface, the survey appears to show a large decline in the number of pyramid scheme victims. [Before continuing, a little math is in order. For example, if we multiply .7 percent times 200 million we will get a much larger number than if we multiply .4 percent times 200 million. For the difference to be meaningful, however, we have to be sure that the .7 percent is actually .7 and the .4 percent is actually .4. In terms of the fraud surveys, these fractions of a percent represent the proportion of the US adult population estimated to be pyramid schemes victims.]

Based on simple multiplication and two estimated proportions, it appears the estimated number of pyramid scheme victims declined by roughly half, from 1.55M in 2003 to 800 thousand in 2005. But as Mark Twain noted, there are “lies, damned lies, and statistics.” In fact, the difference between the two estimated fractions of a percent are not statistically significant at the .05 level – i.e., we have no confidence that the difference we see is a true difference. The actual difference may be negligible. Further, the change to a more conservative definition lowered the number of victim respondents in 2005 by 21 percent, relative to the number that would have been obtained using the old definition. The FTC wrote, “Employing the 2003 definition with the 2005 data, the estimated victim rate for pyramid schemes would be 0.5 percent, which is slightly lower than, though not significantly different from, the 0.7 percent rate estimated from the 2003 survey results” (p. 54, emphasis added). Logically, this conclusion makes sense, as the two surveys were taken just two years apart.

Six years later, in late 2011 and early 2012, the FTC repeated the survey (reported as the 2011 fraud survey). The result shows another apparent decline, albeit it much smaller, in the incidence of pyramid scheme victims with an estimated 700 thousand victims. And, as before, we can have no confidence in this result. Despite a six-year interval there is no statistical significance between the 2005 and 2011 data due to the large confidence interval. While there is a statistically significant difference between the 2003 and 2011 data, the change in definition likely accounts for this difference. If the 2003 definition had been applied to the 2011 data (it was not) and the 21 percent decline in victim respondents noted in the 2005 data holds, then we can have no confidence that the number of pyramid scheme victims in the United States has changed from the proportion estimated in 2003. The lack of confidence in the 2011 result also follows logically, given the dramatic estimated drop in the number of victims in just two years (2003 to 2005) and the very small estimated drop in the number of victims over the following six years (2005-2011)-such is the outcome of large confidence intervals and changing the definition of a pyramid scheme victim.

Of course words used in a survey actually produce the numbers. To try to identify pyramid scheme victims the FTC surveys asked if: a) a respondent “paid anyone for an opportunity to operate [their] own business, such as a work-at-home plan, a business opportunity or a franchise,” b) were “led to believe that most of the money [they] earned from this business would be from recruiting others to join the business, rather than from the sale of products,” and c) “whether they had been led to believe that they would earn a certain amount of money or profit from the business.” A “no” to any one of these questions would have disqualified the respondent from being counted as a pyramid scheme victim. Since designing the first survey, the FTC came to recognize that “Modern pyramid schemes generally do not blatantly base commissions on the outright payment of fees, but instead try to disguise these payments to appear as if they are based on the sale of goods or services” (2004 FTC Staff Advisory). Plus, a smart pyramid scheme operator would not likely promise that participants will “earn a certain amount of money or profit.” Therefore, pyramid scheme participants who join and maintain eligibility solely by purchasing products (e.g., Equinox) and were not promised a certain amount of profit would not self-identify in the survey as a pyramid scheme victims.

From the FTC fraud surveys we can say with 95 percent confidence that there are hundreds of thousands (and possibly millions) of pyramid scheme victims in the United States each year. As legislators and regulators ponder what to do with an MLM industry within which pyramid schemes lurk – in the words of DSA President Mariano, “disguise[ing] themselves as legitimate direct-selling companies” – they may want to first consider who among their friends and family may be the next victim.

Finally, I want to thank the FTC for clarifying with me certain critical elements of the research, which was clearly intended to get a handle on this difficult issue.

Additional disclosure: I have received no compensation from any parties associated with the Herbalife controversy and have no known financial position associated with any firm mentioned.

Herbalife Ltd. HLF Pyramid Scheme