The Direct Selling Association On Pyramid Schemes: Truth And Truthiness by William Keep

Summary

  • Implications for investor risk of a pyramid scheme prosecution and legislators concerned with consumer protection.
  • Contracting “experts” with no industry expertise invites misinformation for investors, consumers, AND industry members.
  • A positive path forward relies on neither damning an entire industry nor sprinkling “industry self-regulation” pixie dust on regulators and legislators.

By Peter Vander, Ph.D. and William Keep, Ph.D.

Public statements presented as true, though without supporting logic or evidence, if repeated frequently and with enough gravitas may eventually be accepted as true. To capture this type of phenomenon, a new word has been added to our lexicon, “truthiness.” Truthiness does not necessarily indicate a false statement, though a false statement authoritatively asserted as though it were true does qualify.

Below we test our understanding of truthiness with regard to a recent report commissioned by the Direct Selling Association (DSA) and other assorted DSA public statements. Curiously, the authors of the DSA report are antitrust experts, who have neither published any scholarly works concerning multilevel marketing companies (MLMs), nor acted as pyramid scheme experts in a court of law. Perhaps it is due to this lack of expertise and experience that their report mainly appeals to truthiness.

As for truth, it is certainly true that much effort, time and many words went into criticizing a paper* that we wrote thirteen years ago. But it must be pointed out at the start that the model we developed as a scholarly work has never been used in a court of law to determine whether or not a company is operating a pyramid scheme, and it was never proposed that it could function in that way. This is so because each pyramid case presents a unique set of available data, and the analysis in each case must address how the company functions in practice. Unfortunately, the authors of the DSA report did not appreciate these relevant points. If they had, their report could have been cut in half, and perhaps more.

The DSA report grants at the start that we are recognized experts in the field of distinguishing a legitimate business enterprise from a pyramid scheme. But it omits the recognition that, in the 15 pyramid scheme cases in which Dr. Vander Nat was appointed the government’s expert – each time submitting an economic analysis to the court — no court has ever rejected his conclusion that the organization is/was a pyramid scheme. That is to say, the vast majority of arguments made in the DSA report are old news, having been considered and either rejected or ignored in numerous courts of law.

Unencumbered by this precedent, the DSA report takes a novel stand and boldly declares (literally puts in bold), “[t]he key diagnostic for a pyramid scheme is whether the transactions defining the commercial enterprise yield incremental value to society,” — a claim that is firmly rejected by eminent scholarship in law and economics (see Posner below). Here is a respectful word of advice to DSA members: although you might like what this report has to say, if ever an MLM company is in court defending itself against pyramid scheme allegations, waxing poetic about the firm’s value to society won’t help; far better to focus on retail sales.

We further highlight that the 2014 BurnLounge decision, which is used as the basis for the DSA’s critique of our work, does not invalidate our emphasis on retail sales, whether in the 2002 paper or in specific court testimony (below). By presenting a few selective portions of the BurnLounge ruling and ignoring the fully articulated basis for the ruling that BurnLounge was a pyramid scheme, the DSA report dismisses our emphasis on retail sales as “a premise that cannot be sustained.” Actually, we show the opposite. Not only can it be sustained, an emphasis on retail sales is being sustained by the appellate decision itself (2014) and in a recent federal court injunction against Vemma (2015).

A Sampling of Truthiness in the DSA Report and Public DSA Statements

As to the report’s purported “key diagnostic:”

  • This assertion (quoted earlier), conveying a concomitant need for cost/benefit analysis regarding a pyramid scheme, is a striking example of ignorance for known principles in economics and law. A pyramid scheme is inherently fraudulent (every court has said so), and is properly analyzed under the established maxim that deception/fraud carries no social benefit. As explained by Judge Posner in his Economic Analysis of Law (2nd ed. P.81), “The question of affirmative misrepresentations in consumer transactions is straightforward: the costs of making and of unmasking the misrepresentation represent a deadweight social loss,” and later continues with “Misrepresentation involves costs to both sellers and buyers that yield no social gain.”
  • The FTC follows the same principle and never offers extrinsic evidence by way of cost/benefit analysis in prosecuting deception. Ironically, based on the DSA report, the FTC must be missing the “key diagnostic for a pyramid scheme.”
  • Instead, the agency affirms (FTC Policy Statement on Deception; 1983) that extrinsic evidence in cases of deception “can consist of expert opinion, consumer testimony (particularly in cases involving oral representations), copy tests, surveys, or any other reliable evidence of consumer interpretation.”

In sympathy with the DSA report, Mr. Mariano, President of the DSA declared: “The legal analysis should be: is the product being used by real consumers?” Whether the consumer is a distributor is immaterial, he says.

  • What about the following? Courts have ruled that whether product purchasers are primarily business participants versus consumers is an important part of pyramid determination, with numerous courts finding MLM companies to be pyramid schemes with negligible sales beyond what their distributor-recruits purchase, and with documented harm to tens of thousands of victims. MLM companies continue to face pyramid scheme charges.

“Even if one were to accept the faulty premise that case law trumps economics when it comes to performing economic analysis, recent developments have made it clear that the premise underlying the V&K paper cannot be sustained.”

  • Our 2002 paper purposely uses case law to further elucidate the economics underlying a pyramid scheme, since the law, not economics, determines the legality of company behavior-similar in concept to anti-trust cases. In most pyramid cases a judge (and sometimes a jury) considers expert economic analysis presented by opposing sides. Our model is consistent with that same consideration, as it is based on prior cases that incorporate both the law and the accepted economic analysis. As noted above, all the cases encompassed by the model were either won by court decisions or settlements favorable to the government’s prosecutorial position.
  • The economic analysis presented by the government shows that by the very design of the pyramid compensation plan, the vast majority of participants are doomed to predictable economic losses -thereby addressing the core deception of the scheme. The above quote from the DSA report indicates some adversarial relationship between economic analysis and case law that is neither logical nor relevant to pyramid scheme deception and prosecution.

The Report’s Review and Mischaracterization of The Retail Sales Criterion

“Under the ‘retail sales criterion’, only third parties with no connection to the selling organization are considered legitimate ‘ultimate users’. Consequently, the V&K paper deems the consumption of product by distributors (‘internal consumption’) to be illegitimate and simply a cover for fraud.”