UNITED STATES OF AMERICA 

FEDERAL TRADE COMMISSION 

WASHINGTON, D.C. 20580 

Division of Marketing Practices 

James Kohm 

Direct Dial 

202 326 2640 

Fax Numb er 

202 326 3395 

January 14, 2004 

Mr. Neil H. Offen, President 

Direct Selling Association 

1275 Pennsylvania Ave., NW

 Suite #800 

Washington, DC 20004-2411 

Re: Staff Advisory Opinion - Pyramid Scheme Analysis 

Dear Mr. Offen: 

Thank you for your inquiry requesting a staff Advisory Opinion regarding the Federal Trade 

Commission's analysis of pyramid schemes. You have identified two areas of concern: 1) the 

Commission's analysis of compensation based on personal consumption by members of a multi-level 

company's sales force ("internal consumption”); and 2) the legal significance of consent orders that the 

Commission has entered into with several pyramid scheme operators. I am pleased to provide you with 

the following staff guidance. 

Internal Consumption 

Much has been made of the personal, or internal, consumption issue in recent years. In fact, the 

amount of internal consumption in any multi-level compensation business does not determine whether 

or not the FTC will consider the plan a pyramid scheme. The critical question for the FTC is whether the 

revenues that primarily support the commissions paid to all participants are generated from purchases of 

goods and services that are not simply incidental to the purchase of the right to participate 

in a money-making venture. . 

A multi-level compensation system funded primarily by such non-incidental revenues does not depend 

on continual recruitment of new participants, and therefore, does not guarantee financial failure for the 

majority of participants. In contrast, a multi-level compensation system funded primarily by payments made 

for the right to participate in the venture is an illegal pyramid scheme. 
In a pyramid scheme, participants hope to reap financial rewards well in excess of their investment 

based primarily on the fees paid by members of their "downlines." Downline members pay these fees 

to join the scheme and meet certain prerequisites for obtaining the monetary and other rewards offered 

by the program. A participant, therefore, can only reap rewards by obtaining a portion of the fees paid by 

those who join the scheme later. The people who join later, in turn, pay their fees in the hope of 

profiting from payments of those who enter the scheme after they do. In this way, a pyramid scheme 

simply transfers monies from losers to winners. For each person who substantially profits from the 

scheme, there must be many more losing all, or a portion, of their investment to fund those winnings. 

Absent sufficient sales of goods and services, the profits in such a system hinge on nothing more than 

recruitment of new participants (i.e., fee payers) into the system. 

The Commission's recent cases, however, demonstrate that the sale of goods and service; alone does 

not necessarily render a multi-level system legitimate. Modem 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. The most common means employed to 

achieve this goal is to require a certain level of monthly purchases to qualify for commissions. While 

the sale of goods and services nominally generates all commissions in a system primarily funded by 

such purchases, in fact, those commissions are funded by purchases made to obtain the right to 

participate in the scheme. Each individual who profits, therefore, does so primarily from the payments 

of others who are themselves making payments in order to obtain their own profit. As discussed 

above, such a plan is little more than a transfer scheme, dooming the vast majority of participants to 

financial failure. 

1 A participant’s downline usually consists of the people the participant recruits to join the 

program as well as the people her recruits recruit, and so on through a predetermined number of 

levels. 

2 It is important to distinguish an illegal pyramid scheme from a legitimate buyers club. A 

buyers club confers the right to purchase goods and services at a discount. If a buyers club is 

organized as a multi-level reward system, the purchase of goods and services by one’s downline 

could defray the cost of one’s own purchases (i.e., the greater the downline purchases, the greater 

the volume discounts that the club receives from its suppliers, the greater the discount that can be 

apportioned to participants through the multi-level system). The purchase of goods and services 

within such a system can, therefore, be distinguished from a pyramid scheme on two grounds. 

First, purchases by the club's members can actually reduce costs for everyone (the goal of the 

club in the first place). Second, the purchase of goods and services is not merely incidental to the 

right to participate in a money-making venture, but rather the very reason participants join the 

program. Therefore, the plan does not simply transfer money from winners to losers, having the 

majority of participants with financia11osses. 

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Consent Orders 

With regard to your second question, the Federal Trade Commission often enters into consent orders 

with individuals and companies that the Commission has determined have violated the FTC Act. To 

protect the public from those who have demonstrated an unwillingness to follow the law, these orders 

often contain provisions that place extra constraints upon a wrongdoer that do not apply to the general 

public. These "fencing-in" provisions only apply to the defendant signing the order and anyone with 

whom the defendant is acting in concert. They do not represent the general state of the law. 

For example, when the Commission brings a pyramid scheme action, the case often concludes with a 

consent order. The scope and severity of the order will depend upon the facts of the case; however, 

most such orders contain definitions that exclude any sale to a participant in the business from the 

calculation of the venture’s legitimacy. These definitions draw very clear lines for those who have 

demonstrated a willingness to violate the law, but are not intended to represent the state of the law for 

the general public. 

Thank you for your inquiry. 

James A. Kohm 

Acting Director of Marketing Practices 

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