For decades, muti-level marketing companies like Amway, Mary Kay, Herbalife, Avon, and Usana have fought against being labeled as pyramid schemes. They say that pyramid schemes are illegal, and that their MLM business format is perfectly legal.

My definition of MLMs is a little nuanced. I tend to call them legalized pyramid schemes. What I mean by this is that multi-level marketing companies are indeed pyramid schemes, but our state and federal governments allow them to operate and generally call them legal if they have the right window dressing.

There are attorneys who specialize in MLM work, advising companies on exactly how to set up their systems and compensation plans to comply with the letter of the law and avoid government accusations of being pyramid schemes. But this setup doesn’t change the fact that most of these companies operate like pyramid schemes, even if the government doesn’t call them illegal and shut them down.

This issue is one of the key disputes in my ongoing litigation with Medifast (which has an MLM component Take Shape for Life). Medifast admits that one of its key business risks is being fingered as a pyramid scheme:

Our direct selling distribution channel is subject to risk of interpretation of certain laws pertaining to the prevention of “pyramid” or “chain sale” schemes. Although we believe we are in full compliance, should the governing body alter or enforce the law in an unanticipated way, there may be a negative result on the Company’s operations.

Yet when I questioned whether Medifast and TSFL might be a pyramid scheme, the company saw fit to litigate me to death. I gave the following opinion on the company:

Take Shape For Life, however, makes it clear that to make real money, you have to recruit new people into the plan. This is where the allegations of being a pyramid scheme come in. Like all other MLMs that I’ve looked at, the product or service isn’t really the focus. It’s simply the bait to get someone in and make the company look legitimate. The real focus, however, is the recruiting of new marks into the scheme.

So the company’s products haven’t been proven to be stellar. The traditional outlets for the products are not doing well. And the MLM portion of the company is booming, even though there’s no evidence that the products themselves are actually selling well. Everything points to the real deal being endless chain recruitment into a pyramid scheme.

Oddly, Medifast says this isn’t an opinion at all. The company said in a brief in their appeal of my total victory in the case:

There is no indication that what Coenen is writing on her blog should not be taken seriously–the average reader would assume they were reading the statements of an expert providing objective facts, not subjective opinion or “observations”. CRB36. Coenen presents herself as someone with authority. Readers will give deference to her claimed expertise, and assume she speaks the truth. See Wilbanks, 121 Cal.App.4th at 904.

Apparently, I am so awesome that my opinions are not opinions at all, and are actually believed to be facts by my readers. Since I am such and expert and so credible, people apparently think my opinions are actually statements of fact. Who knew!

The judge in the case saw it differently. She dismissed Medifast’s case against me, saying in her order:

These statements do not charge Medifast with commission of a crime, nor are they otherwise defamatory without the necessity of explanatory matter; accordingly, they cannot support Medifast’s claim for libel per se. Cal. Civ. Code § 45a.

[snip]

Medifast’s allegations suffer from a fatal flaw: Defendants’ statements cannot reasonably be understood as implying the provably false assertion of fact Medifast claims they imply, namely, that Medifast is running a Ponzi scheme.

[snip]

If any statement of fact can be implied from Defendants’ statements, it is this: Things at Medifast are not what they seem. Such a statement is too inexact or subjective to support a libel per se claim; no reasonable person could construe it to be provably false.

Viewing Defendants’ statements in their context, no reasonable factfinder could conclude that Defendants accused Medifast of running a Ponzi scheme. Accordingly, Minkow’s and Coenen’s motions are GRANTED as to these statements.

So are multi-level marketing companies pyramid schemes or not? This is a frequently debated issue. Medifast appears to claim that since the government has not found it guilty of running a pyramid scheme, it therefore does not run a pyramid scheme. We are all smart enough to know that the lack of legal action or the lack of a civil or criminal conviction does not mean that certain (possibly illegal) conduct has not occurred.

Let’s look at the facts. A common dictionary definition of a pyramid scheme reads like this:

A fraudulent moneymaking scheme in which people are recruited to make payments to others above them in a hierarchy while expecting to receive payments from people recruited below them. Eventually the number of new recruits fails to sustain the payment structure, and the scheme collapses with most people losing the money they paid in.

Does this describe multi-level marketing companies? Maybe.

• Fraudulent – MLMs may be committing fraud if they are using misinformation to recruit people. I have seen this happen time and again. The independent contractors recruiting new marks often make false earnings claims. And the MLM companies themselves often put out information that is incomplete and/or misleading.
• Recruiting – This is the heart of MLM.
• Payments to others – In MLMs the “payments to others” do not occur directly. The participants pay money to the company, and part of that money is given to the people above them. This appears to be an indirect payment to those above.
• Number of new recruits fails to sustain the payment structure – We see this when participants are unable to keep recruiting enough new people to maintain their level or commission payouts.
• Scheme collapses – In all MLMs that I’ve looked at, individual hierarchies are continuously collapsing. The company as a whole may continue to operate, but individual lines of distributors collapse daily.
• Most people lose money – In-depth research proves time and again that 99% of people lose money in multi-level marketing.

Based on this definition, I believe the vast majority of MLMs in the United States could be deemed pyramid schemes.

And a user-generated definition confirms that controversy exists as to whether MLMs are pyramid schemes:

pyramid scheme

A fraudulent business model, illegal in most places, in which participants are paid to recruit more participants, rather than commissions on sales.

Frequently passed off as Multi-Level Marketing by incorporating sales of an unmarketable product or service into the scheme. In such cases, participants are usually required to maintain a monthly purchase quota to qualify for payments.

Most MLMs carefully craft their payment plans so that they appear NOT to make payments for recruiting. They set up the pay plans such that they appear to pay commissions on sales. But in fact, most of the time the commissions are paid on products PURCHASED by the recruiters, without regard to whether or not those products are actually SOLD to customers.

The government chooses not to prosecute MLMs. That is likely the result of intensive and successful lobbying by organizations such as the Direct Selling Association. But that doesn’t mean that MLM structures are necessarily legal or are not pyramid schemes.

Medifast would have you believe that Robert FitzPatrick, Barry Minkow, and I are the only people questioning whether MLMs are actually pyramid schemes. This is far from the truth:

• Earlier this year, short seller David Einhorn asked some questions about Herbalife (NYSE:HLF) that indicate he may be questioning the business model and whether it is a pyramid scheme.
• David Phillips questioned whether Medifast is a pyramid scheme.
• Consumer advocate and researcher Dr. Jon Taylor is of the opinion that recruiting MLMs are often pyramid schemes.
• Penn & Teller did an episode on multi-level marketing for their cable television show Bullshit, apparently concluding that MLMs are pyramid schemes.
• Consumer advocate Dean Van Druff says that MLMs may well be pyramid schemes.
• The National Consumer league discusses MLMs and pyramid schemes, and anyone who knows a lot about MLMs will likely believe that several of the descriptors under the “pyramid scheme” column actually apply to many MLMs.
• The SEC has posed questions to companies such as Herbalife which may suggest it takes seriously the possibility than an MLM could be a pyramid scheme.
• The SEC has gone even further in some cases, shutting down companies such as ZeekRewards that were deemed to be pyramid schemes, in spite of being marketed as MLMs.
• The FTC published the following about multi-level marketing: Not all multilevel marketing plans are legitimate. Some are pyramid schemes. It’s best not to get involved in plans where the money you make is based primarily on the number of distributors you recruit and your sales to them, rather than on your sales to people outside the plan who intend to use the products.

And the list could go on.  The issue of whether multi-level marketing companies are pyramid schemes is not as cut-and-dry as companies like Medifast would have you believe. It is hotly contested, with MLM supporters crying loudly that the lack of legal action by the government indicates MLMs are not pyramid schemes, and the anti-MLM people arguing that these companies sure have a lot of characteristics that may lead reasonable people to believe that they are indeed pyramid schemes.