The great FTC blunder (FTC v. Amway) occurred in 1979, a decision that facilitated the proliferation of product-based pyramid schemes
Amway led the way in an MLM industry that has caused massive consumer losses. While the practice of multi-level marketing had been evolving for decades, the industry was given a huge boost by a key decision of an FTC administrative judge in 1979. This decision opened a Pandora’s Box of MLM look-alikes that since that time have numbered in the thousands.
Is Amway a pyramid scheme?
According to an FTC release on May 23, 1979, Amway – one of the earliest MLM companies – was ordered by the FTC “to stop fixing retail and wholesale prices and misrepresenting the profitability of Amway distributorships.” Since that time Amway Corporation (as a company) has been more careful about making inflated promises to prospects.
However, on a far more important issue, Amway and – by extension – an emerging industry triumphed. The complaint that Amway’s sales plan was an illegal pyramid scheme was dismissed by the Commission – a major coup for Amway and for all MLM companies that followed – and a huge setback for consumer protection.
Amway’s “retail rules.”
As part of the agreement with the FTC, Amway agreed to abide by “retail rules,” such as the “ten-customer rule” (10 customers outside the network of distributors), the “70% rule (70% of products purchased are sold at retail), and a buyback policy. Amway assured the FTC it had procedures in place to assure compliance with these rules. However, the retail rules have never been consistently enforced. Except for the buyback policy, Amway and other MLMs have essentially ignored the retail rules accepted by the FTC. Both company officials and participants employ a “wink-wink, nod-nod” attitude towards compliance. In fact, the image of Amway as distributors of patented soap products has yielded to the reality of a pseudo-business of opportunity or entrepreneurial chains.
The FTC’s 1979 Amway ruling gave credence to MLM and led to enormous growth in an industry that in the past three decades (if you understand the math in Chapter 7) has cost consumers worldwide hundreds of billions of dollars and left hundreds of millions of participants holding the bag of broken promises – and in many cases – broken lives. This has been accomplished through a whole litany of misrepresentations – over a hundred of them listed in Chapter 8. Taken together, MLM constitutes one of the most massive and successful con games in history.
A lack of retail sales is also a red flag that a pyramid exists.
Many pyramid schemes will claim that their product is selling like hot cakes. However, on closer examination, the sales occur only between people inside the pyramid structure or to new recruits joining the structure, not to consumers out in the general public.
Amway’s “retail rules” focused on behavior, not the underlying structural flaws.
As discussed in earlier chapters, MLMs typically incentivize an endless chain of recruitment of participants as primary customers. Their compensation plans assume an endless chain or infinite recruitment in finite markets and in virgin markets, neither of which exists. MLMs are therefore inherently flawed, uneconomic, and deceptive.
In focusing on the (sales) behavior of participants, the FTC’s Amway decision failed to address these inherent structural flaws that many believe should have led to a decision that MLM is per se an unfair and deceptive trade practice, and therefore illegal. The end result is an 800-pound gorilla in the Commission chambers. Thousands of MLMs have sprung up since 1979, resulting in losses of literally hundreds of billions of dollars suffered by hundreds of millions of participants worldwide.
Perspective of a former SEC official – and of a former Assistant AG for Wisconsin.
Gary Langan Goodenow, Sr., a former senior trial attorney in the SEC enforcement division, wrote:
The FTC, not the SEC, first went to court to combat the “serious potential hazards of entrepreneurial chains” and urged the “summary exclusion of their inherently deceptive elements, without the time-consuming necessity to show occurrence of the very injury which justice should prevent.” FTC In Koscot Interplanetary case, the FTC enjoined a promoter from “offering, operating, or participating in, any marketing or sales plan or program wherein a participant is given or promised compensation for inducing other persons to become participants in the plan or program”.
This FTC opinion had nothing to do with the federal securities laws. The holding was based on common law fraud concepts on the theory that such programs will inexorably fail because eventually there are not enough people on earth to support it.
[Note by Jon Taylor: This reasoning resonates in decisions today, since it has legal precedence, even though the reasoning is based on a weak understanding of how markets work. In Chapter 3, I explained the difference between total saturation and market saturation. In a town of 100,000 people, the notion of total saturation of 100,000 distributors would be absurd. But the market could be said to be saturated with 10 or 20 distributors, after which adding more distributors would mean less and less opportunities for them to thrive in the market because the market is too saturated. So market saturation could be said to exist, and market saturation can happen very quickly in a population, especially so in MLM, since hundreds of MLMs are now saturating the market with such schemes.]
The FTC test for determining what constitutes an illegal pyramid scheme holds that they “are characterized by the payment by participants of money to the company in return for which they receive the right to sell a product and the right to receive in return for recruitment, rewards which are unrelated to sale of the product to ultimate users.” The key concept is the “unrelated” idea—that the program is so divorced from economic reality or mercantile endeavor, as to be merely a chain letter passing around money.
The FTC later recognized the distinction of “saturation” between legitimate pyramid structured programs and illegal pyramid schemes. In 1979, the FTC determined that the MLM program operated by Amway was neither fraudulent nor illegal. The FTC found that Amway Corporation was essentially structured as a pyramid, not a Ponzi scheme, with an ever increasing downline privity of recruits. Nonetheless, the FTC determined that the plan did not constitute an illegal pyramid because certain Amway rules ensured a focus on retailing merchandise over pyramiding of members.
This effort at retailing, the FTC found, meant that the program would never be ‘saturated’ with members sending’ money to each other until there were no further people to join. These “anti-saturation” rules saved Amway from the ambit of the anti-Ponzi and pyramid scheme rules, not the specific structure of the enterprise. So, an Amway-like program that happened to pay participants a small fixed fee for bringing in recruits could constitute a “pyramid” but not a scheme to defraud because saturation will not occur.
Insights from Bruce Craig, former assistant AG in Wisconsin.
Bruce A Craig, an assistant attorney general for the State of Wisconsin Department of Justice has questioned the logic of not considering Amway an illegal pyramid scheme. His comments deserve serious consideration because, during 30 years of service he has prosecuted a significant number of pyramid scheme including the Koscot case. In a letter to Robert Pitofsky, the FTC Chairman who drafted the original Amway opinion, Craig noted that since the Amway decision, “investments in pyramid type offerings have resulted in billions of dollars over the years.” He highlights that “the FTC Amway decision has created a good deal of uncertainty in respect to private and public legal efforts to deal with abuses of pyramid plans” that “will only increase with the onset of marketing over the Internet.”
I certainly agree. Every time I prosecuted a pyramid or Ponzi for the SEC, the first words out of the founder’s mouth were: “I set this up just like Amway.” Craig has urged the FTC to reexamine the aspects of Amway that make it legal because “the premise of ‘multilevel vs. pyramid’ may well represent a distinction without a difference.” I believe Craig is correct when he asks “whether these exculpatory factors can be effectively evaluated in time to prevent losses to the consuming public.” In my experience, the fraudsters know that; and that is why, unfortunately, when the SEC Enforcement Division comes in with an asset freeze, the money is long gone.
Pitofsky tried to redeem himself for his part in the Amway decision.
In 1995 Clinton appointed FTC Chairman Robert Pitofsky [D], who had noted the meteoric rise in “business opportunity” frauds about which consumer complaints surged in the 1980s and early 1990s, and in April 1995 Pitofsky began soliciting public comments about the possible inadequacy of the Franchise and Business Opportunity Rule (the “Franchise Rule” or “The Biz Op Rule”). He described the biz op problem in a February 1996 warning to consumers thusly: “Lured by deceptive promises of independence and easy income, many would-be entrepreneurs are jumping into the arms of con artists who claim: ‘we are not just selling you a business, we put you in business'”, further calling the problem “epidemic.”
Still, MLM misrepresentations continued unabated. But it would be disingenuous to be critical of Pitofsky as being too soft, as he proved quite the pitbull for the remainder of his six-year term (likely to atone for his disastrous decision as the administrative judge in the 1979 Amway case) until Republican President George Bush replaced him with Timothy Muris in 2001 – after which new MLM prosecutions came to a virtual halt.
The MLM industry did note the pattern under Pitofsky: MLMs were ambushed, with the FTC often gaining injunctions that froze assets as it fined the targeted MLM for FTC violations, often to the point of bankruptcy, and without the MLM ever admitting guilt. Pitofsky successfully applied the FTC Act and Franchise and Business Opportunity rule to end many MLMs and like businesses, including promoters selling “franchises” of vending machines, pay telephones, medical billing biz ops, and envelope-stuffing schemes.
References: In the Matter of Amway Corp., 93 F.T. C. 618 (1979)  For more information on this legislative history, read the treatise by Robert Fitzpatrick, President of Pyramid Scheme Alert, titled “Pyramid Nation – The Growth, Acceptance, and Legalization of Pyramid Schemes in America.  These figures are based on DSA figures of direct sales worldwide. What the DSA calls “sales revenues” may be sales revenues for the companies, but since 99% of participants lose money, they represent losses for the participants, nearly all of whom are victims.  Mr. Goodenow, a former senior trial attorney in the SEC enforcement division, is licensed to practice in the Florida and the District of Columbia. This quotation is posted on Dr. Stephen Barrett’s MLM Watch web site at –