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February 2, 2004
Words from Georgetown
By QBlog in
I recently received a pdf copy of a 1972 article from "The Georgetown Law Journal" titled Pyramid Schemes: Dare To Be Regulated (pdf). The article examines several aspects of pyramid schemes, some of the problems resulting from such schemes and explores various remedies to the "growing problem."
The article was written by lawyers, for lawyers and can be a little difficult for non-lawyer types (like me) to digest. However, after repeated readings I began to get a better understanding of pyramid schemes and how they are defined by our U.S. legal system.
What are you saying?
Some who read this post will wrongly assume that I'm making some sort of statement about Quixtar or Amway. The truth is, I don't feel qualified to make any sort of claims about Quixtar and Amway as they relate to pyramid schemes or the linked article. Also, the article itself predates the famous 1979 Amway vs. FTC case and to my knowledge makes absolutely no mention of Amway (though I haven't thoroughly reviewed the footnotes). The primary reason for this post is help others understand the historical and legal background of pyramid schemes.
Below you'll find that I've directly quoted some interesting (to me) passages from the article. As always, I recommend that you read the quoted passages within their intended context by thoroughly examining the source. My comments appear in italics.
Definition of Pyramid Schemes
(page 1-2) Pyramid schemes, a relatively new sales concept, bear a striking resemblance to franchising, a widely utilized marketing technique. Pyramid schemes began to proliferate in size and number during the late sixties, the same period the franchising frenzy was sweeping the nation. Because franchising appeals to individuals with little capital and little or no business experience, not only have legitimate franchises grown but corporations which resemble franchises have been able to capitalize on franchising's popularity. Pyramid schemes, though they operate very differently from the ordinary franchise, are among this latter group.
Federal Trade Commission Action
(page 11) The FTC has alleged that various pyramid scheme operations violate section five by misrepresenting the potential earnings of investors, by false, misleading and deceptive representations regarding the commercial feasibility of the scheme for all participants, and by misrepresenting the earnings of existing members. The Commission also has alleged that the schemes fix wholesale and retail prices and bonuses, restrict sellers and distributors to certain company-approved outlets, and refuse to refund money to participants who have been induced to invest and have failed to recover their investment...
(page 12) ...While pyramid schemes may rely more on deceptive statements than on actual untruths to recruit new participants, failure to state material facts, overbroad representations, and creation of false impressions may constitute violations of section five...
...The FTC has alleged that the entire marketing program of pyramid schemes violates section five because it contemplates a virtually endless recruiting of participants in which later purchasers necessarily must lose their investment as the supply of new participants is exhausted.
FTC recognizes the reality of market saturation?
The article goes on to discuss the dilemma surrounding pyramid scheme regulation. One of the proposed remedies is to define pyramid schemes as a security and thus be regulated by the SEC. This is where it gets most confusing (to me) and spends a lot of time examining specific cases where the SEC became involved at some capacity.
SEC Action Against Pyramid Schemes
(page 35) If the structure of the scheme were altered to eliminate the elements isolated by Judge Skopil, investors would not need protection. If only experienced, knowledgeable investors were recruited, they presumably would be aware of the risks of the investments. If the investor's sales efforts were relied upon rather than promoter-run meetings, the investor might be found to have sufficient control over the venture to negate a security relationship. This, of course, would require that market saturation be controlled by setting a realistic limit on the number of franchises that could be sold in a given market area.
Again, the recognition of market saturation as a reality.