Earlier this year, at the request of the Federal Trade Commission and the states of Illinois, Kentucky, and North Carolina, a federal court halted an alleged pyramid scheme. Fortune Hi-Tech Marketing (Fortune), a national multi-level marketing company, was charged with operating an illegal pyramid scheme involving over 100,000 people. The founders were paid over US$40million in commissions and bonuses.

As in New Zealand, pyramid schemes are prohibited in the United States.

A pyramid scheme can take many forms, but they all share the following key characteristics:

  • an offer of a financial return based on the payments made by new recruits; and
  • the return is dependent primarily on the continued recruitment of new members, not from the sales of a product or service.

Pyramid schemes are an impossible system for continuing. Eventually, recruits will dry up, the scheme will collapse and a substantial percentage of participants will lose their money.

A preliminary injunction has been issued against Fortune, freezing Fortune's assets. It seems that the biggest pitfall of the multi-level marketing company was the way in which it paid commission to its representatives. In total, 85% of representatives’ commission paid was from recruitment of new members, and only 15% from profit sales. Also, the representatives had to pay an annual fee of US$250 and be on an autoship of US$130 - US$400 worth of products to remain in the scheme. While it is uncertain at this stage what the annual fee was for or whether payment was used to remain in the scheme were justifiable, the Court found that the mandatory fees paid by the representatives funded the commissions and bonuses paid out to the representatives.

This indicated that the primary purpose of the scheme was to recruit new members, not to offer members a financial return based on sales of products and services.

What to take away from this case

This case serves as a reminder of the need to design and maintain your compensation plan so that the return to members is primarily based on the sale of products to consumers and not recruitment bonuses. You also need to carefully consider whether any mandatory fees charged to the representatives to remain eligible to receive bonuses, are reasonable and justifiable.