In this groundbreaking new book, former federal prosecutor Pamela Barnum investigates the often-criticized and misunderstood profession of network marketing. She combines insight learned from twenty years in the criminal justice system with observations made as a professional network marketer. The information is delivered with the wit and humor you would expect from someone who transitioned from a career of Breaking Bad to a profession focused on Breaking Busy, and will provide you with a path to the freedom to build your own career.
"I don't even know how to bake," I said.
"You don't have to know how to bake!" Patti stood beside my desk, talking in a half-confidential voice. It was 1997, and she was the only woman in the drug unit. "You just come as my guest and say you want in. Look, you said you want to work undercover, so here's your chance! And it'll be easy. Come on. I need a new Muffin Club member for my case."
I was still working as a uniformed officer at the time but I was very interested in working undercover in the drug enforcement section. I knew that I would have to pay my dues to become an undercover officer but I thought it would be more Charlies Angels and less Martha Stewart.
The Muffin Club-yes, that's what it was really called-was a Ponzi scheme. Most Ponzi and pyramid schemes work the same way: they pay off old investors with the money from new investors. Both schemes are seductive because they promise a high rate of return in a short period with little or no work, a version of the something-for-nothing promised on late night infomercials.
To be a part of the Muffin Club you had to give a "gift" of $5000 cash which was brought to the meeting in a muffin tin. Then you invited friends to join the club and gift their $5000. When new people joined the club, you moved up a spot on the list. When your reached the top, you walked away with your "gift" of $40,000, or eight times the money paid into the club. Once you had your 'muffins' aka $40k, the remaining muffin ladies moved up a space on the list and waited their turn to be crowned Muffin Queen. I can't recall exactly what they called her but I called her the Muffin Queen.
The lead muffin lady, who was hoping to be crowned Queen, explained to us new muffinettes that if you gave the money in a muffin tin as a "gift" no crime was committed. An added bonus was that you did not have to pay tax on that money because it was a gift. This suburban home-maker was so convincing while she offered a smorgasbord of fraud, tax-evasion, and muffins. It was like a James Bond movie starring Julia Child.
"Sounds good to me." I said as I sat cross-legged on a floral sofa that looked a lot like my grandma's. This was not what I expected my first undercover job to be like. I thought we'd be sitting around cocaine and scales in a condemned high-rise, not sipping tea and admiring muffin tins in suburbia. Now don't get me wrong, these were nice ladies; they looked and acted like they would be baking actual muffins and donating them to charity. But they all had that something-for-nothing mentality that attracts people to pyramid schemes. I want to share a little bit of legal advice with you: If it sounds too good to be true, it likely is.
When I first started considering network marketing I thought the same thing about it: It seemed too easy to be legitimate. How could ordinary people be making extraordinary money? They didn't have exceptional business skills or an MBA, so it must be a scam. The hype and hoopla splashed over social media was too much to handle. Big checks, fancy cars, and "working" from the beach? Come on, you're either at the beach, or you're working. And who other than Jackie Moon cashes those big checks anyway? Maybe you've felt the same way so you didn't bother to investigate any further. Your skeptical Spidey senses told you to stay away and that's exactly what you did.
I was very skeptical until I put my policing and legal skill set to work. I had to find out the truth behind this network marketing pyramid thing everyone was talking about. So, I went right to the source materials: government websites, including the US Federal Trade Commission (FTC) and the Canadian Competition Bureau, as well as consumer protection agencies. Although there are some variances between countries, the essence of the laws are very similar.
Essentially, legitimate network marketing companies have real products or services that they sell to real people and the distributors are paid on multiple levels, hence the name. At the core of the business model is the premise that commissions are paid for actual sales of real products or services to real people, not for recruiting people into the plan 1. A pyramid scheme, on the other hand, involves making money from recruiting people, like the muffin club, not from retailing real products or services to customers, like other legitimate businesses.
Per the FTC:
If the money you make is based on the number of people you recruit and your sales to them, it's not. It's a pyramid scheme. Pyramid schemes are illegal. 2
In other words, if you're just recruiting people to become distributors and you're only selling products to other distributors, not to any retail customers, it is a pyramid scheme. Real customers are a very important part of network marketing. There are several FTC staff advisory papers, legal dicta (a fancy legal term meaning a statement of opinion considered authoritative, not binding) and factums (written legal arguments) that try to define what a customer is as they relate to network marketing. Although there is no legal definition of customer in network marketing, it is inferred from these sources that a customer is a real person, an end-user, that buys the product or service regardless of the compensation plan. In other words, a customer is someone who buys the product or service because they want it, not because they want to participate in a compensation plan. Legally, network marketing companies are required to generate significant revenue from customers outside of the compensation plan. Most companies have a large customer base of eighty-percent or more.
Here's an example to clarify this point. Let's imagine a network marketing company, called Acme Water and they sell amazing bottled tap water. Distributors can buy the water for $100 per unit and can then retail it for $120, earning a $20 profit. Sounds great, right? Not so fast, Serpico. Clearly, there would be little to zero demand for expensive tap water and people who are not a part of the business would not buy the water. As a result, Acme distributors would be forced to focus on finding other distributors and encourage them to buy the over-priced tap water, and then encourage them to find people to do the same. This would be a pyramid scheme because the end-game is to recruit, not to sell viable products.
Many pyramid schemes operate under the guise of gift-giving, or investing to con people, like the Muffin ladies. Some unscrupulous fraudsters have created network marketing companies to mask their pyramid schemes. These companies have a sham product or service with no independent value or they are sold at an inflated cost. The money is made from recruiting others, not from selling products or services demanded by the marketplace.
So yes, some network marketing opportunities are pyramid schemes in disguise. Just like some investment opportunities are Ponzi schemes. Just like some stock market and real estate deals are fraudulent scams. Unethical people will take any legitimate business and twist it to serve their criminal purpose, but that doesn't make the business model fraudulent. Imagine if all investments were considered Ponzi schemes after Bernie Madoff was convicted of orchestrating the biggest fraud in US history. Madoff was a well-respected financier who convinced thousands of investors to hand over their savings, falsely promising a profitable rate of return. Madoff managed to fly under the radar, despite complaints to the SEC, because he was a respected and active investor. Like anything in life, some things are legitimate and others are not. The important thing is to understand and know the difference before you get involved.
What about those network marketing companies that charge membership fees, surely they must be pyramid schemes? Why should you have to pay a membership? That sounds fishy. But think about Costco, or the membership fee that my favorite furniture store, Restoration Hardware, charges. It's quite common to pay a membership fee that entitles you to purchase products at wholesale or discounted prices. Most network marketing companies charge a membership fee that allows people to purchase a product or service at a discounted or wholesale price. This is completely legal and common in many businesses.
The FTC has regulatory authority over many U.S. business activities, including network marketing. The FTC has been instrumental in determining the business standards used by legitimate network marketing companies. Anti-pyramid laws and statutes are very broad in nature so that they can cover all the possible variations of illegitimate schemes that people come up with. What legislator could have ever imagined a "Muffin Club"?
The most often cited definition of a "pyramid" scheme is found in the FTC's decision, In the Matter of Koscot Interplanetary, Inc. 3.The FTC's decision in Koscot provided a broad definition of unlawful pyramid schemes; the basic test was that a pyramid rewards recruiting alone "unrelated to the sale of product to ultimate users" through headhunting fees and inventory loading. Inventory loading happens when a distributor (salesperson) is encouraged to stock up on products they don't need to meet sales goals or bonuses.
There is currently no federal statute in America that clearly defines a pyramid scheme. However, decisions made by the FTC and Federal Courts have provided guidance that can be challenging to interpret because they are often case-specific, meaning the decision they make applies to the specific company...