Utah Legislature Passes Pyramid Scheme “Safe Harbor” Amendments

Robert Fitzpatrick, Robert L. Fitzpatrick
March 1, 2006

In Utah, chain-selling schemes have become a leading export. With a new bill amending Utah’s Pyramid Scheme Act, these schemes will have state protection in Utah, similar to the de facto protection that the government of Nigeria provides to the notorious Nigerian scams.

On February 17, 2005, the President of the Utah State Senate signed a bill (SB 182—“Direct Sales Amendments”) that effectively nullifies Utah’s Pyramid Scheme Act, at least as it applies to the most damaging of all the classes of pyramid schemes—product-based programs that have proven to cause financial loses to over 99% of participants. This extraordinary loss rate has been documented in at least four separate independent investigations. The financial harm is mathematically predetermined by the scheme’s multilevel and recruitment based structure and operation.

These schemes have proliferated in Utah to the point that the state holds a commanding lead over all other states in per capita sponsorship of multilevel marketing (MLM) programs, with pay plans that primarily reward recruitment of participants as customers and in which relatively few products are legitimately sold on a retail basis to end users. In fact, Utah County has the highest concentration of MLM schemes, with no county in the country holding even a close second place. The vast majority of victims of Utah-based schemes are not in Utah, but in other states and countries. Approximately 85% of revenues of Nu Skin, for example, which is one of the nation’s largest MLM’s based in Utah, are from Asia. If Utah Governor Jon Huntsman, Jr., signs the bill, victims will only have protection against the classic, no-product pyramid scheme, such as the “gifting scheme”—which has never been a Utah-based export.

At hearings on SB 182, a Nu Skin company spokesperson stated claimed that the “direct sales” (actually “MLM”) industry brought in four times as much revenue as the ski industry, for which Utah is famous—and which was highlighted at the 2002 Winter Olympics. This may be good for Utah in purely monetary terms, but ignores the financial harm to people in other states and around the world caused by the Utah-based schemes. It also ignores the further damage caused to Utah’s reputation—or is already being called the “scam state”—for its affiliation with pyramid selling schemes.

Washington-Based DSA Lobbies for Changes in Pyramid Laws

SB182 was initiated by the Direct Selling Association (DSA), which has been essentially taken over by the network marketing (or MLM) industry and has been lobbying from state to state and even in Congress to take the teeth out of laws against pyramid schemes—at least as they apply to product-based programs, where investments in the schemes are laundered through what appear to be legitimate product purchases. DSA’s aim is to protect their member MLM companies from being prosecuted for violating laws against pyramid schemes.

DSA membership has included some of the most notorious of MLM-related pyramid schemes—including Equinox International and Trek Alliance [1], which were prosecuted and shut down by federal and state (other than Utah) prosecutors. DSA lobbyists and communicators go to great lengths to reclassify multilevel or endless-chain selling programs as legitimate “direct selling” programs, even though with the DSA-influenced legislation, little if any direct selling is required. Indeed, most of the MLM companies in DSA engage in little actual “direct selling.” The products of the member companies are purchased primarily by newly recruited sales representatives (“distributors,” “consultants,” etc.) in an endless chain of recruitment. The recruits seldom resell the goods to non-participating end users, but instead seek to recoup their investment by recruiting other “downline” participants in the chain who will buy goods and services to “play the game.”

The DSA has persuaded some regulators, legislators, and many in the media and the general public into believing that these chain-selling schemes are profitable and viable, despite their verified record of causing 99% loss rates among participants. In Utah, SB 182 passed both houses of the legislature with only a handful of dissenting votes. Among other tactics, the DSA has engaged in the web version of identity theft, registering alternate name extensions of web sites critical of their programs and then redirecting web surfers to the DSA site and its skewed pyramid-scheme definition that exempts MLM’s.

Why Most MLM’s Should Be Considered Pyramid Schemes.

Recent studies demonstrate that product-based (MLM) schemes are the worst of all pyramid schemes by virtually any measure—loss rate, aggregate losses, and number of victims. Four separate studies by three independent researchers (not connected to the DSA or any MLM) have established that the percentage of participants who lose money is over 99%—even as much as 99.9% in one report using the MLM companies’ own published statistics. The loss-rate of no-product pyramid schemes, such as the infamous “Women Helping Women” and other “gifting schemes” that recently swept the country, is approximately 90%. So one has at least ten times the likelihood of gaining a profit from these obvious scams (which are illegal under SB 182) as from a “recruiting MLM” program (which rewards recruitment over actual sales of products to end users) ”—which gets a pass under SB 182.

Studies on the (lack of) profitability of MLM programs are available at Truth on MLM (follow links from the MLM research and numbers pages) and Pyramid Scheme Alert Web sites. The main deception common to product-based pyramid schemes is the presentation of the MLM as a “business” or “income opportunity,” while the odds of profiting are so abysmally low. This would be analogous to placing signs above gaming tables in Las Vegas with these words in big and bold type: “Business Opportunity” or “Opportunity of a Lifetime.” As with gambling, MLM is an opportunity only for the “winners.” In MLM, the “winners” are those who are pre-positioned at or near the top of their respective pyramids—or who by employing aggressive and misleading recruitment tactics manage to recruit a large and continuously churning downline of participants, over 99% of whom lose money.

As harmful as recruiting MLM’s may be, few participants in these programs appear to realize the harm they are causing. And most of the victims are tactically led to believe their losses were “their own fault.” We find even top officials in extreme denial about the verified losses their programs are causing. If there is a villain, it is the inherently uneconomic nature of all endless chain selling schemes, which produce the losses by their design and promotion.

Utah Has Found a Substitute for Gambling Used by Other States As a Source of Revenue

Many MLM participants engage in compulsive behavior similar to gambling addiction. Compulsive MLM “addicts” have been called “MLM junkies.” Indeed, we see MLM as problematic as gambling—even worse, in some respects. Legalized gambling in the U.S. is regulated, but MLM typically is not—or not enforced. Also, persons who gamble usually know they are gambling, while promoters of MLM programs are allowed to offer “permanent income” or “residual income that will free you from having to work—ever again.” “Time freedom” is the mantra at MLM opportunity meetings. Yet, strangely, Utah is only one of two states with legislatures that stand four-square against gambling, even though it could enhance state revenues. But statistics from leading MLM companies show a loss rate among MLM participants far worse than for playing craps or roulette in Las Vegas.

In a survey of all the tax preparers in one Utah county where 6% of the population participates in MLM, there were no MLM participants in 2002 who reported a profit in any recruiting MLM. However, during that same year, over 300 people had reportable profits from gambling. In Utah County, where MLM is highly concentrated, some top-of-the pyramid promoters were making as much as a million dollars a month! So the lack of revenue from any state-sponsored lottery is more than replaced in Utah by revenue from out-of-state victims of Utah-based endless chain MLM schemes. At the legislative hearings, SM 182 sponsors stressed how much revenue Utah made from these MLM companies, as well as from the jobs that support their operations. No mention was made of the millions of victims worldwide who have suffered losses from the recruitment campaigns of their promoters. Among some consumer activists, Utah is referred to as the “scam capital of the world”—usually in reference to product-based pyramid schemes. SB 182 gives that reputation statutory support. Nu Skin, the largest of Utah’s chain-selling schemes, enjoys the distinction of having been fined by the FTC twice for more than one millions dollars for making deceptive income or product claims to recruits.

How SB 182 Weakens Utah’s Pyramid Scheme Act

The existing Pyramid Scheme Act (Title 76) specifies that in a pyramid scheme, “a person gives consideration to another person in exchange for compensation or the right to receive compensation which is derived primarily from the introduction of other persons into the sales device or plan rather than from the sale of goods, services, or other property.” This suggests that if compensation is derived from sales that are primarily to downline participants recruited into the scheme and not from legitimate retail sales by the participants to end users, it is an illegal pyramid scheme. SB 182 turns that language around by specifying: “‘Compensation’ does not include payment based on the sale of goods or services to anyone purchasing the goods or services for actual personal use or consumption.” This would include newly recruited participants who buy goods to become eligible for commissions they mistakenly believe they will earn. In other words, the only money that would count in deciding whether a scheme is illegal would be money spent purely for joining the scheme. As long as products are involved, MLM would be effectively exempted.

Under this wording, the workings of a product-based pyramid are magically legalized. The purchase of goods and payments of fees serve as “consideration” that the participants pay for joining. For making these payments, the participant gains “the right to receive compensation which is derived primarily from the introduction of other persons into the sales device.” Based on the recruitment of new participants and their subsequent purchase of goods and services to “play the game,” the recruiter is compensated with commissions and bonuses. No real customer base is established. These “incentivized” sales to newly recruited participants are the engine that drives the schemes. The scheme can be a closed system at fixed prices in which the currency for joining and the compensation paid out for recruiting are based primarily on the participants’ own purchases of the scheme’s products.

This kind of scheme violates Utah’s existing Pyramid Scheme Act, but is “perfectly legal” with the amendments in SB 182. The wording actually facilitates the harmful consequences that the existing law sought to prevent, i.e., the losses suffered by 99% of the participants who are doomed—by the scheme’s design—to lose money.

Closed-Door Maneuverings: What Happened at the Legislative Hearings

SB 182 was “protected” from public scrutiny until the very last day for “numbering,” then rushed to committee hearings in two days, obviously to limit input from experts and consumers who could be affected. The bill was misrepresented to both the Senate and the House as providing added protection to consumers against the worst schemes. In fact, the bill has the opposite effect, as explained above, by using the word “anyone” instead of “non-participants.”

Utah’s top law enforcement official, Attorney General Mark Shurtleff, supported the bill. He argued, contrary to the facts, that one of the distinguishing features of illegal pyramid schemes was the lack of legitimate products. This may have been a valid argument 30 years ago when product-based schemes were less common. Since then, however, the largest and most harmful of all pyramid schemes that have been prosecuted—such as Equinox, Trek Alliance, and International Heritage—offered products or services as their form of “paying consideration.” The existence or quality of the products is, today, irrelevant to the analysis. Some of Shurtleff’s top contributors were the very companies that would benefit the most from SB 182 [2]. Their operations would no longer violate the state’s anti-pyramid scheme statute.

Both the present and former directors of Utah’s Division of Consumer Protection supported the statute change. Why would they favor SB 182? One possibility is that they would no longer have to endure criticism for failure to enforce the existing statute. The current law takes aim at any MLM in which few products are ever retailed to end-users. The products are purchased almost solely by a revolving door of new recruits, resulting in an endless chain-recruitment scheme, not a genuine business of “direct selling.” Many such schemes operate with impunity in Utah today. SB 182 not only shields the MLM companies from future prosecution; it also takes the Division of Consumer Protection “off the hook.”

Additionally, at the House committee hearing, the position of the Federal Trade Commission [1] was blatantly misrepresented by the DSA representative on this issue—with no opportunity to correct the falsehoods before the committee voted.

A co-sponsor of the bill expressed his concern that he “had a problem with protecting people from themselves.” So why have consumer protection laws or anti-fraud statutes at all? It would be interesting to see if he would take the same stance if he had lost most of his money in the Enron or WorldCom debacles. Would he blame himself for having made the investments he was told were solid?

Consumer Protection Is Endangered

Make no mistake about it, SB 182 will undermine consumer protection. Bruce Craig, former Assistant Attorney General in Wisconsin, warned in a letter to Utah Senators:

This [SB 182 bill] is a package deal set up by those who want to legalize pyramids . . . . If you want to pass the bill, do it. However, you shouldn’t be allowed to pretend that you were unaware of the adverse economic consequences that will be visited upon Utah citizens [and outsiders] by this legislation. Having spent 30 years litigating consumer pyramid cases, and dealing with related legislation, I am familiar with the legal deficiencies of SB 182, the significant damage caused by pyramids, and how some legislation is passed . . . The only remaining matter for consideration is whether anyone will hold the Utah legislature accountable for what is about to happen. This may well be the case only after a scandal or some public outcry.

And Dr. Jon Taylor of the Consumer Awareness Institute (a Utahn and and one of our advisors) lamented after his hard-fought efforts to reveal the misrepresentations that were used to promote SB 182:

Many of our pioneer ancestors sacrificed their all to establish settlements here in the Rocky Mountains where they could be safe to practice their religion without the constant persecution they left behind. One of the primary tenets of these pioneers was: “We believe in being honest . . . ” (Article of Faith #13)

I fear we have been corrupted and deceived into accepting pyramid schemes as a primary export to enrich our coffers. Passage of SB 182 deeply saddens me. My pioneer ancestors would not have been pleased to see what is happening here.

If you agree that SB 182 is a bad idea, please ask Utah Governor Jon Huntsman, Jr., to veto it. Letters, faxes, or e-mails should be sent to him c/o Mike Mower, Legislative Liaison, Utah State Capital Complex, Suite E220, P.O. Box 142220, Salt Lake City, UT 84114. (Fax: 801-538-1557 or 801-538-1344) If Utah really wants to protect consumers, it should require MLM companies to (a) derive most of their income from retail sales to end users and (b) disclose how much (or how little) new distributors are likely to earn.

  1. One of the most notorious pyramid schemes of all time was Equinox International, a fraudulent MLM pyramid scheme (among others) that was a member of the DSA, which is the main lobbyist for SB 182. Equinox was a classic recruitment-based MLM in which the salespeople themselves were the primary customers of the scheme, with little or no legitimate retail selling taking place. It took eight states (Utah was not among them) working together with the FTC to shut Equinox down. For the purposes of definition in that case, the FTC wrote “‘sale of products or services to ultimate users’ does not include sale to other participants or recruits in the multilevel marketing program or to participants’ own accounts.” The word “anyone” now used in Utah’s SB 182 contradicts this usage and actually opens the door for the very abuse and fraud that Equinox was prosecuted for by the FTC. The buyers are led to believe they are buying a “business opportunity,” when in fact over 99% lose money, as subsequent statistical studies of large MLMs have documented.
  2. Mark Shurtleff received at least $72,000 from DSA (which initiated and lobbied for SB 182) MLM companies directly affected by the bill. The largest single corporate contribution was $50,000 from the MLM company Pre-Paid Legal (PPL), which is currently the subject of a “sweeping investigation” by the Connecticut Attorney General’s office and in recent months was ordered by a jury to pay over $9 million in damages to distributors who charged deception. PPL has also been accused of operating a pyramid scheme and sued by investors and distributors more often than any other MLM in the country. Nu Skin which contributed $5,000, has been fined twice by the FTC for more than $1 million for deception in income and product claims. Alticor, Amway’s parent company, is also a major contributor. Amway has been prosecuted and fined by the FTC for price-fixing and deception. A 2004 exposé on NBC Dateline revealed extensive misrepresentation of income claims. A decision by an FTC Administrative Law Judge laid down retail requirements on MLMs that SB 182 seeks to supercede.

Mr. FitzPatrick consults and writes about trends in manufacturer/distributor relationships. He founded and is president of Pyramid Scheme Alert, a consumer advocacy group focused on exposing and preventing pyramid schemes. He has served as an expert witness in several cases involving pyramid schemes and MLM companies. He writings include False Profits (a book about MLM deception) and “Pyramid Nation” (a booklet that laments the growth and “legalization” of pyramid schemes.)

This article was posted on March 1, 2006.