This blog post is the companion post to the video: Short Course on Network Marketing: Q&A with Jeffrey Babener on Pyramid Schemes. Expert MLM Attorney, Jeff Babener, answers the question, when it comes to pyramid schemes, how do you tell the difference between one that’s legitimate and one that is not? How do compensation plans affect a company’s legality?

Jeff Babener: There’s a famous Supreme Court decision that where one of the Supreme Court judges was asked to comment on the definition of pornography. He replied that he couldn’t define it, but he knew it when he saw it.  Sometimes you need a metaphor to understand the difference between an illegal pyramid, headhunting, recruitment scheme and a legitimate MLM company.

This story is a good example of the difficulty in defining pyramid schemes. And, you may come to your own conclusion. Here is a metaphor that I use a lot to help people with the definition of pyramid schemes:

The metaphor is about a gentlemen, will call him Party #1, and he sells a case of canned tuna fish to Party #2 for $10. And, Party #2 sells it to Party #3 for $20, and Party #3 sells the case of canned tuna fish until it gets to Party #10, who buys the case of canned tuna for $500. And, Party #10 opens up the case of tuna fish and it’s rancid. It’s inedible.

He goes back to Party #9 and complains, “I bought this case of tuna for $500 and it’s rancid.” Party #9 tells him to take it to Party #8, and Party #8 tells him to take it to Party #7, and so on until Party #10 goes all the way back to Party #1 and says, “You’re the one who started all of this! I have a problem!”

And, Party #1 asks, “What’s your problem?”

Party #10 says, “Well, I bought this tuna fish, I opened it up, it’s rancid.
It’s no good!”

Party #1 asks, “Well, what’s your problem?”

Party #10 says, “Don’t you understand? It’s rancid. How am I going to sell

And, Party #1 says, “Well, you don’t have a problem.”

Party #10 answers, “What do you mean I don’t have a problem?”

And, Party #1 says, “You don’t understand, this tuna is for selling, not for

Interviewer: Everybody will make money on the product. What’s the problem?

Jeff Babener: Well, yes. Look at any MLM company out there, their whole menu: product, service, quality, price, and you ask if it is something that customers would really want to use. What is the answer?

Interviewer: And you make a good point. If you have people who are really consuming this product then you’re going to solve a lot of problems that you would otherwise might have with regulators.

Jeff Babener: That’s right. The product has to stand on its own in the marketplace.

Interviewer: A lot of companies have start-up kits that you can spend $100-$500 for a package of product, why are those legal if in fact they are? And I know that some of them are because I know you’ve reviewed some programs like this. Why would those be legal and Burnlounge would be illegal?

Jeff Babener: Virtually every major direct selling company that sells hard goods, such as skincare or vitamins, allow distributors to stock inventory for resale. And, the company pays commissions on that inventory. Of course, to safeguard against stockpiling in garages, the company has to have a buyback policy. The company will take back 90% of the inventory, it also generally will adopt what’s called a 70% rule that says don’t order more inventory unless you have used or sold it. As a general matter, all leading direct selling companies require only one thing to become a distributor and that’s the purchase of typically a $49.00, up to a $100.00, at-cost sales kit. Meaning, the sales kit is not for profit. No commissions are paid on it.

The sales kit clearly is a tool. It contains things that are necessary for the distributor to sell product. It may also provide for a year’s worth of ongoing updates on product and the opportunity. And, many of the MLM and pyramid statutes all recognize that is a legitimate expectation of a company that prospective distributors should purchase a sales kit. It is not a prohibited investment. However, mandatory purchases of products, up-front or otherwise, would be viewed as prohibited investments.

So, most distributors join a company and they pay fifty bucks for the sales kit or online access to sales materials. They’re offered the opportunity to jumpstart their business by buying inventory for resale. This has been going on for 50 years.

And usually it’s at a favorable price and it’s optional.

When distributors decide to buy into the program then the purchase of product is commissionable.

On the other hand, if they were buying training materials, sales tools, bumper stickers, protectors for your windshield, or t-shirts then those things would not be commissionable because those are not items that are destined to be sold to the general public.

When you think about MLM, and the enthusiastic aspects of MLM, is this anything that a distributor has to be concerned about? You go to conferences, people get excited. MLM it’s not like other businesses where you work 9 to 5 and nobody talks to anybody else. It is a different kind of business, isn’t it?

Interviewer: You’re absolutely right. This is a business of involvement.

Jeff Babener: This is a business of passion.

In quoting one the articles from, where I mention a quote from Eminem, “You need to lose yourself in the music.” You don’t just play the notes. You need to lose yourself in the music. And, that is true for every successful MLM company. Every successful distributor is that way because they have some passion or bond with the product, with the vision of company management/owners/leaders. That is an attribute of the direct selling industry.

For more information on pyramid schemes, visit the following links:

MLM Pyramid Schemes – Everything You Need to Know All in One Place

How to Tell if a Direct Selling Company is a Pyramid or a Legitimate MLM

Make sure to visit our blogs for the latest information on the direct selling industry: MLMLegal Blog Home and MLM Attorney Blog Home

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And, as always, visit, the best MLM resource on the web. The next Starting and Running the Successful MLM Company Conference will be here before you know it! On May 16th and 17th, 2013 we are hosting the MLM Conference for the 25th year! This is now our 64th annual conference (held almost consistently three times per year over the last 24 years). All executives/owners of MLM, direct selling, network marking, and party plan companies are welcome to attend. This is the original MLM Startup Conference, hosted and perfected by direct selling industry expert, MLM Attorney Jeff Babener. Call 503-226-6600 or 800-231-2162 to register. (Can’t make this event? Keep an eye out for our October and February conferences as well.)

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