In this article, we will be examining what the concepts of multi-level marketing (“MLM”), Ponzi- and Pyramid Schemes are, with the aim to equip readers with sufficient information to draw a distinction between them.

  1. WHAT IS A PYRAMID SCHEME?
  • In South African law a pyramid scheme is defined in Section 43(4) of the Consumer Protection Act, No 68 of 2008 as follows:[1]

(4) An arrangement, agreement, practice or scheme is a pyramid scheme if—

(a)      participants in the scheme receive compensation derived primarily from their respective recruitment of other persons as participants, rather than from the sale of any goods or services; or

(b)      the emphasis in the promotion of the scheme indicates an arrangement or practice contemplated in paragraph (a).

  • In a Pyramid Scheme, money is generated by current investors who are actively recruiting new participants/potential investors to join in the business by having them pay joining/administration fees in order to embark on the so-called business venture. The joining or administration fees are then used to pay earlier investors.[2] New recruits who have invested in the scheme are in turn encouraged to recruit additional people to share in the funds.[3] So the cycle continues, allowing the business to expand, and over a period of time a hierarchy of investors, resembling a pyramid-like structure, is formed.[4] This type of scheme requires a steady influx of revenue to survive.[5]
  • The National Consumer Commission has cautioned potential investors against the illegality of such investments as well as the fact that Pyramid Schemes are by no means sustainable.[6] Pyramid schemes are guaranteed to fail as soon as the pace of recruiting new investors slows down and the flow of funds starts drying up.[7]
  1. WHAT IS A PONZI SCHEME?
  • A Ponzi scheme, named after the infamous swindler Charles Ponzi,[8] is regarded as an investment scam that is not only fraudulent in nature but also sets out to entrap vulnerable people into investing their hard-earned money in what they believe to be a legitimate business opportunity. Promoters/recruiters of such investment scams have the ability to be very persuasive and manipulative in putting potential investors’ concerns and fears to rest, giving them no reason to doubt or even question the legitimacy of the business they intend to invest in.[9] Potential investors are promised excessively high and unrealistic returns with little or even no risk attached, over a short period of time, in exchange for their investment funds.[10]
  • Ponzi schemes ultimately rely on new investors to be recruited in order to continue to provide returns to its older investors and ensure that there is a continuous flow of revenue.[11] Should there be no new investors, the flow of income required to keep the operation afloat ceases and ultimately the scheme will start to collapse.
  • Just as with a pyramid scheme, a Ponzi scheme is guaranteed to fail and is ultimately not regarded as a legal business venture.
  1. WHAT IS MULTI-LEVEL MARKETING (“MLM”)?
  • MLM is a well-known strategy and business model used by various direct sales companies to distribute their products to their customers. The uniqueness of this strategy lies is the fact that the products can only be acquired from sales representatives, who happen to be investors or active participants in the company.[12]
  • The technique used is specifically designed to ensure that the products being marketed are not easily available online or in-store, but rather encourages interested parties to directly engage with a sales representative. The sales representative will usually advertise his/her products on various social media platforms and will simultaneously attempt to entice interested parties into joining the company to generate income for themselves.
  • The multi-level aspect comes in when the representative of the company is able to recruit and train interested parties to become representatives themselves who will then also sell the company’s products in exchange for an incentive. These recruits will make their own sales and ultimately start to recruit other interested parties, which ensures their incentive and also sees to it that the person above them (i.e. the person who initially recruited him/her) earns a commission. So the cycle continues, allowing the business to expand exponentially and to simultaneously generate a higher income through the sale of products and the recruitment of new participants.
  • MLM business models are legitimate in that they:[13]
  • Do not charge up-front joining or investment fees from new members/recruits;
  • Do not require their sales representatives to buy large amounts of non-returnable inventory; and
  • Provide ways to help their sales representatives earn incentives from selling products directly to consumers.
  • If the source of earnings derived from a person’s involvement in a MLM is predominately from converted product sales, it is indicative of a proper MLM business model. If, on the other hand, earnings are predominantly derived from the recruitment of new members/participants, without a connection to product sales, indications are that it may not be a legitimate MLM business model, but rather a Pyramid Scheme.

If you are currently considering investing your hard-earned money into what you believe to be a “once in a lifetime opportunity” or have interest in joining a MLM, feel free to contact one of our qualified attorneys to assist you in evaluating the legitimacy and legality of such investment.

 

Louis Stroebel                                                             Heidi Wagner

LLB; LLM (Import/Export Law)                                    BCom (Law); LLB

Director                                                                        

Corporate and Commercial Law                        

E-mail: Lstroebel@sstlaw.co.za                             

Phone: 012 361 9823

 

[1] Section 43(4) of the Consumer Protection Act No 68 of 2008.

[2] “How to spot fake investment and Ponzi schemes in South Africa” Businesstech, 10 March 2018

(https://businesstech.co.za/news/finance/229361/how-to-spot-fake-investments-and-ponzi-schemes-in-southafrica/#:~:text=In%20South%20Africa%2C%20these%20schemes%20generally%20meet%20the,are%20more%20existing%20investors%20than%20new%20investors%2C%20). Accessed on 22 October 2020.

[3] “Ponzi Schemes” Find law, dated 24 April 2019 (https://criminal.findlaw.com/criminal-charges/ponzi-schemes.html).

[4] “Easy Come, Easy Go: The Myth and Law Behind Pyramid/Ponzi Schemes in Zimbabwe”  Muvingi Mugadaze, dated 20 October 2020 (https://www.mmmlawfirm.co.zw/easy-come-easy-go-the-myth-and-law-behind-pyramid-ponzi-schemes-in-zimbabwe/).

[5] “Ponzi Schemes” Find law, dated 24 April 2019 (https://criminal.findlaw.com/criminal-charges/ponzi-schemes.html).

[6] National Consumer Commission (https://www.thencc.gov.za/sites/default/files/media/Pyramid%20Scheme%20Final.pdf).

[7] National Consumer Commission (https://www.thencc.gov.za/sites/default/files/media/Pyramid%20Scheme%20Final.pdf). Accessed on 22 October 2020. ; “Ponzi Schemes” Find law, dated 24 April 2019 (https://criminal.findlaw.com/criminal-charges/ponzi-schemes.html)..

[8] Charles Ponzi Biography dated 26 June 2020 (https://www.biography.com/crime-figure/charles-ponzi).

[9] “A Legal Analysis Of The Regulation Of Pyramid/ Ponzi Schemes In South Africa With Specific Focus On The Following; The R699 Car Deal Scheme And The Travel Scheme World Ventures” by Rivona Ajodapersad, dated January 2018.

[10]“Don’t Say Bye-Bye to Your Money” The South African Reserve Bank (https://www.resbank.co.za/AboutUs/PublicAwareness/Pages/Don%E2%80%99t%20say%20Bye-Bye%20to%20your%20Money.aspx).

Business Maverick, dated 14 May 2020 (https://www.dailymaverick.co.za/article/2020-05-14-a-ponzi-scheme-by-another-name-the-case-of-invest200/).

[11] “A Ponzi Scheme by another name: The case of Invest200” Business Maverick, dated 14 May 2020 (https://www.dailymaverick.co.za/article/2020-05-14-a-ponzi-scheme-by-another-name-the-case-of-invest200/).

[12] “Multilevel Marketing” Investopia, dated 13 September 2020  (https://www.investopedia.com/terms/m/multi-level-marketing.asp#:~:text=Key%20Takeaways%201%20Multilevel%20marketing%20%28MLM%29%20is%20a,questionable%20legitimate%20practices%20such%20as%20running%20pyramid%20schemes.)

[13] “Ponzi Schemes” Find law, dated 24 April 2019 (https://criminal.findlaw.com/criminal-charges/ponzi-schemes.html).