The Fair Trading Act 1973 defines a trading scheme as anything which “includes any arrangements made in connection with the carrying on of a business, whether those arrangements are made or recorded wholly or partly in writing or not”. Trading schemes in and of themselves are not illegal and are widely used throughout many different commercial businesses. A trading scheme begins to cross the line from commercially acceptable to illegal if it satisfies the requirements under Part XI, Section 118 (1) of the Fair Trading Act 1973 for defining an illegal trading scheme. Fraudsters have generated enormous amounts of money through the application of illegal trading schemes on vulnerable people. This vulnerability exists due to a lack of understanding of the modern pyramid scheme, and the limited resources available through law for shutting down these illegal trading schemes. It is useful to know what constitutes an illegal trading scheme in order to identify it and to do so we must understand the three main forms of illegal trading schemes.
The term ‘Ponzi Scheme’ was named after Charles Ponzi in the 1920s. A Ponzi Scheme operates by convincing participants to provide funds, and then uses those investments to create the illusion of profit, thus driving more participants to invest. Charles Ponzi used the money he received from investors to create the illusion of profit by paying himself and a few others at the top of the chain from the new investments. Every time a new investment was made in the scheme, it was used to pay people at the top of the chain, creating the illusion that the corporation was turning a profit, when the corporation did not actually provide any real services or products. This illegal trading scheme became known as the Ponzi Scheme.
Moving forward in the timeline, Pyramid Schemes are arguably the most well-known term used for illegal trading schemes. A Pyramid Scheme typically functions as a ‘product-based pyramid scheme’, by providing participants with an arbitrary product to sell, while their main incentive is rooted in locating and obtaining new recruits with the hopes of receiving commission bonuses from these new recruits, in a chain which continues downwards through each recruit from the top of the pyramid-shaped scheme. However, minimal services or products are provided or sold, and the illusion of profit is created by using the funds received from new recruits which are disguised as investments, registration, initial membership fees, or something similar, to pay the individuals at the top of the chain. These fees may be recurring as well, disguised as an annual membership fee, to create an ongoing revenue for the individuals at the top of the pyramid.
Another form of the Pyramid Scheme is a ‘no-product pyramid scheme’, which has become mostly outdated and does not function as commonly as the more modern forms of illegal trading schemes. This scheme is usually detected very easily, as there are no products or services offered, and the participation fees mentioned above are the only way this specific type of Pyramid Scheme generates revenue.
The Multi-Level Marketing Trading Scheme
A Multi-Level Marketing (“MLM”) Trading Scheme is the most modern form of trading schemes and exists commonly today. The MLM functions through two methods of operation; the first is by providing participants with products to sell while providing the participants with a commission for each sale made. The second method is by following the same method mentioned above in the Pyramid Scheme, which is to incentivize current participants to recruit new participants by offering them a commission for every new recruit, as well as from the new recruit’s sales and further recruits, and so on and so forth. The MLM has taken the traditional Pyramid Scheme and disguised it by offering a second ‘legitimate’ method of profit for participants. MLM’s use the disguise of selling products to claim that they fall under the classification for direct selling industries, and attempt to avoid being classified as MLM’s at all costs. The issue becomes evident when it is revealed that the commission which is offered from actual sales of the products is so minimal that it pales in comparison to the commissions being offered through the method of recruiting participants, rendering it pointless for participants to actually focus on selling any products, when their largest source of revenue lies within recruitment of further participants and takes us right back to the Pyramid Scheme, where the sale of products/services is secondary, and profit is generated almost entirely from recruiting new participants.
The Appeal of MLM’s
There are numerous reasons as to why MLM’s and illegal trading schemes in general appeal to the general population, and the largest of all is the promise of a high return from a relatively small investment. MLM’s promise participants extravagant benefits and profits, while claiming that they will have minimal work to do. The recruiter claims that the participant will not be an employee, but rather a business owner, in charge of setting their own schedules and working for themselves. An illusion is created that these are opportunities cannot be missed, and with such experienced recruiters, it becomes difficult for the uninformed victims to look past what is being presented to them and see the underlying truth. There are many common misrepresentations and enticements made to potential participants, which are detailed further in The 5 Red Flags, a very useful consumer report created to assist people in identifying Pyramid Schemes and MLM’s by their common characteristics.
Trading schemes which operate in the same way as MLM’s, or Ponzi/Pyramid Schemes are illegal because they are designed to defraud participants, are not sustainable businesses, and they essentially do not provide any real service or product to consumers.
A common argument made by participants involved in MLM’s is that an MLM is not a Pyramid Scheme because it functions the same way that corporations do, with a CEO at the top and employees beneath it. This reasoning is incorrect, as the difference between a traditional business structure and an MLM is that the traditional business structure functions with a pyramid organizational structure (POS), while the MLM functions with a pyramid revenue structure (PRS). Revenue generated through the traditional business POS is received from independent consumers which are not participants of the business. The revenue generated in MLM’s is received from participants in the MLM, which are not acting as employees of the company. Eventually, the entire scheme will collapse on itself like a dying star, leaving participants at a net loss.
Applying the law
The disguise which the MLM functions under has caused issues in the law when it comes to revealing MLM’s as illegal trading schemes and shutting them down. There have been quite a few cases in the past decade where pyramid selling has been discovered and the schemes have been shut down. However, it appears that MLM’s remain predominant, as they are not as blatant as the other widespread forms of illegal trading schemes. Since it is so difficult to unravel MLM as an illegal trading scheme, the law can still apply by finding other ways to shut down MLM’s. The participants in MLM’s are commonly known not to compete with one another and have a set price for products which they cannot typically negotiate. This price usually can only be discounted if the consumer becomes a participant, and sells the products as well, becoming part of the scheme and receiving a discount for products purchased. As briefly mentioned above, the participants claim not to be employees, and to be business owners, which exempts them from statutory benefits. Additionally, this also means that the participants have performed price-fixing, which is another form of fraud in commercial law. By setting a fixed price on products amongst all participants within the MLM acting as “business owners”, it is quite possible that the MLM could be investigated for price-fixing, which may begin the process of shutting down the MLM once further evidence is found identifying it as an illegal trading scheme. There remain a few other methods which could be used to identify illegality within MLM’s, which could at the very least provide a difficult environment for MLM’s to function within. Ultimately, it remains that MLM’s are the most difficult illegal trading scheme to shut down.
It is very difficult to reveal corporations operating illegal trading schemes because of the methods employed by MLM trading schemes, and potential participants are manipulated into believing that they are being invited to a once in a lifetime opportunity by the trained recruiters. Existing statute does well to protect the participants of illegal trading schemes from prosecution even after they have become entrenched in the illegal trading scheme, as they are the largest group of victims affected by this form of fraud. Educating ourselves on identifying illegal trading schemes and their adaptations throughout history will prove to be an efficient method for preventing consumers from being taken advantage of to begin with while reducing an individual’s reliance on the law to recoup their losses after the fact.
Table of Legislation:
Competition Act, 1998 c. 41
Directive 2005/29/EC concerning unfair business-to-consumer commercial practices in the internal market  OJ L149
Fair Trading Act, 1973 c. 41
The Consumer Protection from Unfair Trading Regulations, 2008 No. 1277
Table of Cases:
Case 667/15, Loterie Nationale – Nationale Loterij NV van publiek recht v Adriaensen  Bus. L.R. 609
R. v Godley (William)  EWHC 2343 (QB)
White v Serious Fraud Office  EWHC 446 (Admin)
Table of Articles & Journals:
Conway L, Pyramid Selling and Similar Trading Schemes (House of Commons Library, 1996)
Mugarura N, The use of anti-money laundering tools to regulate Ponzi and other fraudulent investment schemes (Journal of Money Laundering Control, 2017)
Sarker R, Pyramid selling (Company Lawyer, 1995)
Sheppard D F, South Africa: trade practices regulations – pyramid selling scheme (European Intellectual Property Review, 1990)
Stuber W, Brazil: virtual currencies – pyramid financial schemes (Journal of International Banking Law and Regulation, 2014)
Taylor J M, The 5 Red Flags Five Causal and Defining Characteristics of Product-Based Pyramid Schemes, or Recruiting MLM’s (Report for Consumers, Regulators, and Legislators, 2006 edn)